Lessler v. Little, 88-1015

Decision Date10 June 1988
Docket NumberNo. 88-1015,88-1015
Citation857 F.2d 866
PartiesFed. Sec. L. Rep. P 94,020 Richard LESSLER, Plaintiff, Appellant, v. Arthur D. LITTLE, et al., Defendants, Appellees. . Heard
CourtU.S. Court of Appeals — First Circuit

Mordecai Rosenfeld, P.C. and Alan E. Bandler, P.C., New York City, with whom Benjamin J. Stein, Amedeo C. Merolla and Asquith, Merolla, Anderson, Ryan & Wiley, Providence, R.I., were on brief, for plaintiff, appellant.

Robert G. Flanders, Jr., with whom Jeffrey C. Schreck, Robert Karmen, Flanders & Medeiros Inc., Paul V. Curcio, John Gyorgy, and Adler Pollock & Sheehan Inc., Providence, R.I., were on brief, for defendants, appellees Narragansett Capital Corp., William P. Considine, John M. Fox, Frederick G. Frost, III, Harlow W. Gage, Norman E. McCulloch, Jr., John R. Rockwell, Harvey J. Sarles, and Rosalie J. Wolf, Narragansett Management Corp., Arthur D. Little, Robert D. Manchester, Gregory P. Barber, Roger A. Vandenberg, Jonathan Nelson, and Geraldine M. McNulty.

John D. Donovan, Jr., with whom Ann Pauly Michalik and Ropes & Gray, Boston, Mass., were on brief, for defendant, appellee Monarch Capital Corp.

Before BOWNES and BREYER, Circuit Judges and CAFFREY, * Senior District Judge.

BOWNES, Circuit Judge.

Richard Lessler appeals the dismissal of his complaint against Narragansett Capital Corporation (Narragansett), Narragansett Management Company (Management Company), Monarch Capital Corporation (Monarch) and various individual defendants who are officers and directors of Narragansett and Management Company. Lessler, as a shareholder of Narragansett and acting on behalf of all shareholders, challenged the sale of Narragansett's assets to Monarch under federal and state securities laws. Adopting the report and recommendation of the magistrate, the district court found that Lessler's complaint failed to state a claim upon which relief could be granted, Fed.R.Civ.P. 12(b)(6), and failed to plead fraud with particularity, Fed.R.Civ.P. 9(b). We affirm in part and reverse in part.


In reviewing the dismissal, we consider only those facts and allegations set forth in the complaint and must view them in the light most favorable to the plaintiff, Lessler. Harper v. Cserr, 544 F.2d 1121, 1122 (1st Cir.1976); see also Miree v. DeKalb County, 433 U.S. 25, 27 n. 2, 97 S.Ct. 2490, 2492 n. 2, 53 L.Ed.2d 557 (1977). The "accepted rule" is that Lessler's complaint should be dismissed for failure to state claim only if it appears beyond doubt that Lessler can prove no set of facts which would entitle him to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 101-02, 2 L.Ed.2d 80 (1957); Harper, 544 F.2d at 1122.

Incorporated in Rhode Island, Narragansett was a closed-end investment company registered under the Investment Company Act of 1940. 15 U.S.C. Sec. 80a-1 et seq. Its shares were traded in the over-the-counter market. Management Company, a separate corporation, provided investment advice to Narragansett pursuant to a series of investment advisory contracts. Prior to the events here at issue, the individual defendants in this action attempted to take Narragansett "private," arranging for the sale of Narragansett's assets to themselves and certain other individuals. Such a transaction, however, required approval of the Securities and Exchange Commission, and after Lessler and others opposed the transaction, the individual defendants withdrew the plan.

Subsequently, Narragansett management proposed the sale of Narragansett's assets to Monarch. A proxy statement dated September 19, 1986, was mailed to all shareholders, giving notice of a special shareholders meeting to be held on October 30, 1986, for the purpose of voting on the proposed sale. At the special meeting, the Narragansett shareholders voted to approve. Under the terms of the sale to Monarch, Narragansett shareholders received fifty-five dollars in cash plus approximately one dollar in tax credits for each share of stock owned.

The Monarch-Narragansett agreement also provides that Monarch, which is not a registered investment company, will continue to employ Management Company as its investment adviser. For its services, Management Company will receive a management fee of two percent plus a potential additional one percent based on performance. Management Company will also receive a special fee of twenty percent of the cumulative net profit that Monarch realizes from the disposition of any assets it purchased from Narragansett.

Claiming that the special twenty percent contingent fee effectively constitutes an ownership interest by Management Company in Monarch, and thus in Narragansett, Lessler filed a putative class action on behalf of all Narragansett shareholders in United States District Court for the District of Rhode Island. Lessler's complaint has three counts, based respectively on alleged violations of the Investment Company Act, the Securities Exchange Act of 1934 (1934 Act) and Rhode Island state corporation law.

Lessler argues first that the Monarch-Narragansett transaction violates section 17(a)(2) of the Investment Company Act, which prohibits any "affiliated person" knowingly from purchasing the assets of a registered investment company. 1 15 U.S.C. Sec. 80a-17(a)(2). Management Company and the individual defendants are concededly "affiliated persons" of Narragansett, see 15 U.S.C. Sec. 80a-2(a)(2)-(3), and Lessler claims that Management Company through the sale to Monarch has itself indirectly purchased assets of Narragansett. See 15 U.S.C. Sec. 80a-47(a) ("It shall be unlawful for any person, directly or indirectly, to cause to be done any act or thing through means of any other person which it would be unlawful for such person to do under the provisions of this subchapter."). Lessler also alleges that the twenty percent contingent fee constitutes an excessive advisory fee in violation of section 36(b) of the Investment Company Act. 15 U.S.C. Sec. 80a-35(b). 2 Because of the alleged violations of section 17(a)(2) and 36(b), Lessler seeks the following relief under the Investment Company Act: (1) rescission of the Monarch-Narragansett sale contract under section 47(b)(1), 15 U.S.C. Sec. 80a-46(b)(1) 3; (2) recovery of the excessive advisory fee under section 36(b), 15 U.S.C. Sec. 80a-35(b), and/or an injunction preventing enforcement of the advisory contract; and (3) recovery against the individual defendants for unjust enrichment pursuant to section 47(b)(3)(B), 15 U.S.C. Sec. 80a 46(b)(3)(B) ("This subsection shall not apply ... to preclude recovery against any person for unjust enrichment.").

Lessler's 1934 Act claim arises under sections 10(b) and 14(a), 15 U.S.C. Secs. 78j(b) & 78n(a), and rules 10b-5 and 14a-9 of the Securities and Exchange Commission. 17 C.F.R. Secs. 240.10b-5 & 240.14a-9. 4 It relates primarily to Narragansett's proxy statement. Lessler claims that the proxy statement was materially false and misleading in that it characterized Management Company's contract with Monarch as a legitimate investment advisory contract rather than as "a guise and a sham to conceal the true fact that the Management [Company and individual defendants] are diverting to themselves assets of [Narragansett] that belong to all the shareholders." Amended and Supplemental Complaint at 11.

Lessler's state law claim alleges a breach of fiduciary duty by the individual defendants in approving a sale which "diverted" twenty percent of Narragansett's assets to Management Company. Amended and Supplemental Complaint at 17. As a result of this breach, Lessler asserts, Narragansett shareholders received less than the full and fair price for their shares in the sale to Monarch. Lessler also argues that Monarch is liable under state law as an aider and abettor of the other defendants in their breach of fiduciary duty.

All defendants moved to dismiss Lessler's complaint and the motions were referred to the magistrate by the district court. The magistrate recommended that Lessler's complaint be dismissed in its entirety. Lessler v. Little, No. 86-0639P (D.R.I. Sept. 29, 1987) (Report). With respect to Lessler's Investment Company Act claims, the magistrate drew a bright line distinction between the sale of Narragansett's assets to Monarch and the advisory agreement between Monarch and Management Company, which he characterized as "[i]ndependent of and subsequent to" the purchase. Report at 3. Noting that only Management Company and not Monarch was an "affiliated person," the magistrate held that, considered in isolation, Narragansett's sale to Monarch was not a violation of section 17(a)(2). The magistrate also found that Monarch's contingent compensation arrangement with Management Company did not "as a matter of law transform [Management Company] into [a purchaser] of Narragansett property" because the compensation agreement was entered into after Monarch, an independent company, purchased Narragansett's assets. Report at 8.

In support of his recommended dismissal of Lessler's claim under section 36(b), the magistrate cited the following statutory exception to section 36(b) suits: "This subsection shall not apply to compensation or payments made in connection with transactions subject to section 80a-17 of this title...." 15 U.S.C. Sec. 80a-35(b)(4). Notwithstanding the magistrate's prior conclusion that the Monarch-Narragansett transaction was not a purchase governed by section 17(a)(2), the magistrate found that Lessler's section 36(b) claim fell within this exception and thus failed to state a claim. Report at 9-10. Because he found that Lessler had no claims under section 17(a)(2) and 36(b), the magistrate also recommended dismissing Lessler's claims under sections 47(b) and 48(a), which the magistrate described as "purely remedial" provisions not creating substantive rights. Report at 10-12.

The magistrate recommended dismissing Lessler's 1934 Act claim on the basis of ...

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