Moses v. Burgin

• Decision Date: 27 August 1970
• Docket Number: Civ. A. No. 67-880.
• Parties: Rose MOSES v. C. Rodgers BURGIN et al.
• Court: U.S. District Court — District of Massachusetts

316 F. Supp. 31

Rose MOSES v. C. Rodgers BURGIN et al.

Civ. A. No. 67-880.

United States District Court, D. Massachusetts.

August 18, 1970.

As Amended August 27, 1970.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Abraham L. Pomerantz and Richard M. Meyer, Pomerantz, Levy, Haudek & Block, New York City, Avram G. Hammer, Boston, Mass., for plaintiff.

Edward B. Hanify, Edward P. Lawrence, George C. Caner, Jr., Ropes & Gray, Joseph P. Rooney, Richard M. Reilly, Boston, Mass., for Edward C. Johnson, II, George Sullivan, Frank D. Mills, George S. McEwan, Edward C. Johnson, III, Caleb Loring, Jr., Edward D. Windsor, William L. Byrnes, Chester Hamilton, Fidelity Management & Research Co. and The Crosby Corp.

Sumner H. Babcock, Bingham, Dana & Gould, Boston, Mass., for C. Rodgers Burgin, George R. Harding, Gilbert H. Hood, Jr., and Ronald Jones.

Richard C. Evarts, Lyne, Woodworth & Evarts, Boston, Mass., for Fidelity Fund, Inc.

FINDINGS OF FACT AND OPINION INCORPORATING CONCLUSIONS OF LAW

WYZANSKI, Chief Judge.

I.

Introduction.

This is a stockholder's derivative action brought against a mutual fund registered under the Investment Company Act of 1940, 15 U.S.C. secs. 80a-1 et seq., (hereafter called "the Act"), its directors, its investment adviser, and its underwriter. Plaintiff alleges that she through her company has been injured by defendants' violations of their statutory duties under secs. 1, 15, 36 and 37 of the Act, 15 U.S.C. secs. 80a-1, 15, 35 and 36, and of their non-statutory fiduciary duties.

Plaintiff's main challenge is to the practices followed by the mutual fund in (a) placing much of its portfolio brokerage (that is, orders for the purchase and sale of securities) with stock-brokers who as dealers had sold to the public new shares of the fund or who had provided statistical information for the fund or its manager and (b) directing such parts of a stockbroker's commission as he is willing to surrender, (that is, give up,) to other stockbrokers who had sold such shares or who had provided such statistical information.

In the language of the securities industry, the placing of portfolio brokerage with a stockbroker who has sold fund shares, or has supplied information, or otherwise served the customer is called "reciprocity"; the part of that stockbroker's commission which he retains is called a "reciprocal"; and the part which he surrenders to another stockbroker designated by the customer is called a "customer-directed give-up", or more simply and more usually a "give-up".

Stated broadly, the principal questions presented by this action are: (1) did defendants in placing the fund's brokerage on a reciprocal basis violate a statutory or non-statutory duty to secure for the fund the best execution of its purchase and sale orders; (2) did defendants in using the give-ups to stimulate sales of fund shares and supply of statistical information violate a statutory or non-statutory duty to secure for the fund a greater benefit by using the give-ups in some other way, such as by directing them to the fund's underwriter, or to a stockbroker affiliated with the fund or its management; (3) did defendants in taking into account sales of shares of, and information furnished to, sister funds (into whose shares the shares of this fund were convertible) when defendants placed this fund's brokerage on a reciprocal basis and directed give-ups violate a statutory or non-statutory duty not to mingle the assets of different trusts; and (4) did defendants in omitting from the text of the investment advisory and underwriting contracts of the fund sufficient reference to reciprocal and give-up practices they followed render those contracts invalid under section 15 of the Act.

II.

Findings of Fact.

A. Parties

1. Plaintiff Rose Moses is and since 1960 has been a stockholder of Fidelity Fund, Inc.

2. Defendant Fidelity Fund Inc. ("FF"), a Massachusetts corporation, is an investment company or open-end mutual fund, registered under the Act, and seeking long term capital growth and income. As of mid-1968 it had net assets of over $834 million. In December 1967 it had 76,600 shareholders. FF is part of a group of 12 sister funds (hereafter collectively called "the Fidelity group"). They have different sizes and different investment objects, but they all have the same officers, directors, adviser and underwriter. As of mid-1968 the group had net assets of about $4 billion.

3. Defendant Fidelity Management & Research Company ("FMR"), a Delaware corporation, is the investment adviser of FF pursuant to annual contracts in purported compliance with Section 15 (a) of the Act. Under the contracts, FF pays FMR an annual advisory fee equal to 0.5% of FF's net assets up to $200 million and 0.35% of all net assets in excess of that amount. FMR received in advisory fees from FF more than $2.7 million in 1967 and $3.1 million in 1968 and from the whole Fidelity group in 1967 about $14 million.

4. Defendant The Crosby Corporation ("Crosby"), a Delaware corporation, is a wholly owned subsidiary of FMR, and is an underwriter which has as its exclusive business selling at wholesale shares of the Fidelity group to independent securities dealers across the country who in turn sell them to prospective investors. FF, pursuant to annual contracts in purported compliance with Section 15(b) of the Act, sells its shares at their current asset value to Crosby, and Crosby and its dealers are authorized to make sale charges as set forth in a prospectus. The incoming shareholders pay these sale charges which start at 7½% of the offering price and scale down after $25,000, according to the amount of the sale. Of the sales charge Crosby retains a maximum of 1½%, and the dealer a maximum of 6%. Crosby received net underwriting commissions from new investors in FF in 1967 over $533 thousand, and in 1968 over $803 thousand.

5. Defendant Edward C. Johnson 2d is the president and a director of FF. He is also the president, a director, and the principal stockholder of FMR.

6. Defendant Edward C. Johnson 3d is a director of FF and of FMR.

7. Defendants Burgin, Harding, Hood, Jones, McKenzie, and Schermerhorn are or recently have been directors of FF, and each claims he is not "an affiliated person" within the meaning of Section 10(a) of the Act. These defendants call themselves "unaffiliated directors".

B. FF's Methods of Handling Brokerage

8. At all material times, FF, pursuant to its advisory contract, relied for investment advice as to which securities it should buy, sell, and hold upon the investment committee of FMR and of FF which reached its conclusions with the aid of FMR's research department.

9. FMR transmitted lists of securities to be bought, or sold, or held to a so-called portfolio manager, Joseph Midwood, a vice president of FF, but paid by FMR. He, within the framework of those lists, which constituted FMR investment committee authorizations, determined when a particular purchase or sale should be effected. He transmitted his determination to buy or sell a security to FF's trading department, headed by Miller Laufman, FF's manager of securities transactions, but paid by FMR.

10. Under Laufman's direction, the FF trading department decided through whom or with whom FF would execute the transaction specified by Midwood. At all times, the trading department was under instructions to check prices on all exchanges and on the third market in order to get always the best price, and also the best execution.

11. Examples of those instructions are to be found in what are called "reciprocal reports", that is monthly memoranda from D. George Sullivan, executive vicepresident of FF, and William L. Byrnes, vice president of FF. The earliest reciprocal report in evidence, the one for January 1966, states that "The Trading Department and the account managers should be always mindful that the persons we serve are the shareholders * * *", and that "The Trading Department should continue to use and explore this third market, always in the interest of best execution." Ex. 4A, pp. 2, 3. The same themes appear consistently in later reports. Ex. 4B, pp. 2, 3; Ex. 4C, p. 3; Ex. 4D, p. 3, etc.. Thus the report for August 1966 directs that "In accordance with its usual procedure, the Trading Department should continue to check prices on the third market as well as those on the exchanges in order to get always the best price and, also, the best execution." Ex. 4H, p. 3.

12. Subject to his over-all instruction that "the best price is paramount" Ex. 4X, p. 3, Laufman used a list of 50 to 60 primary or lead brokers. This was a compilation of stockbrokers whom Laufman had investigated and of whose capacity to execute transactions he was satisfied. Sometimes Laufman, after investigation, added to that list a broker proposed by Sullivan, on the ground the broker had been successful in selling shares of FF or its sister funds.

13. When determining which broker to select for a particular transaction, Laufman had information from Crosby of the amount of Fidelity group shares each of the primary brokers had sold in the previous month. From that information he set up a quota system so that he could give in the current month each of the primary brokers business from which each would derive and retain commissions equal to at least one percent of his sales of Fidelity group shares during the previous month. Such retained commissions constituted "reciprocals" received by the primary brokers.

14. In the period when give-ups were allowed, that is, until December 5, 1968, before Laufman placed an order with a broker, he knew or learned whether the broker would submit to a give-up of part of his commission on that order. If the transaction did involve a give-up, Chester Hamilton, the treasurer of FF, but paid by FMR, wrote to the giving-up broker a letter identifying the transaction and directing to whom the give-up should be paid. When writing such a...