Scalisi v. Fund Asset Management, L.P.

• Decision Date: 17 August 2004
• Docket Number: Docket No. 03-9233.
• Citation: 380 F.3d 133
• Parties: April SCALISI, as Custodian for her minor children, Felix Amsler, Plaintiffs-Appellants, v. FUND ASSET MANAGEMENT, L.P., Merrill Lynch Focus Twenty Fund, Inc., Defendants-Appellees, Merrill Lynch Focus Twenty Fund, Inc. Nominal Defendant-Appellee.
• Court: U.S. Court of Appeals — Second Circuit

380 F.3d 133

April SCALISI, as Custodian for her minor children, Felix Amsler, Plaintiffs-Appellants, v. FUND ASSET MANAGEMENT, L.P., Merrill Lynch Focus Twenty Fund, Inc., Defendants-Appellees Merrill Lynch Focus Twenty Fund, Inc. Nominal Defendant-Appellee.

Docket No. 03-9233.

United States Court of Appeals, Second Circuit.

Argued June 18, 2004.

Decided August 17, 2004.

Appeal from the United States District Court for the Eastern District of New York, Thomas C. Platt, Jr., Senior District Judge.

COPYRIGHT MATERIAL OMITTED

Scott W. Fisher, Garwin, Bronzaft, Gerstein & Fisher, L.P., New York, N.Y. (Joel C. Feffer and Daniella Quitt, Wechsler Harwood LLP, on the brief) for Plaintiffs-Appellants.

James N. Benedict, Clifford Chance U.S. LLP, (Mark Holland, Mary K. Dulka, Jennifer Wendy, Sanny B. Hua, Clifford Chance U.S. LLP; Lori A. Martin, First Vice President and Assistant General Counsel, Merrill Lynch Investment Managers L.P., of counsel), for Defendant-Appellee Fund Asset Management, L.P.

Marvin E. Barkin, Trenam, Kemker, Schars, Barkin, Frye, O'Neill & Mullis, P.A., Tampa, FL (Thomas J. Lilly, Jr., O'Donnell, Schwartz, Glanstein & Lilly, Garden City, NJ, on the brief) for Defendant-Appellee Merrill Lynch Focus Twenty Fund, Inc.

Before: LEVAL, and B.D. PARKER, Circuit Judges, IRENAS, Senior District Judge^*.

IRENAS, Senior District Judge.

Plaintiffs April Scalisi and Felix Amsler appeal a decision of the United States District Court for the Eastern District of New York (Thomas C. Platt, Jr., District Judge) dismissing their shareholder derivative action against Defendants Fund Asset Management, L.P. and Merrill Lynch Focus Twenty Fund, Inc. Plaintiffs contend that the district court failed to apply the proper legal standard in determining whether the directors of a mutual fund lacked sufficient independence to render demand upon them futile. We conclude that the district court applied the proper legal standard and correctly held that Plaintiff's Complaint should be dismissed. Accordingly, we affirm.

I

Plaintiffs in this matter are shareholders in Merrill Lynch Focus Twenty Fund, Inc. ("MLF"). MLF is a Maryland corporation registered as an "investment company" under the Investment Company Act of 1940 ("ICA"). 15 U.S.C. § 80a-1 et seq.¹ MLF is one of a complex of funds managed and advised by Defendant, Fund Asset Management, L.P. ("FAM"), a Merrill Lynch and Company, Inc. ("ML") controlled entity.

MLF has a nine-member board of directors. Each of MLF's assertedly independent directors sits on the boards of 49 funds managed by FAM and each is paid between $160,000 to $260,000 yearly for his or her service as a director of those funds. On October 21, 2002, Plaintiff April Scalisi² instituted a derivative action for the benefit of MLF against FAM in the United States District Court for the Eastern District of New York.³ The two-count Complaint alleges: (1) breach of fiduciary duties under ICA § 36(a)⁴; and (2) negligence, gross negligence and negligent misrepresentation. Specifically, Plaintiffs allege that FAM, with actual or imputed knowledge of improprieties within the Enron Corporation ("Enron"), caused MLF to purchase a large block of Enron stock which subsequently became valueless when those improprieties were made public.⁵ See In re Merrill Lynch Focus Twenty Fund Inv. Co. Act Litig., 218 F.R.D. 377, 378 (E.D.N.Y.2003). As a result, MLF suffered economic damages. Id. Prior to filing suit, Plaintiffs did not make a demand on the MLF board that MLF bring the suit; rather, Plaintiffs allege in their Complaint that such a demand would be futile because the MLF directors are "interested persons" under the ICA and, thus, not independent. Pl. Compl. at 7-17. Subject matter jurisdiction in the district court was proper pursuant to 15 U.S.C. § 80a-43 and 28 U.S.C. §§ 1331 and 1367.

On September 24, 2003, Defendants moved to dismiss the Complaint pursuant to Fed.R.Civ.P. 8(a), 12(b)(6) and 23.1. The district court heard oral argument on October 3, 2003, and on October 30, 2003, issued an opinion denying Defendants' Rule 8(a) and Rule 12(b)(6) motions, but granting Defendants' motion pursuant to Rule 23.1. The court held that dismissal of Plaintiffs' Complaint was proper for "their failure to fulfill the demand requirement." In re Merrill Lynch, 218 F.R.D. at 381. Plaintiffs filed their notice to appeal to this Court on November 7, 2003. Jurisdiction is proper pursuant to 28 U.S.C. § 1291. For the reasons set forth below, we affirm.

II

When reviewing a district court's decision to grant a motion to dismiss, we view the facts in the light most favorable to the non-moving party. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); In re Bank of New York Derivative Litig., 320 F.3d 291, 293 (2d Cir.2003); Abramson v. Pataki, 278 F.3d 93, 97 (2d Cir.2002); Comer v. Cisneros, 37 F.3d 775, 786 (2d Cir.1994). However, we are not required to accept as true the legal conclusions or unwarranted deductions of fact drawn by the non-moving party. Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1092 (2d Cir.1995); First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 771 (2d Cir.1994); 2 James Wm. Moore et al., Moore's Federal Practice ¶ 12.34 [1][b] (3d ed.2004).

We have said that where "determination of the sufficiency of allegations of futility depends on the circumstances of the individual case," the standard of review for dismissals based on Fed.R.Civ.P. 23.1 is abuse of discretion. Kaster v. Modification Sys., 731 F.2d 1014, 1018 (2d Cir.1984); see also Lewis v. Graves, 701 F.2d 245, 248 (2d Cir.1983); Elfenbein v. Gulf & W. Indus., Inc., 590 F.2d 445, 450-51 (2d Cir.1978). However, where a challenge is made to the legal precepts applied by the district court in making a discretionary determination, plenary review of the district court's choice and interpretation of those legal precepts is appropriate.⁶ See, e.g., Fama v. Comm'r of Corr. Serv., 235 F.3d 804, 808 (2d Cir.2000); Blasband v. Rales, 971 F.2d 1034, 1040 (3d Cir.1992).

III

A derivative suit "permits an individual shareholder to bring `suit to enforce a corporate cause of action against officers, directors, and third parties.'" Kamen v. Kemper Fin. Serv., 500 U.S. 90, 95, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991) (citing Ross v. Bernhard, 396 U.S. 531, 534, 90 S.Ct. 733, 24 L.Ed.2d 729 (1970)) (emphasis in original). Thus, a derivative action permits an individual shareholder to "protect the interests of the corporation from the misfeasance and malfeasance of `faithless directors and managers.'" Id. at 95-96, 111 S.Ct. 1711 (citing Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548, 69 S.Ct. 1221, 93 L.Ed. 1528 (1949)); see also 13 William Meade Fletcher et al., Fletcher Cyclopedia of the Law of Private Corporations §§ 5939, 5940 (perm.ed., rev.vol.2004) (describing a derivative claim as "an equitable device" which developed "to enable shareholders to enforce a corporate right ... that the corporation had either failed or refused to assert on its own behalf").⁷

Concerned about the potential for abuse of the remedy, however, "equity courts established as a precondition `for the suit' that the shareholder demonstrate `that the corporation itself had refused to proceed after suitable demand, unless excused by extraordinary conditions.'" Kamen, 500 U.S. at 95-96, 111 S.Ct. 1711 (citing Ross, 396 U.S. at 534, 90 S.Ct. 733). "Thus, in the usual case, a shareholder seeking to assert a claim on behalf of the corporation must first exhaust intracorporate remedies by making a demand on the directors to obtain the action desired." 13 Fletcher § 5963; see also Kamen, 500 U.S. at 102 n. 7, 111 S.Ct. 1711 (noting that "[a]ll States require that a shareholder make a precomplaint demand on the directors" yet most also excuse demand in limited circumstances). However, demand may be excused where a shareholder is able to show that demand would be futile. 13 Fletcher § 5965; Kamen, 500 U.S. at 102, 111 S.Ct. 1711. The specifics of what constitutes futility vary from state to state. See 13 Fletcher § 5965 (indicating that demand may be deemed futile "if it would be directed to individuals who, by reason of hostile interest or participation in the alleged wrongdoing, cannot be expected to institute litigation on behalf of the corporation").

The substantive law which determines whether demand is, in fact, futile is provided by the state of incorporation of the entity on whose behalf the plaintiff is seeking relief. See Kamen, 500 U.S. at 108-09, 111 S.Ct. 1711. Because MLF is a Maryland corporation, Maryland law applies to the futility analysis.⁸

Maryland's requirements for a viable claim of demand futility are set forth in the Maryland Supreme Court's decision in Werbowsky v. Collomb, 362 Md. 581, 766 A.2d 123 (2001). The Werbowsky court, emphasizing the importance of the demand requirement, explicitly noted that demand futility is

a very limited exception, to be applied only when the allegations or evidence clearly demonstrate, in a very particular manner, either that (1) a demand, or a delay in awaiting a response to a demand, would cause irreparable harm to the corporation,⁹ or (2) a majority of the directors are so personally and directly conflicted or committed to the decision in dispute that they cannot reasonably be expected to respond to a demand in good faith and within the ambit of the business judgment rule.

766 A.2d at 144.

IV

Plaintiffs challenge the district court's reliance on Werbowsky and argue that "[w]hen applied to registered investment companies, the Maryland law of demand is different than when applied to business corporations" such as the entity involved in the Werbowsky case. Br. Pls.-Appellants at 19. Noting that under Maryland law, Md.Code. Ann. Corps. & Ass'ns § 2-405.3, a director of an ICA registered investment company is "independent" if he is not an "interested person" as defined by the ICA,¹⁰ Plaintiffs...