Tarlov v. Paine Webber Cashfund, Inc.

• Decision Date: 15 March 1983
• Docket Number: No. Civ. B 80-260(WWE).,Civ. B 80-260(WWE).
• Citation: 559 F. Supp. 429
• Court: U.S. District Court — District of Connecticut
• Parties: Fannie TARLOV, as Executrix of the Estate of Marjorie Landy, Plaintiff, v. PAINE WEBBER CASHFUND, INC.; Paine, Webber, Jackson & Curtis, Inc.; Provident Institutional Management Corporation; Donald B. Marron; John F. Curley, Jr.; George W. Gowen; Paul Kolton; and Thomas F. Murray, Defendants.

559 F. Supp. 429

Fannie TARLOV, as Executrix of the Estate of Marjorie Landy, Plaintiff, v. PAINE WEBBER CASHFUND, INC.; Paine, Webber, Jackson & Curtis, Inc.; Provident Institutional Management Corporation; Donald B. Marron; John F. Curley, Jr.; George W. Gowen; Paul Kolton; and Thomas F. Murray, Defendants.

No. Civ. B 80-260(WWE).

United States District Court, D. Connecticut.

March 15, 1983.

COPYRIGHT MATERIAL OMITTED

Richard J. Stull, of Stull, Stull & Brody, and Daniel W. Krasner, of Wolf Haldenstein Adler Freeman & Herz, New York City, for plaintiff.

Richard M. Phillips, Cherif Sedky, Michael S. Miller, Jonathan Eisenberg, of Kirkpatrick, Lockhart, Hill, Christopher & Phillips, Washington, D.C., for defendants Paine, Webber, Jackson & Curtis, Inc., Donald B. Marron, and John F. Curley.

Peter M. Mattoon, Richard Z. Freeman, Jr., John B. Langel, George E. Moore, of Ballard, Spahr, Andrews & Ingersoll, Philadelphia, Pa., for defendant Provident Institutional Management Corp.

William J. Kennedy, Robert P. vom Eigen, Keith Vandivort, of Dechert Price & Rhoads, Washington, D.C., for defendants George W. Gowen, Paul Kolton, and Thomas F. Murray.

Meyer Eisenberg, Joseph Zuckerman, Marc Rowin, of Rosenman, Colin, Freund, Lewis & Cohen, New York City, for defendant Paine Webber Cashfund, Inc.

RULING ON MOTIONS TO DISMISS

EGINTON, District Judge.

At the heart of this shareholder derivative suit is an allegation that a money market fund paid excessive fees to its investment advisers. The plaintiff seeks damages and injunctive relief for this alleged misfeasance under a spectrum of federal statutes and common law. The defendants have moved to dismiss the action. Magistrate Thomas P. Smith denied these motions, and his ruling is now before this court for review. For the reasons stated below, the magistrate's ruling is reversed in part and adopted in part.

This action was commenced by Mrs. Landy,¹ a shareholder in the defendant money market fund, on May 20, 1980, against the following defendants:

—Paine Webber CASHFUND, Inc. ("the Fund"), a no-load diversified, open-end investment company, commonly known as a money market fund;

—Paine, Webber, Jackson & Curtis, Inc. ("Paine Webber"), the organizer, sponsor, and underwriter of the Fund;

—Provident Institutional Management Corporation ("PIMC"), which at one time served as the Fund's investment adviser;

—Donald B. Marron and John Curley, Jr., directors of the Fund who are affiliated with Paine Webber ("the affiliated directors"); and

—George W. Gowen, Paul Kolton and Thomas F. Murray, who are also directors of the Fund but are not affiliated with Paine Webber ("the independent directors").

In late 1980, each of the defendants moved to dismiss the complaint on various grounds. Common to each motion was the argument that this action should be dismissed under Rule 23.1 of the Federal Rules of Civil Procedure because plaintiff did not make the required demand on the directors of the Fund before filing her suit.² Without reaching any of the defendants' other arguments, Magistrate Smith ruled on October 16, 1981, that the complaint should be dismissed for failure of the plaintiff to make demand on the directors or to allege with particularity the reasons for not doing so.

This court adopted the magistrate's ruling, but permitted the plaintiff to file an amended complaint, which she did on January 27, 1982. Because it is this amended complaint which is attacked here, its allegations are set forth below in some detail.

The principal claim is that the Fund has paid excessive compensation pursuant to its Administration, Advisory and Distribution Agreement ("Distribution Agreement") with defendant Paine Webber and pursuant to its Investment Advisory Contract ("Advisory Agreement") with defendant PIMC ("the Agreements"). Plaintiff alleges in Count I of the amended complaint that Paine Webber and PIMC have made excessive profits from the Agreements in violation of Section 36(b) of the Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 through 80a-64 (hereinafter "the 1940 Act" or "the Act"), at § 80a-35(b).³

Count II alleges that the annual approval and renewal of the Agreements by all the defendants constitutes a breach of fiduciary duty in violation of the common law and of Sections 1(b)(2), 15(a), 15(b), 36(a) and 47 of the 1940 Act, 15 U.S.C. §§ 80a-1(b)(2), 15(a), 15(b), 35(a) and 46.

Count II also alleges that, by failing to disclose in the Fund's June 13, 1979, proxy statement the alleged fact that PIMC was receiving investment advisory fees without performing services for the Fund, all of the defendants violated Section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a) ("the Exchange Act"), Rule 14(a)-9 adopted thereunder, 17 C.F.R. § 240.14(a)-9, and Section 20(a) of the 1940 Act, 15 U.S.C. § 80a-20(a).

The plaintiff alleges in Count III that it is unlawful under Sections 16 and 21 of the Banking Act of 1933, 12 U.S.C. §§ 24, 378(a) ("Glass-Steagal Act"), for PIMC, as the wholly-owned subsidiary of a national bank, to provide advisory services to an open-end fund.

Finally, Count IV realleges the receipt of excessive fees by Paine Webber in violation of Sections 1(b)(2), 15(b), 36(a) and 36(b) of the 1940 Act. It also alleges that Paine Webber has received compensation for its distribution services and that it is a violation of the 1940 Act for the Fund to bear such distribution expenses.

Paragraphs 40 through 42, which apply to all four counts, relate to plaintiff's failure to make a pre-suit demand on the Fund's directors. It is alleged, in a conclusory fashion, that demand would have been futile, and that, in any event, plaintiff made a post-suit demand in July, 1981, which was rejected by the directors in November, 1981.

For the reasons set forth below, Counts II and III must be dismissed for failure to state a claim upon which relief can be granted. The action will continue as to PIMC and Paine Webber only, and only under the allegations of Counts I and IV.

I) Suit Under Section 36(b) of the 1940 Act.

Interest in money market funds increased dramatically in the late 1960's. Because, as in this case, adviser fees are usually calculated as a percentage of a fund's assets, this sudden growth created a risk of unduly high compensation to investment advisers. Section 36(b)⁴ was added to the 1940 Act in 1970 to permit recovery of excessive adviser compensation. See S.Rep. No. 184, 91st Cong., 1st Sess. 6 (1969), reprinted in 1970 U.S.Code Cong. & Ad.News 4897, at 4902 ("Senate Report").

The plaintiff seeks relief under Section 36(b) in the first count of her complaint against Paine Webber and PIMC. These defendants have argued that this count must be dismissed under Rule 23.1 of the Federal Rules of Civil Procedure.

The First and Third Circuits have held that compliance with Rule 23.1 is required in suits under Section 36(b). Grossman v. Johnson, 674 F.2d 115 (1st Cir.), cert. denied, ___ U.S. ___, 103 S.Ct. 85, 74 L.Ed.2d 80 (1982); Weiss v. Temporary Investment Fund, 692 F.2d 928 (3rd Cir.1982).

Adopting a different rule, the Second Circuit recently held in a case identical in all material respects to this one that demand is not required in actions seeking the return of excessive adviser fees under Section 36(b). Fox v. Reich & Tang, Inc., 692 F.2d 250 (1982). In light of that decision, the magistrate properly denied defendants' motion to dismiss Count I.

PIMC and Paine Webber, realizing that their original argument is now moot and having no other challenge to plaintiff's Section 36(b) claim at this stage of the case, ask this court to stay any action under Section 36(b) in order to await a possible grant of certiorari by the Supreme Court and a possible reversal of the Second Circuit's position. The court will not stay proceedings in this action for such a speculative reason.

A stay would be particularly inappropriate here since a reversal of Fox would not necessarily require that this case be dismissed. Plaintiff has made demand on the directors, albeit after her original complaint was filed. A reversal of Fox might therefore impact only on the question of when the one-year period of limitation in Section 36(b)(3) should be held to have begun. If Fox stands, the instant suit covers fees paid from May, 1979, to the close of this action. If Fox is reversed, this court will have to decide whether that period should be held to start in January, 1981, a year before the amended complaint was filed pleading demand on the Fund's directors, or July, 1980, a year before the demand was made, or some other date suggested by the parties. In any event, there would be no obvious policy requiring dismissal of the action. See, e.g., Gartenberg v. Merrill Lynch Asset Management, Inc., 91 F.R.D. 524, 527 (S.D. N.Y.1981), on the relation back of a post-complaint demand in a Section 36(b) suit.

The defendants are directed to comply expeditiously with discovery on Count I and the court will consider appropriate sanctions if the defendants are dilatory.

II) Claims Under Sections 1(b)(2), 15(a), 15(b), 36(a) and 47 of the 1940 Act.

Plaintiff seeks in Count II to proceed under Sections 1(b)(2), 15(a), 15(b), 36(a) and 47 of the 1940 Act. The defendants have moved to dismiss these claims for failure to comply with Rule 23.1 and because these sections do not provide for a private right of action.

A) Failure to Comply With Rule 23.1.

Plaintiff's original complaint was dismissed for failure to either allege demand on the Fund's directors or to state with particularity why it would have been futile to make such demand, as required by Rule 23.1. Plaintiff was permitted to file an amended complaint which, she was warned, would then be scrutinized for compliance with the rule. See Ruling on Objection to Magistrate's Ruling of January 6, 1982, at 2.

The only change from a proposed amended complaint which this court reviewed in its January 6, 1982,...