Grossman v. Johnson

• Citation: 674 F.2d 115
• Decision Date: 29 March 1982
• Docket Number: No. 81-1348,81-1348
• Parties: , Fed. Sec. L. Rep. P 98,619 Stanley M. GROSSMAN, Plaintiff-Appellant, v. Edward C. JOHNSON, 3rd, et al., Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (1st Circuit)

Page 115

674 F.2d 115

65 A.L.R.Fed. 525, Fed. Sec. L. Rep. P 98,619

Stanley M. GROSSMAN, Plaintiff-Appellant, v. Edward C. JOHNSON, 3rd, et al., Defendants-Appellees.

No. 81-1348.

United States Court of Appeals, First Circuit.

Argued Nov. 5, 1981.

Decided March 29, 1982.

Richard M. Meyer, Washington, D. C., with whom Avram G. Hammer, Boston, Mass., and Milberg, Weiss, Bershad & Specthrie, New York City, were on brief, for appellant.

James S. Dittmar, Boston, Mass., with whom Berman, Dittmar & Engel, P. C., Boston, Mass., was on brief, for appellees Edward C. Johnson, 3d, et al.

E. Milton Farley, III, Richmond, Va., with whom Sumner H. Babcock, E. Susan Garsh, Bingham, Dana & Gould, Boston, Mass., John W. Riely, Joseph C. Kearfott and Hunton & Williams, Richmond, Va., were on brief, for appellees Dwight L. Allison, Jr., et al.

Jerome P. Facher, Boston, Mass., with whom Harry T. Daniels, James R. Gomes, Hale & Dorr, Peter M. Saparoff, and Gaston Snow & Ely Bartlett, Boston, Mass., were on brief, for appellee Fidelity Municipal Bond Fund, Inc.

Richard A. Kirby, Sp. Counsel, Washington, D. C., with whom Ralph C. Ferrara, Gen. Counsel, Paul Gonson, Sol., Edward F. Greene, Gen. Counsel, Jacob H. Stillman, Associate Gen. Counsel, Robert Mills and Louis C. Whitsett, Attys., Washington, D. C., were on briefs, for the Securities and Exchange Commission, amicus curiae.

Before CAMPBELL, and BOWNES, Circuit Judges, and DAVIS, Judge. ^*

DAVIS, Judge.

Plaintiff-appellant Stanley M. Grossman brought this derivative action in the District Court for Massachusetts, under the Investment Company Act of 1940, as amended, 15 U.S.C. §§ 80a-1 et seq. (1976) (the Act). ¹ He is and has been a shareholder of Fidelity Municipal Bond Fund, Inc. ("the Fund"), a registered open-end investment company, and he sues the Fund's investment adviser, Fidelity Management & Research Company ("FMR"), the corporation that is the sole owner of that adviser ("FMR Corp."), the affiliated directors of the Fund, as well as most of the unaffiliated directors (whom we shall call "disinterested"). ² ] Against these defendants, Grossman makes two charges: (a) breach of fiduciary duty to the Fund with respect to the allegedly excessive amount of advisory fees paid to FMR by the Fund; and (b) breach of fiduciary duty to the Fund by failing to recapture (or have recaptured) excessive underwriting commissions, discounts and spreads paid by the Fund on its purchases of securities. Before instituting the suit, plaintiff made no demand on the Fund or its directors to bring or prosecute an action on either of these two bases.

Defendants moved to dismiss the complaint, asserting, as one point, that plaintiff had failed to comply with Rule 23.1 of the Federal Rules of Civil Procedure, governing demand by shareholders in derivative actions. During the lengthy argument on those motions, the District Court suggested that it might be advisable, it might even end the controversy, for plaintiff to send a demand letter to the directors specifying his position, although the litigation had already commenced. After consideration, plaintiff did make such demand.

The District Court then stayed action on the motion and ordered the "disinterested" directors ³ to review the demand and report back to the court. These directors delegated responsibility to a Special Committee composed of the two directors who were not defendants (see note 3, supra). The latter retained a former Chairman of the Securities and Exchange Commission (and his outside law firm) to make a study and render a report on the issues presented by plaintiff's demand. A lengthy report was made, concluding that there had been no statutory violation or breach of fiduciary duty on either branch of the suit, and recommending that the Special Committee seek to have this suit dismissed. The Committee accepted that recommendation.

Defendants then moved to dismiss the amended complaint, ⁴ and, alternatively, for summary judgment, urging two grounds which the District Court considered: (a) the failure to make a proper and timely demand, and (b) the court should accept the Special Committee's good faith "business judgment" that the suit should be terminated. In the decision now before us, the District Court accepted both of these contentions, alternatively. 89 F.R.D. 656 (1981). Judgment was entered for defendants. For the reasons to be given in Parts I, II and III of this opinion, we affirm on the former ground, by-passing the latter.

I

Rule 23.1 of the Rules of Civil Procedure ("Derivative Actions by Shareholders") declares:

In a derivative action brought by one or more shareholders or members to enforce a right of a corporation or of an unincorporated association, the corporation or association having failed to enforce a right which may properly be asserted by it, the complaint shall be verified and shall allege (1) that the plaintiff was a shareholder or member at the time of the transaction of which he complains or that his share or membership thereafter devolved on him by operation of law, and (2) that the action is not a collusive one to confer jurisdiction on a court of the United States which it would not otherwise have. The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for his failure to obtain the action or for not making the effort. The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corporation or association. The action shall not be dismissed or compromised without the approval of the court, and notice of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the court directs.

Plaintiff urges that Rule 23.1 is wholly inapplicable to that portion of his case charging the payment of excessive advisory fees to the investment adviser (FMR), which is brought under the special provisions of section 36(b) of the Act, 15 U.S.C. § 80a-35(b) (1976). In this segment of our opinion we consider that contention. ⁵

Section 36(b), added in 1970, prescribes a separate statutory claim for excessive advisory fees to an investment adviser. ⁶ The Securities and Exchange Commission and security holders of the investment company are specifically authorized to sue "on behalf of such company" to recover such fees. The section (among other limitations) places on the plaintiff the burden of proof of showing a breach of fiduciary duty, restricts monetary relief to actual damages and to the persons receiving such compensation, establishes a one-year statute of limitations on recovery, and provides that approval or ratification by the paying company's directors of the compensation to the investment adviser "shall be given such consideration by the court as is deemed appropriate under all the circumstances."

There is no express reference to Rule 23.1 or to demand by the suing shareholder, but plaintiff gives several reasons why, in his view, the structure, terms, and purpose of the provision show that the Rule is wholly inapplicable to such excessive fee suits. We divide these arguments into three groups, first, those that we believe to have little merit, second, those that have substantial weight but are subject to countervailing arguments which likewise have merit, and then we discuss the considerations we believe to tip the balance against plaintiff on this question.

A.1. Appellant says initially that Rule 23.1 must be wholly inapplicable because, though the statute says that suit must be brought on behalf of the investment company and in that sense is a "derivative" action, section 36(b) does not permit an action by the investment company itself (but only by the SEC or a security holder). ⁷ We cannot believe, however, that, for example, a new and independent board of directors, intent on recovering excessive fees from the investment adviser, would be precluded from suing under section 36(b). ⁸ That section is explicit that recovery by a shareholder is to be on behalf of the investment company and that his suit must be brought on the same behalf. With those clear requirements, Congress could well have believed that, though it was appropriate to specify that the Commission and shareholders had the new statutory cause of action under section 36(b), see Moses v. Burgin, 445 F.2d 369, 373 n.7 (1st Cir. 1971), it was unnecessary to say with particularity that the company also did. A suit "on behalf of such company" (a phrase which is more than merely one "for the benefit of the company") is normally a derivative action that the company could itself bring.

Plaintiff, whose complaint and amended complaint both allege that he brings this action "derivatively on behalf of the Fund," seems to have originally agreed that his suit under this section could have been brought by the Fund. Although subsection (3) directly forbids an action under section 36(b) against any person "other than the recipient of such compensation or payments, and no damages or other relief shall be granted against any person other than the recipient of such compensation or payments"-barring as defendants, in this instance, the "disinterested" directors and the Fund itself-this whole proceeding (including that part under section 36(b)) was brought against those "forbidden" defendants, ⁹ apparently on the correct assumption that this is a derivative suit to enforce rights the Fund could itself enforce, and in which the company and its directors should be joined in the ordinary fashion.

2. Another of plaintiff's points we reject outright is the analogy to section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b) (1976) ("profits from purchase and sale of...