Daily Income Fund, Inc v. Fox

• Decision Date: 18 January 1984
• Docket Number: No. 82-1200,82-1200
• Citation: 104 S.Ct. 831,464 U.S. 523,78 L.Ed.2d 645
• Parties: DAILY INCOME FUND, INC. and Reich & Tang, Inc., Petitioners v. Martin FOX
• Court: U.S. Supreme Court

464 U.S. 523

104 S.Ct. 831

78 L.Ed.2d 645

DAILY INCOME FUND, INC. and Reich & Tang, Inc., Petitioners

v Martin FOX.

No. 82-1200.

Argued Nov. 7, 1983.

Decided Jan. 18, 1984.

Syllabus

Respondent, a shareholder of petitioner Daily Income Fund, Inc. (Fund), an open-end diversified management investment company regulated by the Investment Company Act of 1940 (Act), filed suit in Federal District Court against both the Fund and petitioner Reich & Tang, Inc. (R & T), which provides the Fund with investment advice and management services. Respondent alleged that fees paid to R & T by the Fund were unreasonable, in violation of § 36(b) of the Act, which imposes a fiduciary duty on an investment company's adviser "with respect to the receipt of compensation for services" paid by the company and provides that "[a]n action may be brought under this subsection by the [Securities and Exchange] Commission, or by a security holder of such registered investment company on behalf of such company" against the adviser and other affiliated parties. The complaint sought damages in favor of the Fund as well as payment of respondent's costs, expenses, and attorney's fees. The District Court dismissed the suit, finding that § 36(b) actions are subject to the "demand requirement" of Federal Rule of Civil Procedure 23.1—which governs "a derivative action brought by one or more shareholders . . . to enforce a right of a corporation [when] the corporation [has] failed to enforce a right which may properly be asserted by it" and requires a shareholder bringing such a suit to allege his efforts, if any, to obtain the desired action from the directors and the reasons for his failure to obtain or request such action—and that respondent had not complied with the Rule. The Court of Appeals reversed.

Held: Rule 23.1 does not apply to an action brought by an investment company shareholder under § 36(b), and thus the plaintiff in such a case need not first make a demand upon the company's directors before bringing suit. Pp.527-542.

(a) The term "derivative action," which defines the scope of Rule 23.1, applies only to those actions in which the right claimed by the shareholder is one the corporation itself could have enforced in court. This interpretation of the Rule is consistent with earlier decisions (e.g., Hawes v. Oakland, 104 U.S. 450, 26 L.Ed. 827, from which the Rule's provisions were derived) and is supported by its purpose of preventing shareholders from improperly suing in place of a corporation. Pp. 527-534.

(b) The right asserted by a shareholder suing under § 36(b) cannot be judicially enforced by the investment company. Instead of establishing a corporate action from which a shareholder's right to sue derivatively may be inferred, § 36(b) expressly provides only that the new corporate right it creates may be enforced by the Securities and Exchange Commission and security holders of the company. Moreover, an investment company does not have an implied right of action under § 36(b). Consideration of pertinent factors—the statute's legislative history and purposes, the identity of the class for whose particular benefit the statute was passed, the existence of express statutory remedies adequate to serve the legislative purpose, and the traditional role of the States in affording the relief claimed—plainly demonstrates that Congress intended the unique right created by § 36(b) to be enforced solely by the Commission and security holders of the investment company. Pp. 534-541.

692 F.2d 250 (CA2 1982) affirmed.

Daniel A. Pollack, New York City, for petitioners.

Richard M. Meyer, New York City, for respondent.

Justice BRENNAN delivered the opinion of the Court.

The question for decision is whether Rule 23.1 of the Federal Rules of Civil Procedure requires that an investment company security holder first make a demand upon the company's board of directors before bringing an action under § 36(b) of the Investment Company Act of 1940 (ICA or Act) to recover allegedly excessive fees paid by the company to its investment adviser. The Court of Appeals for the Second Circuit held in this case that the demand requirement of Rule 23.1 does not apply to such actions. Fox v. Reich & Tang, Inc., 692 F.2d 250 (CA2 1982). Two other Courts of Appeals have reached a contrary conclusion.¹ We granted certiorari to resolve the conflict, --- U.S. ----, 103 S.Ct. 1271, 75 L.Ed.2d 493 (1983), and now affirm.

I

Respondent is a shareholder of petitioner Daily Income Fund, Inc. ("Fund"), an open-end diversified management investment company, or "mutual fund," regulated by the Investment Company Act of 1940 ("ICA" or "Act"), 15 U.S.C. § 80a-1 et seq. The Fund invests in a portfolio of short-term money market instruments with the aim of achieving high current income while preserving capital. Under a written contract, petitioner Reich & Tang, Inc. ("R & T") provides the Fund with investment advice and other management services in exchange for a fee currently set at one-half of one percent of the Fund's net assets. From 1978 to 1981, the Fund experienced substantial growth; its net assets increased from about $75 million to $775 million. During this period, R & T's fee of one-half of one percent of net assets remained the same. Accordingly, annual payments by the Fund to R & T rose from about $375,000 to an estimated $3,875,000 in 1981.

Alleging that these fees were unreasonable, respondent brought this action in the United States District Court for the Southern District of New York, naming both the Fund and R & T as defendants. The complaint alleged that, because the Fund's assets had been continually reinvested in a limited number of instruments, R & T's investment decisions had remained routine and substantially unchanged as the Fund grew. By receiving significantly higher fees for essentially the same services, R & T had, according to respondent, violated the fiduciary duty owed investment companies by their advisers under § 36(b) of the ICA. Pub.L. No. 91-547, Section 20, 84 Stat. 1428, 15 U.S.C. § 80a-35(b).² The complaint sought damages in favor of the Fund as well as payment of respondent's costs, expenses, and attorney's fees.

Petitioners moved to dismiss the suit for failure to comply with Fed.Rule Civ.Proc. 23.1, which governs "a derivative action brought by one or more shareholders . . . to enforce a right of a corporation . . ., the corporation . . . having failed to enforce a right which may properly be asserted by it. . . ." The Rule requires a shareholder bringing such a suit to set forth "the efforts, if any, made by the plaintiff to obtain the action he desires from the directors . . ., and the reasons for his failure to obtain the action or for not making the effort." ³ Respondent contended that the Rule 23.1 "demand requirement" does not apply to actions brought under § 36(b) of the ICA and that, in any event, demand was excused because the Fund's directors had participated in the alleged wrongdoing and would be hostile to the suit. The district court, finding Rule 23.1 applicable to § 36(b) actions and finding no excuse based on the directors' possible self-interest or bias, dismissed the action. Fox v. Reich & Tang, Inc., 94 F.R.D. 94 (SDNY 1982).

The Court of Appeals reversed. Fox v. Reich & Tang, Inc., 692 F.2d 250 (CA2 1982). The court concluded that Rule 23.1 by its terms applies only when the corporation could itself " 'assert,' in a court, the same action under the same rule of law on which the shareholder plaintiff relies." Id., at 254. Relying on both the language and the legislative history of § 36(b), the court determined that an investment company may not itself sue under that section to recover excessive adviser fees. Id., at 254-261. Accordingly, the court held that Rule 23.1 does not apply to actions by security holders brought under § 36(b). Id., at 261.

II

Although any action in which a shareholder asserts the rights of a corporation could be characterized as "derivative," see n. 11 infra, Rule 23.1 applies in terms only to a "derivative action brought by one or more shareholders or members to enforce a right of a corporation [when] the corporation [has] failed to enforce a right which may properly be asserted by it" (emphasis added). This qualifying language suggests that the type of derivative action governed by the Rule is one in which a shareholder claims a right that could have been, but was not, "asserted" by the corporation in court. The "right" mentioned in the emphasized phrase, which cannot sensibly mean any right without limitation, is most naturally understood as referring to the same right, or at least its substantial equivalent, as the one asserted by the plaintiff shareholder. And, in the context of a rule of judicial procedure, the reference to the corporation's "failure to enforce a right which may properly be asserted by it" obviously presupposes that the right in question could be enforced by the corporation in court.

This interpretation of the Rule is consistent with the understanding we have expressed, in a variety of contexts, of the term "derivative action." In Hawes v. City of Oakland, 104 U.S. 450, 460, 26 L.Ed. 827 (1882), for instance, the Court explained that a derivative suit is one "founded on a right of action existing in the corporation itself, and in which the corporation itself is the appropriate plaintiff." Similarly, Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548, 69 S.Ct. 1221, 1226, 93 L.Ed. 1528 (1949), stated that a derivative action allows a stockholder "to step into the corporation's shoes and to seek in its right the restitution he could not demand in his own"; and the Court added that such a stockholder "brings suit on a cause of action derived from the corporation." Id., at 549, 69 S.Ct., at 1227. Finally, Ross v. Bernhard, 396 U.S. 531, 534, 90 S.Ct. 733, 736, 24 L.Ed.2d 729 (1970), described a derivative action as "a suit to enforce a corporate cause of...