Kalish v. Franklin Advisers, Inc.
| Citation | 742 F. Supp. 1222 |
| Decision Date | 24 July 1990 |
| Docket Number | No. 87 Civ. 6919 (CSH).,87 Civ. 6919 (CSH). |
| Parties | Lucyle KALISH and Sol Joseph Kamen, Plaintiffs, v. FRANKLIN ADVISERS, INC., Franklin Distributors, Inc., Franklin Administrative Services, Inc., Franklin Resources, Inc., and Franklin Custodian Funds, Inc. (U.S. Government Securities Series), Defendants. |
| Court | U.S. District Court — Southern District of New York |
Milberg Weiss Bershad Specthrie & Lerach (Richard M. Meyer, of counsel), New York City, for plaintiffs.
Pollack & Kaminsky (Daniel A. Pollack, Martin A. Kaminsky, W. Hans Kobelt, of counsel), New York City, for Franklin Advisers, Inc., Franklin Distributors, Inc., Franklin Administrative Services, Inc. and Franklin Resources, Inc.
Carro, Spanbock, Kastor & Cuiffo (Brian E. Lorenz, of counsel), New York City, for defendant Franklin Custodian Funds, Inc. (U.S. Government Securities Series).
Plaintiffs Lucyle Kalish and Sol Joseph Kamen brought this derivative action on behalf of defendant Franklin Custodian Funds, Inc. (U.S. Government Securities Series) (the "Fund") under the Investment Company Act of 1940, as amended, 15 U.S.C. § 80a-1 et seq. (the "Act"), to recoup allegedly excessive advisory fees paid by the Fund to its investment adviser.
Franklin Custodian Funds, Inc. is a diversified open-end investment company registered with the Securities and Exchange Commission under the Act. The Fund is one of five series of Franklin Custodian Funds, Inc., and concentrates its investments in obligations of the Government National Mortgage Association ("GNMA"), with the objective of income through investment in securities of the U.S. Government or its instrumentalities.
Plaintiffs Kalish and Kamen became shareholders of the Fund in 1986 and 1987 respectively and remained shareholders throughout the pertinent period.
Defendant Franklin Distributors ("Franklin Distributors") acted as the Fund's investment adviser and manager until January 31, 1986, pursuant to contract. Defendant Franklin Advisers, Inc. ("Franklin Advisers") has acted as the Fund's investment adviser under a contract which became effective February 1, 1986 and has been subsequently renewed and modified. Franklin Distributors continues to act as principal underwriter of the Fund. Defendant Franklin Administrative Services, Inc. ("Franklin Services") has acted as shareholder servicing agent, transfer agent and dividend paying agent for the Fund. Each of these companies is a wholly owned subsidiary of defendant Franklin Resources, Inc. ("Franklin Resources"). These entities are from time to time referred to collectively as "Franklin" or "defendants."
Plaintiffs filed their complaint on September 25, 1987, stating a cause of action under § 36(b) of the Act, 15 U.S.C. § 80a-35(b). Plaintiffs alleged that the fees paid by the Fund to Franklin Advisers were exorbitant, and that Franklin Advisers and the Fund's directors had breached the fiduciary duty imposed upon them by the Act. The Court granted defendants' motion to strike plaintiffs' demand for a jury trial in a Memorandum Opinion and Order dated February 29, 1988. Following discovery, the case was tried to the Court. This Opinion constitutes the Court's findings of fact and conclusions of law under Rule 52(a), Fed.R.Civ.P.
The Fund was formed in 1971. In 1983 its directors decided to emphasize investment in securities issued by GNMA, popularly known as "Ginnie Maes." That has remained the focus of the Fund's investment policy to this date.
For purposes of limitations and streamlining of proof, this action has been deemed by stipulation to have been commenced on September 30, 1987. At issue are the fees paid by the Fund to Franklin Advisers during its fiscal years ending on September 30, 1987 and September 30, 1988. Those fees were paid pursuant to a series of one-year management agreements between the Fund and Franklin running from February to February, and approved by the Fund's board of directors.
The Fund has experienced dramatic growth since its inception, as revealed by the following table:
Outstanding
Date # of Accounts Net Assets Shares
Dec. 31, 1984 178,428 $ 2,496,954,705 351,627,795
Dec. 31, 1985 450,980 $ 8,875,802,045 1,180,547,279
Sept. 30, 1986 679,542 $14,361,682,054 1,938,886,002
Dec. 31, 1986 694,579 $14,941,488,124 2,013,006,042
June 30, 1987 687,256 $14,267,717,200 1,994,862,976
Sept. 30, 1987 665,410 $13,024,436,878 1,895,183,448
Dec. 31, 1987 639,336 $12,650,664,753 1,805,885,572
June 30, 1988 621,240 $12,432,704,402 1,760,935,529
Sept. 30, 1988 609,925 $12,112,775,121 1,735,011,210
Dec. 31, 1988 599,227 $11,646,328,085 1,706,432,500
June 30, 1989 570,386 $11,454,854,549 1,639,288,165
During the relevant time period, virtually all the assets of the Fund have been invested in obligations of the GNMA. GNMA is an agency within the United States Department of Housing and Urban Development which acquires mortgages or mortgage purchase commitments, insured or guaranteed by other government agencies, and resells them to private mortgage lenders, such as mortgage bankers, commercial banks and saving and loan associations. These lenders assemble a pool of mortgages which, upon application, are guaranteed by GNMA. The private lenders, also known as "issuers," create and sell to investors certificates representing fractional or total ownership of such. Securities dealers purchase the certificates created by the issuers and resell them to customers such as the Fund. The originator of a pool and issuer of its certificates receives a servicing fee of 44 basis points a year. GNMA receives 6 basis points a year as a guarantee fee.
Ginnie Mae certificates are referred to as "pass-through" securities because the monthly payments of interest and principal on the mortgages in each pool are passed on by the pool originators to the certificate holders, after deduction of the foregoing fees. The nature of Ginnie Mae securities gives rise to certain complexities in respect of managing a fund consisting of them. Openend mutual funds such as the Fund are required to calculate their net asset values on a daily basis and to offer and redeem their shares on a daily basis. Because the individual mortgages making up the pool underlying the certificates might be prepaid as the result of changing interest rates, the calculation of net asset value on a daily basis poses some administrative problems. Uncertainty on prepayments also causes uncertainty in predicting yields, which impacts upon investment decisions.
Throughout the relevant period the Fund has had five directors. Charles B. Johnson and Rupert H. Johnson, Jr. are affiliated with defendants. The three independent, non-affiliated directors are S. Joseph Fortunato, Harris J. Ashton, and Edmund H. Kerr.
The fees paid by the Fund to its investment adviser-manager are approved by the board of directors and included in a contract between the Fund and the adviser. Franklin Distributors acted as the Fund's investment adviser-manager until January 31, 1986. Franklin Advisers has acted as the Fund's adviser-manager under a contract which became effective February 1, 1986, was renewed as of February 1, 1987, and amended in February 1988, effective April 30, 1988. The fees paid by the Fund to Franklin Advisers may be summarized as follows:
Fee Schedule of the Fund
February 1, 1986 through January 31, .625% on first $100 million of net assets
1988
.50% on next $150 million
.45% on amounts over $250 million
February 1, 1988 (effective April 30, 1988) .44% on net assets in excess of $10 billion
to present: up to $12.5 billion
.42% on net assets in excess of $12.5 billion
up to $15 billion
.40% on net assets in excess of $15 billion
Considerable majorities of the Fund's shareholders voted by proxy to approve each of the management agreements.
Purchasers of shares of the Fund pay a sales charge in accordance with the terms of the prospectus. On a purchase of up to $100,000, the sales charge equals 4% of the gross amount invested. The scale then adjusts downwards by stages to a sales charge of .25% for purchases in excess of $2.5 million. The sales charge is paid with respect to both new purchases and reinvestments of income dividends. One hundred percent of the initial sales charge is paid to securities dealers who sell the shares. The sales charge on reinvested income dividends is shared with the securities dealers. The sale charges received and retained in recent years may be summarized as follows:
Amount Retained
by Franklin Amount Paid to
Year Distributors Securities Dealers Total
1985 $ 3,114,000 $169,066,000 $172,180,000
1986 $16,550,000 $315,271,000 $331,821,000
1987 $14,357,000 $ 99,672,000 $114,029,000
1988 $ 8,118,592 $ 38,224,436 $ 46,343,028
Pursuant to a separate contract, the Fund pays Franklin Services fees on a per-account basis of $6.00 annually. These fees are paid for Franklin Services' work as transfer agent,, dividend disbursing agent and shareholder services agent. For fiscal years ending September 30, the fees have been:
1985 $1,508,043
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