Moses v. Burgin, 7745.

• Decision Date: 23 June 1971
• Docket Number: No. 7745.,7745.
• Citation: 445 F.2d 369
• Parties: Rose MOSES, Plaintiff, Appellant, v. C. Rodgers BURGIN et al., Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

445 F.2d 369 (1971)

Rose MOSES, Plaintiff, Appellant, v. C. Rodgers BURGIN et al., Defendants, Appellees.

No. 7745.

United States Court of Appeals, First Circuit.

June 4, 1971.

As Amended June 23, 1971.

COPYRIGHT MATERIAL OMITTED

Abraham L. Pomerantz, New York City, with whom William E. Haudek, Richard M. Meyer, Pomerantz Levy Haudek & Block, New York City, and Avram G. Hammer, Boston, Mass., were on the brief, for appellant.

Edward B. Hanify, Boston, Mass., with whom George C. Caner, Jr., Edward P. Lawrence, John S. Hopkins, III, Elizabeth Paine, Ropes & Gray, Joseph P. Rooney, and Gaston, Snow, Motley & Holt, Boston, Mass., were on the brief, for Edward C. Johnson 2d, Edward C. Johnson 3d, Fidelity Management & Research Company, and the Crosby Corporation appellees.

Sumner H. Babcock, Boston, Mass., with whom Richard F. McCarthy and Bingham, Dana & Gould, Boston, Mass., were on the brief, for C. Rodgers Burgin, George R. Harding, Gilbert H. Hood, Jr., and Ronald Jones, appellees.

Before ALDRICH, Chief Judge, McENTEE and COFFIN, Circuit Judges.

ALDRICH, Chief Judge.

Plaintiff Moses, a shareholder of Fidelity Fund, Inc. (Fund), a Massachusetts-incorporated investment company, in December 1967 filed a complaint, and in November 1968 an amended complaint, in this derivative action. Fund is an open-end mutual fund, registered under the Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 et seq. Defendants, in addition to Fund, are Fidelity Management and Research Company (Management), Fund's investment adviser; The Crosby Corporation (Crosby), a wholly owned subsidiary of Management and sometimes included within that term, an underwriter whose sole business is selling shares of Fund to independent broker-dealers; E. C. Johnson 2d, president and director of Fund, and president, director and principal voting stockholder of Management; E. C. Johnson 3d, director of Fund since April 1968, and director and substantial voting stockholder of Management; and C. R. Burgin, G. R. Harding, G. H. Hood, Jr., R. Jones, G. K. McKenzie and H. Schermerhorn, who are or were directors of Fund who claim not to be "affiliated" within the meaning of section 10(a) of the Act, 15 U.S.C. § 80a-10(a), hereinafter the unaffiliated directors.¹ Although the last two were named as defendants, the action has been dismissed against them for lack of service of process. Other dramatis personae, not defendants, include D. G. Sullivan, a vice-president of Management and Fund and since April 1968 a director of Fund; C. Loring, Jr., an officer of Fund and counsel for, and a non-voting stockholder of, Management; and S. H. Babcock, retained in December 1966 as counsel to advise the unaffiliated directors.

Plaintiff complained of various breaches of fiduciary duty allegedly imposed by the Investment Company Act and the common law. Following an extensive trial on liability only, the district court resolved all ultimate issues against her. 316 F.Supp. 31. Plaintiff appeals. The record is voluminous, the briefs lengthy and detailed, and the sums of money involved substantial. Many of the claims advanced in the district court are no longer pressed. Before us plaintiff makes one principal complaint, that Fund could, and should, have recovered a portion of the brokerage commissions it was obliged to pay on its so-called portfolio business, viz., on the purchases and sales of the securities in which it invested its assets. Plaintiff's proposals as to how this should have been accomplished require a considerable review of Fund's method of operation.

Fund's shareholders are numbered in five, and its assets in the upper nine, figures. The amount of its assets, apart from changes in the market value of its investments, depends upon the number of shares that it can sell as against the number it must redeem. Both activities are continual. The purchasers of individual participating interests, or shares, pay their net worth in terms of the current value of Fund's assets, plus a 1½% sales charge to Crosby and a brokerage commission of 6%.² In reponse to advice by Management, Fund is constantly changing its portfolio. This is done through independent broker-dealers, and mostly involves trading by them on the New York and regional stock exchanges. The conclusion of a trade is commonly referred to as execution. A claim made in the district court was that defendants, in choosing their brokers, or other trading methods not presently pertinent, did not always obtain best execution. The court resolved this issue against plaintiff, from which no appeal is taken.

The exchanges, at all relevant times, set required commission rates, with no quantity discounts. Because of the size of many mutual fund transactions brokers competing for business were willing to give up a portion of the commissions they received from the fund. "Anti-rebate" rules adopted by every exchange prevented any rebate or discount, direct or indirect, that would bring the net commission paid below the minimum level set by the exchange. As will be described, the total effect of these rules was in doubt, but they at least prevented direct cash refunds to the customer. On Fund's instructions, at Management's behest, the so-called customer-directed give-ups were paid over to brokers who sold shares of Fund acquired from Crosby to the public, in proportion to their success, in order to stimulate sales.³ Customer-directed give-ups are to be distinguished from broker-directed give-ups, a long-recognized practice whereby two or more brokers who have shared in the work divide the commission between themselves. Give-ups which are customer-directed (which is what we shall mean by the term "give-up" hereafter) are inherently and necessarily, as the district court found, in the nature of a refund, or rebate to the customer.⁴

Plaintiff's complaint is double-barreled. First, she complains of Fund's give-up practices because they resulted in the loss of the value of brokerage commissions which could have been recaptured. She claims recapture was possible either by creation of a broker affiliate that could participate in Fund portfolio transactions, or by channeling present give-ups to an affiliate, with the result that in either case the sums involved would be credited to Fund. Second, she complains that the give-up practices, pursued to the exclusion of either course she suggests, benefitted Management and Crosby, since stimulating sales of Fund's shares increased Crosby's commissions, and increased Management's advisory fee, which was measured by the size of Fund's portfolio. Accordingly, plaintiff claims that Management and the two Johnsons, who together owned 90% of its voting stock, were using Fund's assets to their own private advantage. More pointedly, she claims in particular that Fund's board never considered these possibilities because relevant information regarding them was improperly withheld from the unaffiliated directors by the Management defendants.⁵ Recovery is sought, inter alia, under section 36 of the Investment Company Act, 15 U.S.C. § 80a-35. To prevail on this appeal plaintiff must persuade us that the district court's rulings were wrong and that its factual findings in defendants' favor were clearly erroneous. Plaintiff openly accepts this burden.⁶

Jurisdiction

Before coming to the merits we consider briefly the district court's jurisdiction. Defendants contest vigorously plaintiff's claims that the Investment Company Act establishes a general federal common law of fiduciary obligation, or that she has a valid claim, by way of pendent jurisdiction, under Massachusetts corporate law. We reach neither of these questions, since we see no way in which they would change the result. Defendants do not seriously dispute that the Act impliedly authorizes the courts to grant civil recovery if their conduct fell within the scope of the phrase "gross misconduct or gross abuse of trust" contained in section 36 of the Act, 15 U.S.C. § 80a-35.⁷ We agree with the district court that we have jurisdiction at least to that extent. Brown v. Bullock, S.D.N.Y., 1961, 194 F.Supp. 207, 245, aff'd under other sections, 2 Cir., 294 F.2d 415; cf. J. I. Case Co. v. Borak, 1964, 377 U.S. 426, 430-433, 84 S.Ct. 1555, 1559, 12 L. Ed.2d 423.

Case relied on a general grant of jurisdiction to "enforce any liability or duty created by" the act in question, a provision identically repeated in section 44 of the Investment Company Act, § 80a-43. Further, it is apparent that the purpose underlying section 36 included protection of shareholders against self-dealing by the managers. See section 80a-1(b), quoted post. This can best be accomplished if recourse to the courts is available to private parties who have been thus wronged, as well as to the SEC. See Note, The Mutual Fund and Its Management Company, 71 Yale L.J. 137, 152 and nn. 74-75 (1961) (SEC requests private rights of action for effective enforcement of the Act). Our finding of a private right of action is in accord with the majority of the courts that have reached this question. See Esplin v. Hirschi, 10 Cir., 1968, 402 F.2d 94, 103, cert. denied, 394 U.S. 928, 89 S.Ct. 1194, 22 L.Ed.2d 459 (concerning the Investment Company Act in general); Brown v. Eastern States Corp., 4 Cir., 1950, 181 F.2d 26, cert. denied, 340 U.S. 864, 71 S.Ct. 88, 95 L.Ed. 631 (also concerning the Act in general) (by implication); Tanzer v. Huffines, D.Del., 1970, 314 F.Supp. 189, 193; Brown v. Bullock (district court opinion), ante. But see Brouk v. Managed Funds, Inc., 8 Cir., 1961, 286 F.2d 901, dismissed, 369 U.S. 424, 82 S.Ct. 878, 8 L.Ed.2d 6 with which compare Greater Iowa Corp. v. McLendon, 8 Cir., 1967, 378 F.2d 783, 789-790.

The Duty To Recapture

The brief filed on behalf of Management, Crosby and the two Johnsons states,

"The court found that it was the directors\' common business judgment that encouraging sales would promote a net cash inflow and growth of the Fund

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