Gartenberg v. Merrill Lynch Asset Management, Inc., s. 11

• Decision Date: 03 December 1982
• Docket Number: D,14,Nos. 11,s. 11
• Citation: 694 F.2d 923
• Parties: Fed. Sec. L. Rep. P 99,001 Irving L. GARTENBERG, Plaintiff-Appellant, v. MERRILL LYNCH ASSET MANAGEMENT, INC., Merrill Lynch, Pierce, Fenner and Smith, Inc., and Merrill Lynch Ready Assets Trust, Defendants-Appellees. Simone C. ANDRE, Plaintiff-Appellant, v. MERRILL LYNCH READY ASSETS TRUST, and Merrill Lynch Asset Management, Inc., Defendants-Appellees. ockets 82-7142, 82-7074.
• Court: U.S. Court of Appeals — Second Circuit

Page 923

694 F.2d 923

Fed. Sec. L. Rep. P 99,001

Irving L. GARTENBERG, Plaintiff-Appellant, v. MERRILL LYNCH ASSET MANAGEMENT, INC., Merrill Lynch, Pierce,

Fenner and Smith, Inc., and Merrill Lynch Ready

Assets Trust, Defendants-Appellees.

Simone C. ANDRE, Plaintiff-Appellant, v. MERRILL LYNCH READY ASSETS TRUST, and Merrill Lynch Asset

Management, Inc., Defendants-Appellees.

Nos. 11, 14, Dockets 82-7142, 82-7074.

United States Court of Appeals, Second Circuit.

Argued Sept. 15, 1982.

Decided Dec. 3, 1982.

William P. Rogers, New York City (Stanley Godofsky, James N. Benedict, Anne Elizabeth Fontaine, Rogers & Wells, New York City, of counsel), for defendants-appellees Merrill Lynch Asset Management, Inc. and Merrill Lynch, Pierce, Fenner & Smith, Inc.

Stanley M. Grossman, New York City (Stephen P. Hoffman, Bruce G. Stumpf, Pomerantz, Levy, Haudek & Block, New York City, of counsel), for plaintiff-appellant Gartenberg.

Sidney B. Silverman, New York City, for plaintiff-appellant Andre.

James K. Manning, New York City (James B. May, A. Robert Pietrzak, Kent E. Daiber, Brown, Wood, Ivey, Mitchell & Petty, New York City, of counsel), for defendant-appellee Merrill Lynch Ready Assets Trust.

Before MANSFIELD, VAN GRAAFEILAND and NEWMAN, Circuit Judges.

MANSFIELD, Circuit Judge:

Irving L. Gartenberg and Simone C. Andre, two shareholders of the Merrill Lynch Ready Assets Trust, a money market fund (the "Fund"), appeal from a judgment of the Southern District of New York, Milton Pollack, Judge, entered after a non-jury trial, dismissing their consolidated derivative actions against the Fund and its affiliates, Merrill Lynch Asset Management, Inc., the adviser and manager of the Fund (the "Manager") and Merrill Lynch, Pierce, Fenner & Smith, Inc. (the "Broker"). The plaintiffs claimed violations of Sec. 36(b) of the Investment Company Act of 1940, 15 U.S.C. Sec. 80a-35(b) (the "Act"). ¹ 528 F.Supp. 1038, 1040. The principal claim is that the fees paid by the Fund to the Manager for various services, including investment advice and processing of daily orders of the Fund's shareholders, were so disproportionately large as to constitute a breach of fiduciary duty in violation of Sec. 36(b). We affirm the judgment dismissing the complaint.

Since the facts are fully set forth in detail in Judge Pollack's opinion, 528 F.Supp. 1038, only a brief summary here is necessary. The Fund, organized in 1975 as a no-load, diversified, open-end investment company, invests in short-term money market securities expected to pay the highest current income consistent with preservation of capital and maintenance of liquidity, such as short-term securities of the U.S. Government or its agencies, bank certificates of deposit, and commercial paper. An investor may purchase and redeem shares of the Fund without any charges or penalties. There is a daily declaration of dividends, reflecting the net income of the Fund's portfolio. As the district court noted, the purchaser's investment in the Fund is more like a bank account than the traditional investment in securities. Idle money can be invested in the Fund for as little as a day and put to work earning interest. The ease of entrance and egress for the investor, coupled with the ability to share in high yields which the modest investor could not obtain through a bank deposit and might not be able to realize alone, has with the The Fund has an 8-person Board of Trustees, of whom 2 are interested and 6 are independent and unaffiliated. The operations of the Fund are conducted by the Manager, which provides the Fund with office space and facilities, administrative staff, equipment, portfolio management, compliance with SEC and state recordkeeping and reporting requirements, and services to Fund shareholders. For the processing of approximately 80% of the purchases and redemptions of shares of the Fund the Manager uses the Broker, another Merrill Lynch affiliate, which is the largest registered broker-dealer in the United States, with 408 domestic offices located in numerous cities and towns, in which more than 7,000 account executives are located. In addition, the Manager uses the vast facilities of the Merrill Lynch organization and its affiliates to render special services to the Fund. For example, Merrill Lynch Economics, Inc. provides economic research and forecasting services while Merrill Lynch Government Securities, Inc. provides expertise with respect to U.S. government and agency securities. A customer located anywhere in the United States can call the nearest office of the Broker or the Bank of New York, the Fund's custodian and transfer agent, order the purchase or redemption without charge of shares of the Fund, and through use of wires and computers the transaction will be carried out immediately. An average of 30,000 such orders are processed daily by the Broker's large organization.

rise (until recently) of interest rates attracted an increasing number of investors. As a result the size of the Fund increased enormously over a few years, from $288 million in April 1977 to over $19 billion as of September 1981.

Under the foregoing management the Fund has performed reasonably well in terms of average percentage yields for its shareholders. Its average percentage yields from 1978 through 1980 were slightly above the average for all similar funds. In 1980 it ranked 37th out of 76 money funds in terms of yield.

For all of these services the Manager charges the Fund an advisory fee based on a percentage of the average daily value of the Fund's net assets. The fee rate is graduated downward as the Fund's total assets increase in value. Since 1979 the schedule called for payment of 0.50% ( 1/2 of 1%) of the Fund's average daily value of net assets under $500 million and for various intermediate percentages as the value of the net assets increases down to 0.275% for assets in excess of $2.5 billion, resulting in an effective rate of 0.288%. This schedule is the product of a series of negotiations by the 6 independent Fund Trustees with the Manager over the period from 1977 to 1979, which resulted in reductions in the effective rate as the Fund grew in size.

Three studies were made at the Fund's instance to determine the estimated cost of the processing services provided by the Broker through the Manager to the Fund, two by the Merrill Lynch organization's internal accounting staff and one by the independent accounting firm of Peat, Marwick, Mitchell & Co. ("PMM"). The estimates ranged from $2.02 to $7.50 per Fund order. The earlier internal study which produced the lowest figure did so mainly because it used a modified "incremental" cost method of accounting, based on the assumption that most costs would have been incurred by the Broker even if it had processed no Fund orders. By the time the PMM study was conducted in late 1979, however, modified full cost accounting methods were used for the reason that Fund orders represented a sizeable proportion of all business processed by the Broker; indeed, by April 1981 Fund orders accounted for 37% of all Broker business, necessitating the hiring by the Broker of close to 3,000 non-sales personnel. Had the Manager been required to reimburse the Broker for these costs instead of their being absorbed by the Broker as another Merrill Lynch affiliate, the Broker's net profit after taxes would have been greatly reduced, resulting in a figure ranging from a 38.4% profit to a substantial loss depending on which cost accounting study was used. In 1980, for instance, the last calendar year for which full figures are available, the Manager's fee was slightly over $33 million on the Fund's average net assets of $11.16 billion. Based on the volume of orders generated by 675,324 purchasers, the Broker's processing costs, estimated according to the PMM study, were so large that the Manager suffered a loss during 1980. 528 F.Supp. at 1053-54.

Judge Pollack, construing the legislative history of the Act, decided that the standard for determining whether the Manager had been guilty of a breach of fiduciary duty in violation of Sec. 36(b) was not whether its fees were "reasonable" as urged by plaintiffs but whether they were unfair to The Manager's fee schedule was found by Judge Pollack to "bear a fair relation to the subject matter from which they are derived". Id. at 1068. He further found that "the total fee was fair to the Fund" after taking into consideration the nature and extent of the services, the fees charged by other advisers to other money market funds, the overall cost to the Merrill Lynch organization of providing the services, and the fee schedule's allowance for economies of scale by reducing the rate as the Fund's net assets increased. Id. at 1055. Judge Pollack also gave weight to the process by which the 6 noninterested trustees of the Fund approved of its management agreement with the Manager. The trustees, who were represented by capable independent counsel, were found to be competent, independent and conscientious in the performance of their duties. They were furnished with sufficient information to evaluate the contract. They thoroughly reviewed and weighed all facts pertinent to the fee, many of which are now part of the record, before approving the Manager's fee after negotiations.

                the Fund and shareholders, which was to be determined by reference to the nature, quality and extent of the manager's services to the Fund, the money market fund industry practice and level of management fees, and to a lesser extent the Manager's net earnings as a result of providing the services.  After reviewing the evidence and appraising the live witnesses who testified, he concluded that the compensation paid to the Manager was fair.   Id. at 1055.  The package of services described above was found to be extensive and valuable, providing Fund customers with the vast facilities of the Merrill Lynch organization, which were not available to

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