Conviser v. Simpson, Civ. A. No. 7028-7052.

• Decision Date: 25 May 1954
• Docket Number: Civ. A. No. 7028-7052.
• Citation: 122 F. Supp. 205
• Parties: CONVISER v. SIMPSON et al. CONVISER et al. v. BRECK et al.
• Court: U.S. District Court — District of Maryland

122 F. Supp. 205

CONVISER v. SIMPSON et al.

CONVISER et al. v. BRECK et al.

Civ. A. Nos. 7028-7052.

United States District Court D. Maryland.

May 25, 1954.

Harry O. Levin, Marshall A. Levin, Fred Oken, Philip Heller Sacks, Lawrence B. Fenneman, Baltimore, Md., and Edward Rothenberg, Irving Steinman and Mortimer A. Shapiro, New York City, for plaintiffs.

Venable, Baetjer & Howard and H. Vernon Eney, Baltimore, Md., for defendant Tri-Continental Corp.

Piper & Marbury, Baltimore, Md., William L. Marbury and Frank T. Gray, Baltimore, Md., for individual defendants.

WILLIAM C. COLEMAN, Chief Judge.

The first of these suits, No. 7028, is brought by the plaintiff, David J. Conviser, a resident of Florida, and two intervenors, as a stockholders' representative action on behalf of themselves and all other holders of the common stock of Tri-Continental Corporation, incorporated in Maryland, against that corporation and eight of its thirteen directors. In this suit the plaintiffs seek a decree against all defendants, requiring the abandonment of Tri-Continental's policy of retaining realized capital gains, and also requiring the declaration and payment of dividends to its common stockholders equal to those capital gains realized during the years 1951, 1952 and 1953, less any income taxes paid or payable thereon. The result of such decree would be to relieve the company of an obligation to pay approximately $1,874,000 as income taxes on its 1953 realized capital gains.

The second suit, No. 7052, is brought by the plaintiff, David J. Conviser, alone, as a stockholders' so-called derivative suit, against Tri-Continental and its thirteen directors, whereby plaintiff seeks to make these directors liable for approximately $3,500,000 which the company paid as income taxes for the years 1951 and 1952, because of its retention of realized capital gains in those years, instead of disbursing them as dividends to the common stockholders.

This suit was originally brought in 1953 in the Supreme Court of the State of New York, County of New York, but was discontinued in December, 1953, without prejudice, and brought in this Court in order that there might be a single trial of this action with suit No. 7028, which had first been brought in the District Court for the Southern District of New York against Tri-Continental and eight of its directors, resident in that district.

It will be seen that the ultimate object of both suits is the same. Suit No. 7052 purports to be a so-called derivative action against all directors of Tri-Continental, with Tri-Continental as merely a nominal defendant, since it is plaintiff's effort, by this suit, to require the directors of Tri-Continental to reimburse it for the taxes paid by it on its retained and reinvested 1951 and 1952 capital gains. The two suits were accordingly consolidated for trial.

Tri-Continental Corporation is a so-called "closed-end diversified investment company" within the meaning of the Investment Company Act of 1940 and has been registered as such under that Act since its effective date, November 1st, 1940. That Act defines an "investment company" as "any issuer which — (1) is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities; (2) is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type, or has been engaged in such business and has any such certificate outstanding; or (3) is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer's total assets (exclusive of Government securities and cash items) on an unconsolidated basis." 15 U.S.C.A. § 80a-3.

By the same Act, a "management company" is defined as "any investment company other than a face-amount certificate company or a unit investment trust." 15 U.S.C.A. § 80a-4(3). The Act divides "management companies" into "open-end" and "closed-end" companies, as follows: "(a) * * * (1) `Open-end company' means a management company which is offering for sale or has outstanding any redeemable security of which it is the issuer. (2) `Closed-end company' means any management company other than an openend company. (b) Management companies are further divided into diversified companies and non-diversified companies, defined as follows: (1) `Diversified company' means a management company which meets the following requirements: At least 75 per centum of the value of its total assets is represented by cash and cash items (including receivables), Government securities, securities of other investment companies, and other securities for the purposes of this calculation limited in respect of any one issuer to an amount not greater in value than 5 per centum of the value of the total assets of such management company and to not more than 10 per centum of the outstanding voting securities of such issuer. (2) `Non-diversified company' means any management company other than a diversified company. (c) A registered diversified company which at the time of its qualification as such meets the requirements of paragraph (1) of subsection (b) of this section shall not lose its status as a diversified company because of any subsequent discrepancy between the value of its various investments and the requirements of said paragraph, so long as any such discrepancy existing immediately after its acquisition of any security or other property is neither wholly nor partly the result of such acquisition." 15 U.S.C.A. § 80a-5.

Also, since May, 1946, Tri-Continental has qualified as a "regulated investment company" as defined in Supplement Q, Section 361, of Title 26, Internal Revenue Code, 26 U.S.C.A., which entitled it and its shareholders to the tax benefits provided by Section 362 of Supplement Q, which can be briefly stated as follows: if the company pays out to its stockholders as dividends not less than 90 per cent of its net investment income, such income and all realized long term capital gains that it has disbursed are not taxable to the corporation. Such income so distributed as dividends to the stockholders is taxable to them, and such realized capital gains as are distributed are also taxable to them as long term capital gains, at their individual tax rates. But capital gains not so distributed are taxable to the corporation at the capital gain rate of 25 per cent.

This policy of Tri-Continental in retaining realized capital gains has been consistently followed by it, which is the only closed-end regulated investment company which has not made a practice of distributing capital gains to its stockholders. The gist of the plaintiff's contention is that this practice is an abuse of discretion on the part of the directors of the corporation, in that, apart from what may be their...