Fundamental Portfolio Advisors, Inc. v. Tocqueville Asset Management., L.P.

• Decision Date: 04 October 2005
• Docket Number: 5311.
• Citation: 2005 NY Slip Op 07300,22 A.D.3d 204,802 N.Y.S.2d 17
• Parties: FUNDAMENTAL PORTFOLIO ADVISORS, INC., et al., Appellants, v. TOCQUEVILLE ASSET MANAGEMENT, L.P., et al., Respondents.
• Court: New York Supreme Court — Appellate Division

22 A.D.3d 204

802 N.Y.S.2d 17

2005 NY Slip Op 07300

FUNDAMENTAL PORTFOLIO ADVISORS, INC., et al., Appellants, v. TOCQUEVILLE ASSET MANAGEMENT, L.P., et al., Respondents.

5311.

Appellate Division of the Supreme Court of the State of New York, First Department.

October 4, 2005.

Order, Supreme Court, New York County (Richard B. Lowe, III, J.), entered February 13, 2004, which granted defendants' motion for summary judgment dismissing the complaint, and denied plaintiffs' cross motion for partial summary judgment on the issue of liability, affirmed, without costs.

This breach of contract action arises from the decision of the board of directors of a family of mutual funds (collectively the Fundamental Funds or the Funds) to replace plaintiffs as their investment advisor and distributor. Plaintiff Lance Brofman is the founder and former president and chief portfolio strategist of the Funds. He is also the principal shareholder and president of the Funds' former advisor, plaintiff Fundamental Portfolio Advisors (FPA), and a shareholder of their former distributor, plaintiff Fundamental Service Corp. (FSC).

Defendant Tocqueville Asset Management (Tocqueville) is an investment advisor to mutual funds, which succeeded plaintiffs to the management of the Fundamental Funds allegedly in breach of a noncompete clause executed while the parties were negotiating the merger of their businesses and the transfer to defendants of plaintiffs' management contracts with the Fundamental Funds.

In September 1996, Christopher Culp, a Tocqueville officer and portfolio manager, and defendant Robert Kleinschmidt, president of Tocqueville, met with plaintiff Brofman and his partner, nonparty Vincent Malanga, then president of FPA and vice-president of FSC, as well as a member of the board of the Fundamental Funds, to discuss Tocqueville's merger with FPA or acquisition of FPA's investment advisory assets. Culp and Kleinschmidt executed a nondisclosure, noncompete agreement, which provided that "[w]hereas, [Kleinschmidt and Culp] and Brofman and Malanga intend discussing various business proposals involving the investment advisory and mutual funds business," Kleinschmidt and Culp "agree not to solicit or engage in any business activity involving any of the mutual funds which have had, or ever in the future have business relationships with FPA or any company affiliated or associated with FPA, without prior written consent of both Brofman and Malanga."

The agreement also provided that "[n]o delay or omission by FPA, Brofman or Malanga in exercising any right under this Agreement will operate as a waiver of that or any other right. A waiver or consent given by FPA, Brofman and Malanga on any one occasion is effective only in that instance and will not be construed as a bar or waiver of any right on any other occasion."

While the parties were negotiating, the board of directors of the Funds decided, at its December 31, 1996 meeting, to renew FPA's contract but to remove Brofman, who had a history of securities violations, from his position as chief portfolio strategist and to ban him from any position of responsibility on behalf of the Funds. In early 1997, FPA tentatively agreed to sell its investment advisory assets to Tocqueville for a price equal to 63% of the revenues received by Tocqueville from existing client accounts of the Funds for five years, or about $6 million, based on the Funds' assets at the time. It was understood that, in return, Tocqueville would help FPA in its relationship with the members of the board and Culp would perform due diligence for Tocqueville and simultaneously manage the Funds' portfolios.

Thus, in February 1997, Culp began operating the Funds from FPA's offices while performing due diligence for Tocqueville. Tocqueville was given access to FPA's mutual fund shareholder information and Culp made presentations to the board concerning portfolio management. Malanga told his fellow board members at a March 28, 1997 meeting that, as a result of the board's removal of Brofman as chief portfolio strategist, FPA had, among other things, "recruited Mr. Christopher P. Culp to serve, without compensation, as a member of a three-person investment committee created for the purpose of managing the Funds' investment portfolios." Meanwhile, negotiations over Tocqueville's purchase of FPA's investment advisory assets continued.

Also at the end of March, the board decided to replace FPA as soon as an acceptable replacement could be found, and in April, Malanga, on behalf of FPA, forwarded to the members of the board Tocqueville's proposal to advise the Funds. In his cover letter, Malanga said that FPA "strongly endorse[d]" the proposal, "believ[ing] it to be in the best interest of [the Funds'] past, present, and future shareholders." He said that, among other strengths, "Tocqueville's managers are intimately acquainted with [the] Funds" and, because Culp "currently act[s] as an unpaid member of Fundamental's portfolio management committee, ... they are fully aware of the operation of the Funds and their portfolio composition."

In May 1997, the board sent four investment advisory firms, including Tocqueville, requests for proposals to replace FPA, and the board met in July to consider the proposals received from Tocqueville and another firm. At that meeting, board member L. Greg Ferrone pointed out that Tocqueville "has shown enormous good will over the last few months and that they know the Fund portfolios quite well." Malanga moved for approval of Tocqueville's proposal and board member James C. Armstrong seconded the motion. After some discussion, the board voted unanimously that it was the sentiment of the board members to proceed with the Tocqueville transaction, subject to review and final approval at the July 15, 1997 meeting of the Funds' board.

The July 16, 1997 supplement to the Fundamental Funds' April 30, 1997 prospectus states that, subject to shareholder approval, the Funds adopted a plan by which the Fundamental Funds would transfer their assets and liabilities to a newly created corresponding series of "Tocqueville Funds" in exchange for shares of the Tocqueville Funds. The supplement notes that Tocqueville Asset Management L.P. serves as investment advisor to the Tocqueville Funds.

In December 1997, instead of renewing FPA's management agreement for one year, as was its custom, the board approved FPA's continuing for only 90 days, pending Tocqueville's takeover of the Funds' management. At the expiration of the 90 days, the board approved a 60-day continuance.

However, plaintiffs had concluded no agreement with Tocqueville to sell the latter its investment advisory assets, and in April 1998 Brofman launched a proxy battle seeking a shareholder vote to replace the board members who wanted to appoint Tocqueville with members who would retain FPA as advisor. Some of the proposed members were loyal to FPA because they knew that Tocqueville would not permit them to continue "market timing," a controversial investment strategy. In early May 1998, FPA filed its proxy materials and sent the shareholders notice of a special meeting to be held on May 29, 1998, the day before FPA's 60-day continuance was to expire. On May 27 board member Armstrong commenced a shareholder action in federal court challenging the special meeting on procedural grounds and claiming that the proxy materials were inaccurate and misleading. The court granted a temporary restraining order enjoining the meeting. The parties then stipulated to stay the action and agreed that the board and FPA would submit new proxy materials, which they did on June 19, 1998.

Meanwhile, on May 30, 1998, at a meeting called to select an interim advisor to the Funds, the board heard presentations by FPA, Tocqueville and a third firm. It then voted to allow FPA's 60-day continuance to expire and, over Malanga's opposition, to appoint Tocqueville as interim advisor for a period not to exceed 120 days from June 1, 1998. Tocqueville served as interim advisor until September 28, 1998, unable to come to an agreement with the board on the market-timing issue.

Plaintiffs allege that defendants breached the noncompete agreement by engaging in business activity involving the Funds without the prior written consent of Brofman and Malanga, causing the latter to lose their business relationship with the Funds and to suffer damages of at least $6 million.

Defendants argue that the record demonstrates that the board's decision to replace plaintiffs was a result not of defendants' conduct but of the board's loss of confidence in plaintiffs. Indeed, the record reflects the Fundamental Funds' poor performance between 1987 and 1997 and Brofman's and FPA's history of chronic legal violations, which culminated, in early 2001, in the Securities and Exchange Commission's permanent ban of Brofman from the securities industry. The board decided at the end of 1996 to remove Brofman from his position as chief portfolio strategist and to ban him from any position of responsibility for the Funds. It decided at the end of March 1997 to replace FPA as advisor as soon as an acceptable replacement could be found. Culp had only begun working out of FPA's offices in February 1997, and Malanga had only so informed the board at the end of March. Thus, the board made its decision to replace FPA long before it had become disposed toward Tocqueville.

Moreover, when in December 1997 the board approved the continuance of its agreements with FPA for 90 days, "in contemplation of the consummation of a transaction pursuant to which Tocqueville Asset Management L.P. would assume management of the assets of the Funds," it stated, "Otherwise, the [agreements] would have expired on January 1, 1998." When, at the end of the 90 days, the board continued the agreements with FPA for another 60 days, again "in contemplation of the consummation of a transaction pursuant to which Tocqueville Asset...