Norman v. McKee, 45079.

• Citation: 290 F. Supp. 29
• Decision Date: 29 July 1968
• Docket Number: No. 45079.,45079.
• Parties: Lawrence NORMAN and Elisabeth Norman, Plaintiffs, v. R. L. McKEE et al., Defendants.
• Court: U.S. District Court — Northern District of California

290 F. Supp. 29

Lawrence NORMAN and Elisabeth Norman, Plaintiffs, v. R. L. McKEE et al., Defendants.

No. 45079.

United States District Court N. D. California.

July 29, 1968.

Harold S. Kant, Beverly Hills, Cal. (Kant & Gordon, Beverly Hills, Cal., on the brief), and Abraham L. Pomerantz and Richard M. Meyer, New York City (Pomerantz, Levy, Haudek & Block, New York City, on the brief), for plaintiffs.

Moses Lasky and Charles B. Cohler, San Francisco, Cal. (Brobeck, Phleger & Harrison, San Francisco, Cal., on the brief), for defendants Insurance & Securities Incorporated, R. L. McKee, E. R. Foley and Elwood Murphey.

Paul A. Renne, San Francisco, Cal. (Cooley, Crowley, Gaither, Godward, Castro & Huddleson, San Francisco, Cal.), for defendants Pacific National Bank of San Francisco, California, W. H. Draper, Jr., and Waldo W. Weeth.

Alma M. Myers, Berkeley, Cal., for objectors Alma M. Myers and Myrtle G. Cromwell, as executrices of the will of Ethel I. Bumbaugh, deceased.

LeRoy W. Rice, San Francisco, Cal., on behalf of objector Paul E. Geerlings and Donald M. Feuerstein, Special Counsel, Securities and Exchange Commission, Washington, D. C. (Philip A. Loomis, Jr., Gen. Counsel, Walter P. North, Associate Gen. Counsel, Solomon Freedman, Director, Division of Corporate Regulation, and Robert C. Hacker, Atty., Division of Corporate Regulation, Securities and Exchange Commission, Washington, D. C., on the brief), for amicus curiae Securities and Exchange Commission.

MEMORANDUM OF DECISION

SWEIGERT, District Judge.

This suit was commenced on May 9, 1966, by the named plaintiffs, Lawrence Norman and Elisabeth Norman, his wife, as investors since 1963 in Insurance Securities Trust Fund against the Fund (which has approximately 175,000 investors); its directors and officers, its Trustee, Pacific National Bank, and its underwriter and manager, Insurance Securities Incorporated (hereinafter referred to as ISI) derivatively on behalf of the Fund and representatively on behalf of all other investors. Jurisdiction of this Court is invoked under the Investment Company Act of 1940 (15 U.S. C. § 80a-1 et seq).

The complaint alleges in substance and effect that the defendants, acting in violation of the Act, improperly charged the Fund (a) with brokerage commissions totaling $3,772,000 during the fiscal years ending June 30, 1962, 1963, 1964 and 1965; (b) with advisory fees amounting to $5,369,282 during the fiscal year ended June 30, 1965; and (c) with net creation fees amounting to $11,539,666 during the same period. The complaint prays that the defendants be required to account for and restore to the Fund these alleged improper charges, totaling in all over 20 million dollars, and further that defendants be required to pay plaintiffs their costs of suit including reasonable attorneys' fees.

The case comes before the court at this time pursuant to a previous order made under Rules 23(a) and 23.1 Fed. R.Civ.P., and dated and filed herein February 21, 1968, requiring all investors in the Fund, as members of the represented class, to show cause on April 3, 1968, why a certain Stipulation and Settlement and Compromise entered into between the named plaintiffs and the defendants and filed and dated herein February 21, 1968, should not be approved by the court and a judgment entered herein accordingly and binding on all members of the represented class who have not noticed their exclusion as permitted in Rule 23.

The matter came on regularly for hearing on April 3, 1968, at which time certain of the represented class appeared to oppose approval of the settlement, among whom were Alma Myers and Myrtle G. Cromwell, as executrices of the Last Will of Ethel I. Baumbaugh, deceased, a member of the represented class until her death on March 29, 1967. Further hearings were held on April 4th, April 30th, May 24th and the matter was submitted for decision as of June 7, 1968.

During the hearings affidavits of the parties to the action and of appearing members of the class were received, some oral testimony taken and argument was heard. Further, on April 8, 1968, the court, acting on its own motion, requested the Securities and Exchange Commission to appear as amicus curiae. The Commission did so appear through its General, Associate and Special Counsel, by Memorandum filed herein on May 22, 1968.

All parties to the suit and appearing members of the class were given full opportunity to respond to said SEC Memorandum by oral argument, written briefs and further affidavits, the responding briefs of the named plaintiffs herein and of the defendants herein being filed herein as of May 22nd and May 21st, respectively.

The court agrees with the named plaintiffs and the defendants to the extent of their argument that the court should not lightly disapprove a compromise of litigation.

However, settlement of a derivative and representative suit affects, not only the rights of those actually before the court, but also the rights of many persons not present to speak for themselves. Rules 23(a) and 23.1 place the court in the role of a third party to the compromise or guardian of the absent parties and of the corporate fund as a whole. The absence or silence of investors does not relieve the judge of his duty and, in fact, adds to his responsibility.

The burden is on the proponents of the settlement to show that the settlement is fair and reasonable, having in mind the likely results of the litigation as compared with the consideration received for not going forward with it.

Although compromise, generally speaking, is to be encouraged, and the practical judgment of the named parties advised by competent counsel is entitled to considerable weight, and although the court should not simply substitute its practical judgment for that of the parties, the court, nevertheless, should not approve a settlement which appears on its face to be so inadequate and, therefore, so unfair to the corporate fund or represented class as not to merit judicial approval. With this in mind we examine the various aspects of the proposed settlement.

THE BROKERAGE FEE ISSUE

The proposed stipulated settlement provides that ISI will restore to the Fund amounts charged by it as brokerage commissions from and after July 1, 1967, so far as those charges exceed ISI's own costs of performing brokerage service —an amount stipulated to be $618,286.72 —and, further, that hereafter ISI will itself perform all services in connection with the sale or purchase of portfolio for the account of the Fund at a charge no greater than ISI's own costs of performing such service—such costs to be determined according to a prescribed formula—and, further, that this arrangement will remain in effect for a period of ten years.

It will be noted that under the proposed settlement no part of the brokerage fees charged against the Fund by ISI prior to July 1, 1967 is to be restored to the Fund.

According to the record (see SEC Order of 1/11/68, p. 7, as appended to the Stipulation for Settlement and Compromise filed 2/21/68) brokerage commissions charged by ISI against the Fund amounted to more than six million dollars during the fiscal years 1959-1967. Plaintiffs' complaint, filed May 9, 1966, alleged the amount to be $3,772,000 during the fiscal years 1962, 1963, 1964 and 1965, apparently upon the theory that recovery would have to be limited by the four year statute of limitations. Adding brokerage fees charged after the filing of suit, the total would be over five million dollars.

Assuming the propriety of offsetting against this amount in favor of ISI its actual costs of performing brokerage services,¹ the recoverable amount of "profit" on the brokerage fees would still be not less than $2,771,307, according to counsel for the named plaintiffs (see Plaintiffs' Brief of 5/22/68, p. 15) and $1,750,000, according to defendants (see Defendants' Brief of 5/21/68, p. 15).

Counsel for the named plaintiffs express the belief (Plaintiffs' Brief of 5/22/68, p. 10) that giving up of claims for restoration of $2,800,000, past "profit" made by ISI on over five million dollars of brokerage commissions charged against the Fund during the limitations period prior to July 1, 1967, is justified by the fact that the settlement, which obligates ISI to refrain for 10 years from charging the Fund for brokerage services (beyond its actual costs) will eventually benefit the Fund to the extent of an estimated ten million a year, i. e., one million a year over a future 10 year period.

The difficulty with this argument is that the Securities Exchange Commission, as early as August 5, 1964, nearly two years before the commencement of this suit, had issued a formal order directing its staff to investigate the ISI practice of charging the Fund with brokerage commissions and had followed through on March 6, 1967, with a private administrative proceeding against ISI to determine whether the charging of these commissions violated the anti-fraud provisions of the Securities Acts or the Investment Advisory Act of 1940. This latter proceeding eventually resulted in the SEC Order of 1/11/68 already mentioned herein.

That Order sets forth a stipulation (pp. 2-7) of the facts concerning brokerage commissions charged to the Fund by ISI between 1959 and 1967; also a statement of the reasons (p. 8) for the SEC Division of Corporate Regulation and Trading and Markets determination that it was unjustifiable for ISI to charge the Trust Fund brokerage commissions in addition to the so-called management fee provided in the basic Trust Agreement.

The Order then recites that, although ISI denies any violation of the federal securities laws, it has offered to discontinue, retroactively to July 1, 1967, charging any amounts in excess of its actual administrative cost of the brokerage services performed for the Fund and has consented to the entry of a cease and...