In re Mutual Fund Sales Antitrust Litigation, Civ. A. No. Misc. 103-73. Civ. A. No. 2454-72

• Decision Date: 14 December 1973
• Docket Number: 338-73,426-73.,Civ. A. No. Misc. 103-73. Civ. A. No. 2454-72
• Citation: 374 F. Supp. 95
• Parties: In re MUTUAL FUND SALES ANTITRUST LITIGATION. Genevieve M. HADDAD, Plaintiff, v. The CROSBY CORPORATION et al., Defendants. UNITED STATES of America, Plaintiff, v. The NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., et al., Defendants. Arthur GROSS, Joseph Lerman, and Rose Lerman, on behalf of themselves and all other individual mutual fund shareholders similarly situated, Plaintiffs, v. The NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., et al., Defendants.
• Court: U.S. District Court — District of Columbia

374 F. Supp. 95

In re MUTUAL FUND SALES ANTITRUST LITIGATION.

Genevieve M. HADDAD, Plaintiff, v. The CROSBY CORPORATION et al., Defendants.^*

UNITED STATES of America, Plaintiff, v. The NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., et al., Defendants.^**

Arthur GROSS, Joseph Lerman, and Rose Lerman, on behalf of themselves and all other individual mutual fund shareholders similarly situated, Plaintiffs, v. The NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., et al., Defendants.^***

Civ. A. No. Misc. 103-73. Civ. A. No. 2454-72, 338-73, 426-73.

United States District Court, District of Columbia.

December 14, 1973.

Carl W. Schwarz, Daniel R. Hunter, Dept. of Justice, Charles Jay Pilzer, Washington, D.C., David Berger, Philadelphia, Pa., for plaintiffs.

Daniel P. Levitt, (Liaison Counsel) Paul, Weiss, Goldberg, Rifkind, Wharton & Garrison, Lloyd J. Derrickson, Washington, D.C., for defendants.

MEMORANDUM OPINION

CORCORAN, District Judge.

I THE NATURE OF THE CASE

The above-captioned lawsuits are civil actions alleging violations of the federal antitrust laws in connection with the distribution of securities of openend management investment companies ("mutual funds").¹ The operations of such companies are governed generally by the Investment Company Act of 1940² (the 1940 Act).

In Civil Action No. 2454-72, plaintiff Haddad purports to sue on behalf of a class and subclass of mutual fund investors. Haddad alleges violations of the antitrust laws Sherman Act, Sections 1-3, 15 U.S.C. §§ 1-3 and the securities laws Securities Exchange Act of 1934, Section 10(b), 15 U.S.C. § 78j (b); Exchange Act Rule 10b-5, 17 C.F. R. § 240.10b-5 (1972). The antitrust claim is that the various defendants, including underwriters of and dealers in mutual fund shares and unnamed co-conspirators have agreed, combined and conspired to inhibit, or to refuse to participate in, transactions as agents or brokers in mutual fund shares at prices below the applicable public offering prices established in the prospectuses of such mutual funds and have placed unreasonable restraints upon the transferability of such shares. In essence, the securities claim is that there is a failure to disclose the alleged antitrust violations and that such failure constitutes an independent violation of the securities laws. Haddad alleges damages to her and her purported class of undetermined millions of dollars. Haddad's antitrust claim requests treble damages and injunctive relief. The securities claim requests actual damages, punitive damages, and injunctive relief.

Civil Action No. 338-73 is brought by the Antitrust Division of the U.S. Department of Justice. The complaint alleges violations of Section 1 of the Sherman Act, 15 U.S.C. § 1. The gist of the complaint is that defendants National Association of Securities Dealers (NASD)³ funds and dealers have participated in agreements, combinations, and conspiracies, the effect of which has been to inhibit a "market" for "brokerage transactions" and thereby to suppress the growth of a "secondary market in mutual fund securities," and to cause the public to pay artificial and non-competitive sales loads for mutual fund shares. The government complaint seeks only prospective, injunctive relief.

Civil Action No. 426-73, the Gross case, is another private antitrust suit and purported class action which substantially duplicates the government allegations in No. 338-73. This action seeks injunctive relief and treble damages for injury to the purported plaintiff class over an indeterminate past period.⁴

The individual defendants in each case are principal underwriters⁵ or broker-dealers⁶ in mutual fund shares.⁷ Additionally the NASD is named as a defendant in all three cases. In each case the defendants have moved to dismiss the complaints, pursuant to Fed.R. Civ.P. 12(b) on the grounds:

(a) That as a matter of law, Section 22(d) of the Investment Company Act of 1940, 15 U.S.C. § 80a-22(d), establishes a system of fixed, retail price maintenance in the distribution of investment company securities which is totally inconsistent with antitrust concepts and which accordingly creates, as Congress clearly intended, an exemption and immunity from antitrust liability for the defendant dealers' conduct in maintaining the fixed, public offering price of such securities;

(b) That as a matter of law, Section 22(f) of the Investment Company Act of 1940, 15 U.S.C. § 80a-22(f), sanctions contractual restrictions on the transferability or negotiability of investment company securities, subject to supervision of the Securities and Exchange Commission (SEC), which restrictions are totally inconsistent with antitrust concepts and which restrictions, therefore, as incorporated in the defendant dealers' publicly-filed investment company sales agreements, are exempt and immune from antitrust liability; and

(c) That by the Investment Company Act of 1940, Congress subjected the acts and practices of the defendant dealers in the distribution of investment company securities to continuous and pervasive regulation by the SEC as well as NASD acting under the SEC's supervision; and, accordingly, the SEC has exclusive jurisdiction to regulate those acts and practices, and such acts and practices are exempt and immune from the claims herein alleged as violations of the Federal antitrust laws.

The motions were consolidated for argument.⁸

II THE REGULATION OF MUTUAL FUNDS

The dispute can only be determined ultimately by an analysis of the several subsections of Section 22 of the 1940 Act and an antitrust exemption purportedly given by Section 15A(n) of the Securities and Exchange Act of 1934 (the Maloney Act) 15 U.S.C. § 78o-3(n). Before reaching that point, however, it would seem appropriate to view the overall regulatory scheme imposed by Congress on investment companies through the 1940 Act.

It became apparent to the Congress in 1935 that the disclosure and antifraud provisions of the Securities Act of 1933 (the 1933 Act) and the Securities Exchange Act of 1934 (the 1934 Act) were not adequate for the regulation of investment companies. Accordingly, it directed the SEC to make a comprehensive study of the investment company industry with a view to proposing corrective legislation. The SEC did so⁹ producing a draft "Investment Trust Bill" which was the subject of hearings conducted by a Senate subcommittee.¹⁰ Representatives of the investment company industry were invited to participate in the hearings. Ultimately a compromise bill emerged which finally became law as the Investment Company Act of 1940, 15 U.S.C. § 80a-1 et seq.¹¹

The 1940 Act brought many investment companies within the disclosure requirements of the federal securities laws for the first time. It tightened up those requirements and tailored them to prohibit certain undesirable practices in the investment company industry. Presently, pursuant to the 1940 Act investment companies must register themselves (§§ 7 and 8) and their shares § 24(a) with the SEC, update periodically their filings with quarterly and annual reports §§ 30(a)-(c), and submit prospectuses and sales literature to the SEC § 24 (b). Companies must issue to their shareholders, at least semi-annually, financial reports containing specific types of information § 30(d).

The 1940 Act also imposes detailed restrictions upon investment company structure, conduct, financial policies, and dealings with and by affiliates.¹²

In 1938 (prior to the enactment of the 1940 Act), the Congress had amended the 1934 Act through the passage of the so-called "Maloney Act," 15 U.S.C. § 78o-3. The Maloney Act provided for the registration with the SEC of a national securities association with rulemaking power upon the finding by the SEC that:

the rules of the association are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to provide safeguards against unreasonable profits or unreasonable rates of commissions or other charges, and, in general, to protect investors and the public interest, and to remove impediments to and perfect the mechanism of a free and open market; and are not designed to permit unfair discrimination between customers or issuers, or brokers or dealers, to fix minimum profits, to impose any schedule of prices, or to impose any schedule or fix minimum rates of commissions, allowances, discounts, or other charges.¹³

When Congress enacted the Maloney Act in 1938 it specifically provided:

If any provision of this section is in conflict with any provision of any law of the United States in force on June 25, 1938, the provision of this section shall prevail. 15 U.S.C. § 78o-3(n).

The defendant NASD is the only securities association registered with the SEC under the Maloney Act.

By § 22(a) of the 1940 Act, Congress gave the NASD, as a registered national securities association, the power to promulgate rules setting the minimum price at which its members may buy redeemable fund shares from a fund, the maximum price at which its members may resell to or redeem with a fund, and the minimum period which must elapse after sale before a member may resell to or redeem with a fund. The SEC can exercise its overall supervisory power to promulgate rules superseding NASD's rules on sale, redemption and repurchase prices, holding periods, and sales loads § 22(c) 1940 Act.

Section 22(b)(1) of the 1940 Act empowers the NASD to adopt rules prohibiting members from charging "excessive" sales loads, provided that such rules "allow for reasonable compensation for sales personnel, broker-dealers, and underwriters."¹⁴ In so doing the NASD is expressly freed from a provision¹⁵ in the Maloney Act which had prohibited it from issuing rules designed to impede "a free and open market," "fix minimum profits," "impose any schedule of prices," or "impose any schedule or fix minimum rates of commissions, allowances, discounts, or other charges."...