Ross v. Bernhard

• Decision Date: 01 November 1968
• Docket Number: No. 6,Docket 32118.,6
• Parties: Howard ROSS and Bernard Ross, as Trustees for Lena Rosenbaum, Plaintiffs-Appellees, v. Robert A. BERNHARD et al., Defendants-Appellants.
• Court: U.S. Court of Appeals — Second Circuit

403 F.2d 909 (1968)

Howard ROSS and Bernard Ross, as Trustees for Lena Rosenbaum, Plaintiffs-Appellees, v. Robert A. BERNHARD et al., Defendants-Appellants.

No. 6, Docket 32118.

United States Court of Appeals Second Circuit.

Argued September 5, 1968.

Decided November 1, 1968.

Certiorari Granted March 24, 1969.

Rosenthal & Gurkin, New York City (Pomerantz, Levy, Haudek & Block, New York City, Abraham L. Pomerantz and Richard M. Meyer, New York City, on the brief), for plaintiffs-appellees.

Sullivan & Cromwell, New York City (Marvin Schwartz and Cornelius B. Prior, Jr., New York City, on the brief), for defendants-appellants, Clark, Francis, Kircher, Puckett, Reavis, Thornton and Wilde.

Simpson, Thacher & Bartlett, New York City (William J. Manning and Lawrence M. McKenna, New York City, on the brief), for defendants-appellants, Robert A. Bernhard, and another.

Walsh & Frisch, New York City (E. Roger Frisch, New York City, on the brief), for defendant-appellant, The Lehman Corp.

Before LUMBARD, Chief Judge, and SMITH and ANDERSON, Circuit Judges.

Certiorari Granted March 24, 1969. See 89 S.Ct. 1190.

LUMBARD, Chief Judge:

This appeal, taken by permission, questions a district court ruling which would allow a jury trial of a stockholders' derivative action. The defendants in this diversity action appeal from a Southern District order entered November 6, 1967 denying their motion to strike plaintiffs' demand for a jury trial. On December 6, 1967, Judge McLean granted defendants' motion to resettle his order, finding that it involved "a controlling question of law as to which there is substantial ground for difference of opinion and that an immediate appeal from this order may materially advance the ultimate termination of this litigation." As there is a difference of views in the district court on this question, see Richland v. Crandall, 259 F.Supp. 274 (S.D.N.Y. 1966), we thereafter permitted an interlocutory appeal to be taken pursuant to 28 U.S.C. § 1292(b).

We hold that the right to a jury trial guaranteed by the Seventh Amendment to the United States Constitution does not extend to stockholders' derivative actions. Accordingly, we reverse the order of the district court.

This derivative action was brought under the Investment Company Act of 1940, 15 U.S.C. § 80a-1 et seq. Named as defendants are the Lehman Corporation, the investment company for whose benefit the suit is brought, various directors and officers of the corporation, and various partners of Lehman Brothers, an investment banking firm which acts as the investment advisor and principal broker for the corporation. Plaintiffs, stockholders of the Lehman Corporation, pray for a judgment requiring defendants to account for, and pay to the corporation, their profits and gains and its losses resulting from illegal and excessive brokerage commissions paid to Lehman Brothers. These commissions fall in three categories:

1) Commissions paid for carrying out transactions for the corporation on the New York Stock Exchange, despite the fact that these transactions could have been executed on the so-called "Third Market" at favorable net prices without the payment of any commissions, or executed other than on a national securities exchange with the payment of substantially smaller commissions than were paid to Lehman Brothers.

2) Commissions paid in connection with over-the-counter transactions in unlisted stocks, despite the fact that the corporation could have conducted these transactions directly with "market makers" and thus avoided paying any commissions.

3) "Reciprocal brokerage commissions" paid by the corporation for allocation to the brokers who provide investment advice to Lehman Brothers, which commissions constitute excessive compensation to Lehman Brothers under its investment advisory contract with the corporation.

The complaint further alleges that more than half of the corporation's directors are affiliated with Lehman Brothers, in violation of § 10(b) (1) of the Investment Company Act, 15 U.S.C. § 80a-10(b) (1). The payments are alleged to constitute "an unlawful and willful conversion" by defendant partners of Lehman Brothers of the corporation's assets, and "gross abuse of trust, gross misconduct, willful misfeasance, bad faith, gross negligence and a reckless disregard of their fiduciary duties" by the defendant officers, directors and brokers of the corporation.

The Seventh Amendment provides:

In Suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise reexamined in any Court of the United States, than according to the rules of the common law.

Judge McLean held that the question of whether the Seventh Amendment required this action to be tried before a jury, upon plaintiffs' demand, depended upon the nature of the corporate claim asserted derivatively by the stockholders; the Seventh Amendment was to be applied as if the corporation itself were suing. He further found that the corporate claim in this action was legal, rather than equitable, in character, being in essence a demand for a money judgment to recover the funds of the corporation converted by defendants. Thus the right to a jury trial attached to this derivative action.

Our disagreement with the court below stems from the teaching of history that the stockholder's derivative action has always been regarded as exclusively a creature of equity to which the right to a jury trial does not apply. The one previous dissent from this view, DePinto v. Provident Security Life Ins. Co., 323 F.2d 826 (9th Cir. 1963), cert. denied 376 U.S. 950, 84 S.Ct. 969, 11 L.Ed.2d 970 (1964), we do not find persuasive. Because of our view of the jury trial issue we have no occasion to address the question of whether the underlying corporate claim is legal or equitable in character.

In determining whether the constitutional right to a jury trial applies to a given action, the basic inquiry to be made is an historical one: At the time the Seventh Amendment was adopted was the action recognized as a "suit at Common law," as to which the right to a jury trial was to be "preserved." Baltimore & Caroline Line v. Redman, 295 U.S. 654, 657, 55 S.Ct. 890, 79 L.Ed. 1636 (1935). Despite the merger of law and equity accomplished by the Federal Rules of Civil Procedure the right to a jury trial still applies only to actions which historically could have been brought at law. Rule 38(a), Fed.R.Civ. P., preserves the right to a jury trial "as declared by the Seventh Amendment to the Constitution * * *." While the Supreme Court seems to have modified this historical test somewhat to take account of the procedural reforms effectuated by the Federal Rules, Beacon Theatres, Inc. v. Westover, 359 U.S. 500, 508-511, 79 S.Ct. 948, 3 L.Ed.2d 988 (1959), for reasons stated below we do not believe that this modification affects the outcome of this case.

The authorities are agreed that the stockholders' derivative action did not evolve until well after the adoption of the Seventh Amendment in 1791. See, e. g., Prunty, The Shareholders' Derivative Suit: Notes on Its Derivation, 32 N.Y.U.L.Rev. 980, 981, 986 (1957). This fact does not, as defendants suggest, foreclose the possibility that derivative actions fall within the scope of the Seventh Amendment. In instances where either Congress or the courts have evolved a new remedy subsequent to the adoption of the Amendment it is to be analogized to its nearest historical counterpart, at law or equity, for the purposes of determining whether a right to jury trial exists. See 5 Moore, Federal Practice ¶ 38.11 7, at 125 (2nd ed. 1968); James, Right to a Jury Trial in Civil Actions, 72 Yale L.J. 654, 655 (1963). No tortuous process of historical analogy is required in this case, however, for it is clear that the derivative action was an invention of equity.

At law stockholders could not bring a suit in the corporation's name for the vindication of a corporate right because, apparently, such legal standing was regarded as incompatible with the limited liability for the corporation's debts enjoyed at law by the stockholders. Note, The Right to a Jury Trial in a Stockholder's Derivative Action, 74 Yale L.J. 725, 729 (1965). Beginning early in the Nineteenth Century equity began to recognize the derivative action, initially in order to provide a remedy against alleged wrongdoers to the corporation who also controlled its management and consequently refused to allow a suit by the corporation against themselves. Taylor v. Miami Exporting Co., 5 Ohio 162 (1831); Robinson v. Smith, 3 Paige Ch. *222, *223 (N.Y.1832) (dictum); see generally Koster v. (American) Lumbermens Mut. Cas. Co., 330 U.S. 518, 522, 67 S.Ct. 828, 91 L.Ed. 1067 (1947). The remedy soon was extended to instances where the stockholders were seeking to enforce a corporate right against an outsider. Dodge v. Woolsey, 59 U.S. (18 Haw.) 331, 341-344, 15 L.Ed. 401 (1855); cf. Forbes v. Whitlock, 3 Edw. Ch. 446 (N.Y.1841).

From these early suits to the present day the equitable nature of the derivative action has not been disputed. See Dodge v. Woolsey, 59 U.S. (18 How.) 331, 341, 15 L.Ed. 401 (1855); Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548, 69 S.Ct. 1221, 93 L.Ed. 1528 (1949). Likewise, with the sole exception of the DePinto decision, supra, there has been no significant dissent from the conclusion that the equitable nature of the action excludes it from the purview of the Seventh Amendment's jury trial guarantee. E.g., Richland v. Crandall, 259 F.Supp. 274 (S.D.N.Y.1966); 5 Moore, Federal Practice ¶ 38.38 4, at 305-06 (2nd ed. 1968); 2 Hornstein, Corporation Law and Practice, § 730 (1959); 13 Fletcher, Private Corporations § 5931 (Rev. ed. 1961); Note, The Right to a Jury Trial in a Stockholder's Derivative Action, 74 Yale L.J. 725, 732 n. 35 (1965) (citations to state court decisions...