Source: https://supreme.justia.com/cases/federal/us/464/523/case.html
Timestamp: 2017-01-17 15:09:53
Document Index: 559510715

Matched Legal Cases: ['§ 36', '§ 36', '§ 20', '§ 80', '§ 36', '§ 36', '§ 1821', '§ 36', '§ 36', '§ 36', '§ 36', '§ 36', '§ 80', '§ 80', '§ 80', '§ 80', '§ 80', '§ 80', '§ 8', '§ 8', '§ 8', '§ 22', '§ 36', '§ 36', '§ 36', '§ 36', '§ 36', '§ 36', '§ 36', '§ 36', '§ 36', '§ 36', '§ 36', '§ 15', '§ 80', '§ 36']

Daily Income Fund, Inc. v. Fox (full text) :: 464 U.S. 523 (1984) :: Justia U.S. Supreme Court Center Log In
› Daily Income Fund, Inc. v. Fox
Daily Income Fund, Inc. v. Fox 464 U.S. 523 (1984)
U.S. Supreme CourtDaily Income Fund, Inc. v. Fox, 464 U.S. 523 (1984)Daily Income Fund, Inc. v. FoxNo. 82-1200Argued November 7, 1983Decided January 18, 1984464 U.S. 523CERTIORARI TO THE UNITED STATES COURT OF APPEALS
(a) The term "derivative action," which defines the scope of Rule 23.1, applies only to those actions in which the right claimed by the shareholder is one the corporation itself could have enforced in court. This interpretation of the Rule is consistent with earlier decisions (e.g., Hawes v. Oakland, 104 U. S. 450, from which the Rule's provisions were derived), and is supported by its purpose of preventing shareholders from improperly suing in place of a corporation. Pp. 464 U. S. 527-534. Page 464 U. S. 524
BRENNAN, J., delivered the opinion of the Court, in which BURGER, C.J., and WHITE, MARSHALL, BLACKMUN, POWELL, REHNQUIST, and O'CONNOR, JJ., joined. STEVENS, J., filed an opinion concurring in the judgment, post, p. 464 U. S. 542.
The question for decision is whether Rule 23.1 of the Federal Rules of Civil Procedure requires that an investment company security holder first make a demand upon the company's board of directors before bringing an action under § 36(b) of the Investment Company Act of 1940 to recover allegedly excessive fees paid by the company to its investment adviser. The Court of Appeals for the Second Circuit Page 464 U. S. 525 held in this case that the demand requirement of Rule 23.1 does not apply to such actions. Fox v. Reich & Tang, Inc., 692 F.2d 250 (1982). Two other Courts of Appeals have reached a contrary conclusion. [Footnote 1] We granted certiorari to resolve the conflict, 460 U.S. 1021 (1983), and now affirm.
Alleging that these fees were unreasonable, respondent brought this action in the United States District Court for the Southern District of New York, naming both the Fund and R&T as defendants. The complaint alleged that, because the Fund's assets had been continually reinvested in a limited number of instruments, R&T's investment decisions had remained routine and substantially unchanged as the Fund grew. By receiving significantly higher fees for essentially the same services, R&T had, according to respondent, violated the fiduciary duty owed investment companies by Page 464 U. S. 526 their advisers under § 36(b) of the ICA. Pub.L. 91-54, § 20, 84 Stat. 1428, 15 U.S.C. § 80a-35(b) (1982 ed.). [Footnote 2] The complaint sought damages in favor of the Fund as well as payment of respondent's costs, expenses, and attorney's fees. Petitioners moved to dismiss the suit for failure to comply with Federal Rule of Civil Procedure 23.1, which governs
Respondent contended that the Page 464 U. S. 527 Rule 23.1 "demand requirement" does not apply to actions brought under § 36(b) of the ICA and that, in any event, demand was excused because the Fund's directors had participated in the alleged wrongdoing, and would be hostile to the suit. The District Court, finding Rule 23.1 applicable to § 36(b) actions and, finding no excuse based on the directors' possible self-interest or bias, dismissed the action. Fox v. Reich & Tang, Inc., 94 F.R.D. 94 (1982).
Although any action in which a shareholder asserts the rights of a corporation could be characterized as "derivative," Page 464 U. S. 528 see n 11, infra, Rule 23.1 applies in terms only to a
This interpretation of the Rule is consistent with the understanding we have expressed, in a variety of contexts, of the term "derivative action." In Hawes v. Oakland, 104 U. S. 450, 104 U. S. 460 (1882), for instance, the Court explained that a derivative suit is one "founded on a right of action existing in the corporation itself, and in which the corporation itself is the appropriate plaintiff." Similarly, Cohen v. Beneficial Loan Corp., 337 U. S. 541, 337 U. S. 548 (1949), stated that a derivative action allows a stockholder "to step into the corporation's shoes and to seek in its right the restitution he could not demand in his own"; and the Court added that such a stockholder "brings suit on a cause of action derived from the corporation." Id. at 337 U. S. 549. Finally, Ross v. Bernhard, 396 U. S. 531, 396 U. S. 534 (1970), described a derivative action as "a suit to enforce a corporate cause of action against officers, directors, and third parties" (emphasis in original), and viewed the question there presented -- whether the Seventh Amendment confers a right to a jury in such an action -- as the same as Page 464 U. S. 529 whether the corporation, had it brought the suit itself, would be entitled to a jury. Id. at 396 U. S. 538-539. In sum, the term "derivative action," which defines the scope of Rule 23.1, has long been understood to apply only to those actions in which the right claimed by the shareholder is one the corporation could itself have enforced in court. See also Koster v. Lumbermens Mutual Casualty Co., 330 U. S. 518, 330 U. S. 522 (1947); Price v. Gurney, 324 U. S. 100, 324 U. S. 105 (1945); Delaware & Hudson Co. v. Albany & Susquehanna R. Co., 213 U. S. 435, 213 U. S. 447 (1909). [Footnote 4]
The origin and purposes of Rule 23.1 support this understanding of its scope. The Rule's provisions derive from this Court's decision in Hawes v. Oakland, supra. Prior to Hawes, federal courts exercising their equity powers had commonly entertained suits by minority stockholders to enforce corporate rights in circumstances where the corporation had failed to sue on its own behalf. Id. at 104 U. S. 452. See Dodge v. Woolsey, 18 How. 331, 59 U. S. 339 (1856); 7A C. Wright & A. Miller, Federal Practice and Procedure § 1821, pp. 296-297 Page 464 U. S. 530 (1972). The Court in Hawes, while emphasizing the importance of such suits as a means of "protecting the stockholder against the frauds of the governing body of directors or trustees," 104 U.S. at 104 U. S. 453, noted that this equitable device was subject to two kinds of potential abuse. First, corporations that were engaged in disputes with citizens of their home State could collude with out-of-state stockholders to obtain diversity jurisdiction in order to litigate the dispute in the federal courts. Id. at 104 U. S. 452-453. Second, derivative actions brought by minority stockholders could, if unconstrained, undermine the basic principle of corporate governance that the decisions of a corporation -- including the decision to initiate litigation -- should be made by the board of directors or the majority of shareholders. See id. at 104 U. S. 454-457.
To address these problems, the Court in Hawes established a number of prerequisites to bringing derivative suits in the federal courts. These requirements were designed to limit the use of the device to situations in which, due to an unjustified failure of the corporation to act for itself, it was appropriate to permit a shareholder "to institute and conduct a litigation which usually belongs to the corporation." Id. at 104 U. S. 460. With some additions and changes in wording, the conditions set out in Hawes have been carried forward in successive revisions of the federal rules. [Footnote 5] Page 464 U. S. 531
Some of the requirements first announced in Hawes were intended to reduce the burden on the federal courts by diverting corporate causes of action "to the State courts, which are their natural, their lawful, and their appropriate forum." Id. at 104 U. S. 452-453. [Footnote 6] At the same time, however, the Court sought to maintain derivative suits as a limited exception to the usual rule that the proper party to bring a claim on behalf of a corporation is the corporation itself, acting Page 464 U. S. 532 through its directors or the majority of its shareholders. Id. at 104 U. S. 460-461. As the Court later explained, this aspect of the rules governing derivative suits reflects the basic policy that
The principal means by which the Court in Hawes sought to vindicate this policy was, of course, its requirement that a shareholder seek action by the corporation itself before bringing a derivative suit. 104 U.S. at 104 U. S. 460-461. [Footnote 8] This Page 464 U. S. 533 "demand requirement" affords the directors an opportunity to exercise their reasonable business judgment and
In sum, the conceptual basis and purposes of Rule 23.1 confirm what its language suggests: the Rule governs only suits "to enforce a right of a corporation" when the corporation Page 464 U. S. 534 itself has "failed to enforce a right which may properly be asserted by it" in court. In this case, therefore, we must decide whether the right asserted by a shareholder suing under § 36(b) of the ICA could be judicially enforced by the investment company. [Footnote 10] We turn to consider that question.
In determining whether § 36(b) confers a right that could be judicially enforced by an investment company, we look first, of course, at the language of the statute. As noted in n 2, supra, § 36(b) imposes a fiduciary duty on an investment company's adviser "with respect to the receipt of compensation Page 464 U. S. 535 tion for services" paid by the company, and provides that
Petitioners nevertheless contend that an investment company has an implied right of action under § 36(b). In evaluating Page 464 U. S. 536 such a claim, our focus must be on the intent of Congress when it enacted the statute in question. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U. S. 353, 456 U. S. 377-378 (1982). That intent may in turn be discerned by examining a number of factors, including the legislative history and purposes of the statute, the identity of the class for whose particular benefit the statute was passed, the existence of express statutory remedies adequate to serve the legislative purpose, and the traditional role of the States in affording the relief claimed. Ibid.; Middlesex County Sewerage Authority v. National Sea Clammers Assn., 453 U. S. 1, 453 U. S. 13-15 (1981); California v. Sierra Club, 451 U. S. 287, 451 U. S. 292-293 (1981); Cannon v. University of Chicago, 441 U. S. 677 (1979); Cort v. Ash, 422 U. S. 66, 422 U. S. 78 (1975). In this case, consideration of each of these factors plainly demonstrates that Congress intended the unique right created by § 36(b) to be enforced solely by the SEC and security holders of the investment company.
As we have previously noted, Congress adopted the ICA because of its concern with "the potential for abuse inherent in the structure of investment companies." Burks v. Lasker, 441 U. S. 471, 441 U. S. 480 (1979). Unlike most corporations, an investment company is typically created and managed by a preexisting external organization known as an investment adviser. Id. at 441 U. S. 481. Because the adviser generally supervises the daily operation of the fund and often selects affiliated persons to serve on the company's board of directors, the "relationship between investment advisers and mutual funds is fraught with potential conflicts of interest.'" Ibid., quoting Galfand v. Chestnutt Corp., 545 F.2d 807, 808 (CA2 1976). In order to minimize such conflicts of interest, Congress established a scheme that regulates most transactions between investment companies and their advisers, 15 U.S.C. § 80a-17 (1982 ed.); limits the number of persons affiliated with the adviser who may serve on the fund's board of directors, § 80a-10; and requires that fees for investment Page 464 U. S. 537 advice and other services be governed by a written contract approved both by the directors and the shareholders of the fund, § 80a-15.
In order to remedy this and other perceived inadequacies in the Act, the SEC submitted a series of legislative proposals to Congress that led to the 1970 Amendments to the Page 464 U. S. 538 Act. Some of the proposals Congress ultimately adopted were intended to make the fund's board of directors more independent of the adviser and to encourage greater scrutiny of adviser contracts. See, e.g., 15 U.S.C. § 80a-10(a) (1982 ed.) (requiring that at least 40% of the directors not be "interested persons," a broader category than the previously identified group of persons "affiliated" with the adviser, see § 80a-2(a)(19)); § 80a-15(c) (requiring independent directors as well as shareholders to approve adviser contracts); Burks v. Lasker, supra, at 441 U. S. 482-483. The SEC had, however, determined that approval of adviser contracts by shareholders and independent directors could not alone provide complete protection of the interests of security holders with respect to adviser compensation. See SEC Report, at 128-131, 144, 146-147. Accordingly, the Commission also proposed amending the Act to require "reasonable" fees. Id. at 143-147. As initially considered by Congress, the bill containing this proposal would have empowered the SEC to bring actions to enforce the reasonableness standard and to intervene in any similar action brought by or on behalf of the company. H.R. 9510, 90th Cong., 1st Sess., § 8(d) (1967); S. 1659, 90th Cong., 1st Sess., § 8(d) (1967).
Representatives of the investment company industry, led by amicus Investment Company Institute (ICI), expressed concern that enabling the SEC to enforce the fairness of adviser fees might in essence provide the Commission with ratemaking authority. Accordingly, ICI proposed an alternative to the SEC bill which would have provided that actions to enforce the reasonableness standard "be brought only by the company or a security holder thereof on its behalf." Mutual Fund Legislation of 1967: Hearings on S. 1659 before the Senate Committee on Banking and Currency, 90th Cong., 1st Sess., pt. 1, pp. 100-101 (1967) (hereinafter 1967 Hearings). The version that the Senate finally passed, however, rejected the industry's suggestion that the investment company itself be expressly authorized to bring Page 464 U. S. 539 suit. S. 3724, 90th Cong., 2d Sess., § 8(d)(6) (1968). Instead, the Senate bill required a security holder to make demand on the SEC before bringing suit, and provided that, if the Commission refused or failed to bring an action within six months, the security holder could maintain a suit against the adviser in a "derivative" or representative capacity. Ibid. Like the original SEC proposal, however, the Senate bill provided that the SEC could intervene in any action brought by the company or by a security holder on its behalf. Id. § 22.
That conclusion is further supported by the purposes of the statute. As noted above, the SEC proposed the predecessor Page 464 U. S. 540 to § 36(b) because of its concern that the structural requirements for investment companies imposed by the Act would not alone ensure reasonable adviser fees. See supra at 464 U. S. 538. Indeed, the Commission concluded that the Act's provisions for independent directors and approval of adviser contracts had actually frustrated effective challenges to adviser fees. In particular, the Commission noted that, in the three fully litigated cases in which security holders had attacked such fees under state law, the courts had relied on the approval of adviser contracts by security holders or unaffiliated directors to uphold the fees. SEC Report at 132-143. [Footnote 12] For this reason, the Senate Report proposing the final version of the statute noted that, while shareholder and directorial approval of the adviser's contract is entitled to serious consideration by the court in a § 36(b) action, "such consideration would not be controlling in determining whether or not the fee encompassed a breach of fiduciary duty." S.Rep. No. 91-184, at 15; see id. at 5. In contrast to its approach in other aspects of the 1970 Amendments, then, Congress decided not to rely solely on the fund's directors to assure reasonable adviser fees, notwithstanding the increased disinterestedness of the board. See Burks v. Lasker, 441 U.S. at 441 U. S. 481-482, n. 10, and 441 U. S. 484. See also SEC Report at 146-148 (right of SEC and security holders to bring actions essential; although role of disinterested directors should be enhanced, Page 464 U. S. 541 "even a requirement that all of the directors of an externally managed investment company be persons unaffiliated with the company's adviser-underwriter would not be an effective check on advisory fees and other forms of management compensation"). This policy choice strongly indicates that Congress intended security holder and SEC actions under § 36(b), on the one hand, and directorial approval of adviser contracts, on the other, to act as independent checks on excessive fees.
Nor do other factors on which we have relied to identify an implied cause of action support petitioners' claim that the right asserted by a shareholder in a § 36(b) action could be enforced by the investment company. First, investment companies, as well as the investing public, are undoubtedly within "the class for whose especial benefit" § 36(b) was enacted, Cort v. Ash, 422 U.S. at 422 U. S. 78 (emphasis in original); see n 11, supra. Section § 36(b)'s express provision for actions by security holders, however, ensures that, even if the company's directors cannot bring an action in the fund's name, the company's rights under the statute can be fully vindicated by plaintiffs authorized to act on its behalf. For this reason, it is unnecessary to infer a right of action in favor of the corporation in order to serve the statute's "broad remedial purposes." Cf. Herman & MacLean v. Huddleston, 459 U. S. 375, 459 U. S. 386-387 (1983). See also Middlesex County Sewerage Authority v. National Sea Clammers Assn., 453 U.S. at 453 U. S. 13-15. Second, because § 36(b) creates an entirely new right, it was obviously not enacted "in a statutory context in which an implied private remedy [had] already been recognized by the courts." Cf. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. at 456 U. S. 378; Herman & MacLean v. Huddleston, supra, at 459 U. S. 384-386. Third, a corporation's rights against its directors or third parties with whom it has contracted are generally governed by state, not federal, law. Burks v. Lasker, supra, at 441 U. S. 478. See Cort v. Ash, supra, at 422 U. S. 78. Page 464 U. S. 542
The rule that sometimes requires a shareholder to make an appropriate demand before commencing a derivative action Page 464 U. S. 543 has its source in the law that gives rise to the derivative action itself. Rule 23.1 of the Federal Rules of Civil Procedure merely requires that the complaint in such a case allege the facts that will enable a federal court to decide whether such a demand requirement has been satisfied; Rule 23.1 is not the source of any such requirement. The plain language of the Rule makes that perfectly clear; the Rule does not require a demand, it only requires that the complaint allege with particularity what demand if any has been made on the corporation. [Footnote 2/1] Moreover, the history of Rule 23.1 and its predecessors, which the Court recites ante at 464 U. S. 529-533, demonstrates that the demand requirement was not created by the Rule, but rather by a decision of this Court, Hawes v. Oakland, 104 U. S. 450 (1882). When the current Rule's predecessor was promulgated shortly after Hawes, it did not create a demand requirement -- that had already been done by Hawes. Rather it operated to ensure that the pleadings would be adequate to enable courts to decide whether the applicable demand requirement had been satisfied. Thus the Page 464 U. S. 544 Rule concerns itself solely with the adequacy of the pleadings; it creates no substantive rights. [Footnote 2/2]
In this case, the respondent fully complied with Rule 23.1. Having made no effort to obtain action from the directors, he simply pleaded that no demand had been made. [Footnote 2/3] The question in this case is not whether the complaint complies with the pleading requirements in Rule 23.1. [Footnote 2/4] Rather, the question Page 464 U. S. 545 is whether the federal statute that expressly creates a cause of action that the shareholder may maintain on behalf of the mutual fund implicitly conditions that express right on an unmentioned intracorporate procedural requirement. For two reasons it is clear to me that it does not.
First, the text and legislative history of the statute are inconsistent with a demand requirement. No such condition is mentioned in the statute, and it is a matter of sufficient importance to warrant express mention if Congress had intended it. Instead, the express terms of the statute are inconsistent with such a requirement. A demand requirement is premised upon the usual respect courts accord the managerial prerogatives of directors, see n. 2, supra; however, in § 36(b), Congress explicitly rejected the usual rule. As the Court has previously recognized, and acknowledges again today, § 36(b) stands in contrast to the rest of the Act in that, unlike its other provisions, § 36(b) limits the usual discretion accorded directors by providing that the directors' position shall be given only "such consideration by the court as is deemed appropriate under all the circumstances." See ante at 464 U. S. 539-541; Burks v. Lasker, 441 U. S. 471, 441 U. S. 484 (1979). [Footnote 2/5] Congress laid out its own test for consideration of the directors' position in § 36(b), rather than relying on a demand requirement and the usual respect for managerial decisionmaking which it embodies.
The reason for congressional rejection of the usual deference paid directorial expertise and prerogatives is clear enough. The history of the statute is replete with findings that directors could not be relied upon to control excessive advisory fees. See ante at 464 U. S. 537-541; Wharton School Study of Mutual Funds, H.R.Rep. No. 2274, 87th Cong., 2d Sess., 30, 34, 66-67 (1962); Securities and Exchange Commission, Public Policy Implications of Investment Company Growth, H.R.Rep. No. 2337, 89th Cong., 2d Sess., 128-148 (1966); Page 464 U. S. 546 Hearings on S. 1659 before the Senate Committee on Banking and Currency, 90th Cong., 1st Sess., 1193-1200 (1967); S.Rep. No. 91-184, pp. 2, 5-6 (1969). In light of these findings, it cannot be maintained that Congress intended that the very directors who had failed to control excessive fees be involved in the decision whether to challenge those fees.
Second, a demand requirement would serve no meaningful purpose, and would undermine the efficacy of the statute. As noted above, Congress intended to authorize this type of shareholder action even though the contract between the fund and its investment adviser had been expressly approved by the independent directors of the fund. Since the disinterested directors are required to review and approve all advisory fee contracts under § 15 of the Act, 15 U.S.C. § 80a-15 (1982 ed.), a demand would be a futile gesture after the directors have already passed on the contract. Because the directors may not terminate a suit, see Burks, supra, at 441 U. S. 484, the only effect of a demand requirement would be to delay the commencement of the suit. That in turn would reduce the effectiveness of the Act as a vehicle for protecting investors, since § 36(b)(3) limits recovery to actual damages incurred beginning one year prior to commencement of suit. Thus, the demand process would permit investment advisers to keep several months of excessive fees -- a consequence squarely at odds with the purposes of the Act, and hence congressional intent. Page 464 U. S. 547