Mann v. Kemper Financial Companies, Inc.

• Decision Date: 30 December 1992
• Docket Number: No. 1-90-0282,1-90-0282
• Parties: , 187 Ill.Dec. 726 Steven D. MANN and Kenneth L. Cunniff, individually and on behalf of a class of similarly situated persons, Plaintiffs-Appellants, v. KEMPER FINANCIAL COMPANIES, INC., Kemper Financial Services, Inc., and Thomas A. Richards, Defendants-Appellees.
• Court: United States Appellate Court of Illinois

Page 317

618 N.E.2d 317

247 Ill.App.3d 966, 187 Ill.Dec. 726

Steven D. MANN and Kenneth L. Cunniff, individually and on behalf of a class of similarly situated persons Plaintiffs-Appellants, v. KEMPER FINANCIAL COMPANIES, INC., Kemper Financial Services Inc., and Thomas A. Richards, Defendants-Appellees.

No. 1-90-0282.

Appellate Court of Illinois First District, Third Division.

Dec. 30, 1992.

Rehearing Denied July 21, 1993.

Richard J. Prendergast, Richard J. Prendergast, Ltd., Thomas J. Moore, Jane F. Anderson, McCarthy, Duffy, Neidhart & Snakard, Kevin M. Forde, Katrina Veerhusen, Kevin M. Forde, Ltd., James J. Moylan, James J. Moylan & Associates, Chicago, for plaintiffs-appellants.

Joan M. Hall, J. Kevin McCall, Sidney I. Schenkier, Douglas A. Graham, Jenner & Block, Chicago, for defendants-appellees Kemper Financial Companies, Inc., and Kemper Financial Services, Inc.

Justice CERDA delivered the opinion of the court:

Plaintiffs, Steven D. Mann and Kenneth L. Cunniff, individually and on behalf of a class of similarly situated persons, appeal from the dismissal of their consolidated first amended class action complaint alleging fraud in connection with the management of plaintiffs' mutual fund investments. Plaintiffs argue on appeal that they had standing to sue directly for their injuries and that they did not have to bring a shareholder's derivative action.

Plaintiffs alleged the following in their complaint. The action was brought on behalf of all persons who invested in the Kemper Option Income Fund ("KOIF") and the Kemper Investment Portfolios Option Income Fund ("IPI-OP") from January 1985 to the present. KOIF and IPI-OP (referred to collectively as "the mutual funds") were public mutual funds managed by defendant Kemper Financial Services, Inc. ("KFS"), and sponsored by defendant Kemper Financial Companies, Inc. ("KFC") (referred to collectively as "the corporate defendants"). KOIF's prospectus dated February 1, 1987, stated that the mutual fund was organized as a business trust but that, effective January 31, 1986, pursuant to a reorganization, it succeeded to the assets of Kemper Option Income Fund, Inc., a Maryland corporation. IPI-OP's prospectus dated November 15, 1986, stated that Investment Portfolios, Inc. ("IPI"), was a mutual fund, a corporation, and a Massachusetts business trust. IPI offered multiple portfolios, including IPI-OP.

In managing and marketing the mutual funds, KFC and KFS breached duties by failing to maintain and enforce internal trading controls, by commingling financial futures transactions for public and in-house funds, by improperly allocating financial futures trades after the close of trading, by diverting profitable financial futures trades to a Kemper employee profit sharing plan, and by allocating unprofitable financial future trades to the mutual funds, while they were engaged in a pattern of speculative financial futures trading prohibited by the mutual funds' prospectuses.

Plaintiffs further alleged that Mann invested in the KOIF mutual fund on April 1, 1986, and purchased additional shares subsequently. Mann first learned of the corporate defendants' and defendant Thomas Richards' wrongdoing in September 1988. Cunniff invested in the IPI-OP mutual fund on May 7, 1987, and purchased additional shares monthly until March 17, 1988, when he sold his shares. Cunniff first learned of defendants' wrongdoing in October 1988.

KFC was the holding company for KFS. KFC sponsored the mutual funds. KFC controlled and was a "statutory affiliate" of the mutual funds and KFS. KFS served as the investment advisor and underwriter of the mutual funds. KFS was registered as an investment advisor under the Investment Advisers Act of 1940 (15 U.S.C. § 80b-1 (1988)) and was also registered in Illinois. Richards was an officer, employee, and agent of KFS and the portfolio manager of the mutual funds. Richards also managed a portion of the KFS Employee Profit Sharing Plan ("the profit sharing plan"). The corporate defendants shared an agency relationship with respect to their sponsorship, marketing, and management of the mutual funds. Richards shared an agency relationship with KFC in connection with the mutual funds.

The mutual funds' portfolios consisted primarily of dividend paying common stocks whose options were traded on national securities exchanges. The objective of the mutual funds was to provide high current return by investing in common stocks and by writing and selling options on the stocks held to produce additional income. Richards was responsible for managing and maintaining the stock portfolios and for designing strategies to produce additional income. Most of the profit sharing plan's assets were placed in relatively conservative investments, but the portion of the plan that Richards was authorized to trade was intended for speculation in Standard & Poor's 500 Stock Index Futures Contracts ("S & P 500"). Richards spent the majority of his time trading almost exclusively in speculative financial futures and financial index options, which he traded in commingled and unallocated lots for various Kemper funds, including IPI-OP, KOIF, and the profit sharing plan.

The internal compliance procedures required that a portfolio manager complete an order ticket before making a S & P 500 trade; the ticket was to include the name of the Kemper funds on whose behalf the trade was to be executed. After completing the order ticket, the procedures also required that the portfolio manager explain the trade to one of the other portfolio managers or assistant managers and obtain the other's initials. Only then could the order be executed. The order was to be time stamped when it was placed. After the executing broker confirmed that the order had been filled, the procedures required that the fill portion of the trade ticket be completed.

Plaintiffs further alleged that in violation of these procedures, Richards regularly failed to complete his order tickets before he executed trades. After the close of trading, Richards wrote his order tickets and arbitrarily allocated the trades among the various funds. He then telephoned the executing brokers to tell them the names of the funds for which the trades were made and obtained the required signatures without explaining the trades. Richards thereby used the financial resources of the mutual funds to finance his trading for the profit sharing plan. Richards improperly commingled and allocated trades. If the market went against one of the trades, Richards allocated it to the billion dollar mutual funds until the trade could be more favorably closed out.

Plaintiffs further alleged that the prospectuses, which were prepared by the corporate defendants, stated that the mutual funds would not engage in speculative transactions. The corporate defendants failed to properly supervise Richards and failed to enforce federally mandated internal trading controls. Richards persuaded the corporate defendants to exempt him from the portfolio manager peer review system that would have subjected his conduct to scrutiny. Beginning in September 1987, Richards' misconduct was repeatedly reported to the corporate defendants' senior management but no action was taken to stop Richards. Prior to September 1987, the corporate defendants, as "control persons" and "principals" (within the meaning of 15 U.S.C. §§ 77o and 80a-2(a)(9) (1988)) of Richards, knew or in the exercise of reasonable care should have known, of Richards' wrongdoing. Richards' actions benefited the corporate defendants by enhancing the value of their profit sharing plan. As a result, Richards' portion of the profit sharing plan obtained a 400% rate of return while the mutual funds lost tens of millions of dollars. Richards and the corporate defendants concealed their misconduct from plaintiffs.

Count I alleged common law fraud based upon the above allegations. In marketing the mutual funds, the corporate defendants repeatedly made material representations in the prospectuses that the funds did not engage in speculative trading in financial futures contracts. The corporate defendants knew that the representations were false. The corporate defendants and Richards concealed from plaintiffs their speculative trading, commingling of trades, and misallocation of trades. The misrepresentations and subsequent concealment were intended to, and did, induce plaintiffs to invest in the mutual funds. Plaintiffs would not have invested in the mutual funds or retained their investments had they known of the speculation. The reliance was reasonable because the representations were contained in the prospectuses. Plaintiffs were injured as a result of the reliance.

Count II alleged breach of fiduciary duty. As investors, plaintiffs put their entire trust and confidence in the good names of the corporate defendants and allowed them and Richards to exercise complete control over their investments. Plaintiffs had no control over which securities were purchased or how they were purchased. Plaintiffs trusted the corporate defendants and their agents to act prudently in investing their money. The corporate defendants encouraged and promoted this trust and confidence through their advertisements, solicitations, and prospectuses. The corporate defendants and Richards exercised complete domination, superiority, and control in their relationship with plaintiffs. The corporate defendants and Richards owed plaintiffs the highest duty of care, undivided loyalty, fairness, and full disclosure as fiduciaries. The corporate defendants and Richards breached their fiduciary duties to plaintiffs by: (a) violating the terms of the prospectuses and speculating in S & P 500 contracts; (b) failing to disclose and concealing the fact that they were violating the terms of the prospectuses by speculating in S & P 500 contracts; (c) commingling and misallocating S & P 500 trades to their advantage and to plaintiff...