The Inapplicability of the Demand Requirement of Rule 23.1 to Mutual Fund Shareholder Suits Under Section 36(b)

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1 Fordham Law Review Volume 51 Issue 6 Article The Inapplicability of the Demand Requirement of Rule 23.1 to Mutual Fund Shareholder Suits Under Section 36(b) Diane Fruchter Martucci Recommended Citation Diane Fruchter Martucci, The Inapplicability of the Demand Requirement of Rule 23.1 to Mutual Fund Shareholder Suits Under Section 36(b), 51 Fordham L. Rev (1983). Available at: This Article is brought to you for free and open access by FLASH: The Fordham Law Archive of Scholarship and History. It has been accepted for inclusion in Fordham Law Review by an authorized editor of FLASH: The Fordham Law Archive of Scholarship and History. For more information, please contact tmelnick@law.fordham.edu.

2 THE INAPPLICABILITY OF THE DEMAND REQUIREMENT OF RULE 23.1 TO MUTUAL FUND SHAREHOLDER SUITS UNDER SECTION 36(b) INTRODUCTION The portfolio of an open-end investment company, or mutual fund,' is usually managed by a company external to the fund itself. 2 For its services, 3 this managing company, otherwise known as an investment adviser, 4 receives a fee normally calculated as a percentage of the net assets of the fund. 5 Reacting to an enormous growth in the 1. Securities and Exchange Commission (SEC), Public Policy Implications of Investment Company Growth, H.R. Rep. No. 2337, 89th Cong., 2d Sess. 43 (1966) [hereinafter cited as PPI]. The primary business of an investment ("management") company is investing and reinvesting in securities of other companies. The investment company issues shares of its own stock to the public, the value of which fluctuates with the value of the securities in its portfolio. The significant feature of an open-end, as opposed to a closed-end, investment company is that the securities issued to the public are redeemable and therefore entitle the holder to receive, on demand, the approximate proportionate share of the issuer's net assets or their cash equivalent represented by the share tendered for redemption. 1 L. Loss, Securities Regulation (2d ed. 1961); Note, The Mutual Fund Industry: A Legal Survey, 44 Notre Dame Law. 732, (1969) [hereinafter cited as Survey]; see 15 U.S.C. 80a-5(a) (1976). 2. S. Rep. No. 184, 91st Cong., 1st Sess. 5 (1969) [hereinafter cited as 1969 Senate Report], reprinted in 1970 U.S. Code Cong. & Ad. News 4897, 4901; PPI, supra note 1, at 46; Rottenberg, Developing Limits on Compensation of Mutual Fund Advisers, 7 Harv. J. on Legis. 309, 311 (1970); Survey, supra note 1, at The adviser not only manages the fund, but also usually establishes it in the first place Senate Report, supra, at 5, reprinted in 1970 U.S. Code Cong. & Ad. News at The services provided extend far beyond supplying the financial expertise needed to make sound investment decisions. Other services include payment of the salaries of the fund's officers, bookkeeping, and providing office, accounting and clerical personnel. PPI, supra note 1, at 46, 90-92; Wharton School of Finance and Commerce, A Study of Mutual Funds, H.R. Rep. No. 2274, 87th Cong., 2d Sess. 476 (1962) [hereinafter cited as Wharton Report]. For an example of a contractual provision delineating extensive advisory services, see Galfand v. Chestnutt, 402 F. Supp. 1318, 1323 n.4 (S.D.N.Y. 1975), aff'd in part, modified on other grounds sub norn. Galfand v. Chestnutt Corp., 545 F.2d 807 (1976), aff'd inem., 573 F.2d 1290 (2d Cir. 1977), cert. denied, 435 U.S. 943 (1978). The mutual fund is really a "shell" that is the controlled instrument of the adviser. Galfand v. Chestnutt Corp., 545 F.2d 807, 808 (1976), aff'd mem., 573 F.2d 1290 (2d Cir. 1977), cert. denied, 435 U.S. 943 (1978) Senate Report, supra note 2, at 5, reprinted in 1970 U.S. Code Cong. & Ad. News at Id.; PPI, supra note 1, at 46. The advisory fee fluctuates with the value of the fund's portfolio Senate Report, supra note 2, at 5, reprinted in 1970 U.S. Code Cong. & Ad. News at It is usually an average of the net assets throughout the year, PPI, supra note 1, at 46, calculated as average daily net assets. See Gartenberg v. Merrill Lynch Asset Mgm't, Inc., 694 F.2d 923, 925 (2d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 3, 1983) (No ); Dreyfus Liquid 1403

3 1404 FORDHAM LAW REVIEW [Vol. 51 mutual fund industry 6 and the accompanying increase in advisory fees, 7 Congress in 1970 extensively amended the Investment Company Act of 1940 (ICA)." As part of that amendment, Congress added section 36(b)9 to impose a fiduciary duty on an investment adviser with respect to receipt of advisory fees. 10 That section expressly pro- Assets, Inc., Prospectus 2 (Feb. 15, 1983) (on file with Fordham Law Review): Hutton Inv. Series, Inc., Prospectus 3-4 (Dec. 6, 1982) (on file with Fordham Law Review). 6. See 1969 Senate Report, supra note 2, at 3, reprinted in 1970 U.S. Code Cong. & Ad. News at 4899; Rottenberg, supra note 2, at See Rottenberg, supra note 2, at 310. As the fund grows, certain economies of scale develop with respect to management of the fund. In many instances, however, these economies are not passed on to the fund's shareholders by a reduction in fees. See Investment Company Act Amendments of 1967: Hearings on H.R. 9510, 9511 Before the Subcomm. of Commerce and Finance of the House Comm. on Interstate and Foreign Commerce [pt. 1], 90th Cong., 1st Sess. 35 (1967) (statement of Manuel Cohen, Chairman SEC) [hereinafter cited as 1967 House Hearings], Wharton Report, supra note 3, at Investment Company Act of 1940, ch. 686, 54 Stat. 789, amended by Pub. L. No , 84 Stat (1970) (currently codified at 15 U.S.C. 80a-1 to -52 (1976 & Supp. V 1981). The 1970 amendments were preceded by extensive study which began eight years earlier when the SEC, as authorized by the 1940 Act, commissioned the securities research unit of the Wharton School of Finance and Commerce at the University of Pennsylvania to study the investment company industry. The resulting Wharton Report was submitted to Congress in Wharton Report, supra note 3. This was followed by a study conducted by the SEC, which included recommendations to amend the ICA and was presented to Congress in PPI, supra note 1. Numerous bills were proposed, accompanied by extensive hearings and reports. See infra notes and accompanying text. For a general discussion of the legislative history culminating in the 1970 amendments, with an emphasis on advisory fee provisions, see Rottenberg, supra note 2, passim. 9. Pub. L. No , 36(b), 84 Stat. 1413, (1970) (currently codified at 15 U.S.C. 80a-35(b) (1976)) U.S.C. 80a-35(b) (1976). The Senate Report accompanying the enacted bill makes it clear that "as a matter of Federal law, the investment adviser or mutual fund management company has a fiduciary duty with respect to mutual fund shareholders." 1969 Senate Report, supra note 2, at 2, reprinted in 1970 U.S. Code Cong. & Ad. News at The fiduciary standard was a substitute for the standard in earlier bills that fees be reasonable. Id. at 5-6, reprinted in 1970 U.S. Code Cong. & Ad. News at The legislative history is somewhat ambiguous as to the meaning to be given the term "fiduciary duty." The Senate Report states that the fiduciary duty standard "is in accordance with the traditional function of the courts to enforce such fiduciary duties in similar type relationships." Id. at 6, reprinted in 1970 U.S. Code Cong. & Ad. News at The SEC expressed its view that "the failure of fiduciaries to deal fairly or reasonably with those to whom they are so obligated is a breach of fiduciary duty. It is also a breach of fiduciary duty to charge excessive or unreasonable fees." Mutual Fund Amendments: Hearings on H.R. 11,995, S. 2224, H.R. 13,754 and H.R. 14,737 Before the Subcomm. on Commerce and Finance of the House Comm. on Interstate and Foreign Commerce [pt. 1], 91st Cong., ist Sess. 190 (1969) (memorandum of SEC to Chairman Moss) [hereinafter cited as 1969 House Hearings].

4 1983] RULE 23.1 & SUITS UNDER 36(b) 1405 vides that the shareholders of a mutual fund have the right to bring an action to recover excessive fees paid within one year prior to the institution of suit.' 1 The express authorization of a private right of action under section 36(b) clothes shareholder suits with a unique, hybrid quality-the recovery reverts to the fund as it would in a typical shareholder derivative suit,1 2 but the right of action flows from an express statutory grant' 3 rather than from the fund's own cause of action. 4 Indeed, the fund may not even have its own cause of action; the statute provides no express right of action under section 36(b),1 5 and courts disagree whether the fund has an implied right of action under that section.1 6 The effect of this disagreement has been debate among the circuits regarding the applicability to section 36(b) shareholder actions of Federal Rule of Civil Procedure 23.1,17 particularly that Rule's demand requirement.' Rule 23.1 must be complied with if the U.S.C. 80a-35(b) (1976) W. Fletcher, Cyclopedia of the Law of Private Corporations 5939, at 359 n.1 (rev. perm. ed. 1980); id U.S.C. 80a-35(b) (1976); see Fox v. Reich & Tang, Inc., 692 F.2d 250, 255 (2d Cir. 1982), cert. granted sub nor. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ). 14. See Fox v. Reich & Tang, Inc., 692 F.2d 250, 255 (2d Cir. 1982), cert. granted sub nor. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ); Blatt v. Dean Witter Reynolds Intercapital Inc., 528 F. Supp. 1152, (S.D.N.Y. 1982). See generally H. Henn, Handbook of the Law of Corporations and Other Business Enterprises 360, at 755 (2d ed. 1970) (discussing differences between derivative and non-derivative actions). 15. See 15 U.S.C. 80a-35(b) (1976); Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 934 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Fox v. Reich & Tang, Inc., 692 F.2d 250, (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ); Grossman v. Johnson, 674 F.2d 115, (1st Cir.), cert. denied, 103 S. Ct. 85 (1982). 16. Compare Fox v. Reich & Tang, Inc., 692 F.2d 250, 261 (2d Cir. 1982) (no right of action), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ) with Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 936 (3d Cir. 1982) (right of action), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) and Grossman v. Johnson, 674 F.2d 115, 120 (1st. Cir.) (same), cert. denied, 103 S. Ct. 85 (1982). 17. Fed. R. Civ. P Compare Fox v. Reich & Tang, Inc., 692 F.2d 250, 261 (2d Cir. 1982) (Rule not applicable), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ) with Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, , 936 (3d Cir. 1982) (Rule applicable), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) and Grossman v. Johnson, 674 F.2d 115, 120 (1st Cir.) (same), cert. denied, 103 S. Ct. 85 (1982). 18. Compare Fox v. Reich & Tang, Inc., 692 F.2d 250, 261 (2d Cir. 1982) (holding that demand not required because fund has no right of action), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar ) (No ) and Blatt v. Dean Witter Reynolds Intercapital Inc., 528 F. Supp. 1152, 1155 (S.D.N.Y. 1982) (dictum, reasoning that Congress did not intend demand on direc-

5 1406 FORDHAM LAW REVIEW [Vol. 51 action is one that is brought derivatively by a shareholder of a corporation or association and "may properly be asserted by" the corporation or association. 19 Consequently, if the fund itself may not exercise a section 36(b) action, the section is not within the purview of Rule A number of courts either state 21 or assume 22 that an implied right of action exists for the fund under section 36(b). Accordingly, these courts reason that Rule 23.1 applies 2 3 and that pursuant to the Rule, tors of fund to be prerequisite to 36(b) suit) with Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, (3d Cir. 1982) (holding that demand requirement fully consonant with purposes of ICA), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) and Grossman v. Johnson, 674 F.2d 115, (1st Cir.) (same), cert. denied, 103 S. Ct. 85 (1982). The demand requirement of Rule 23.1 states: The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for his failure to obtain the action or for not making the effort. Fed. R. Civ. P This procedural rule governs actions in federal courts. 13 W. Fletcher, supra note 12, 5943, at 367. Federal law governs the demand on director requirement. Whether a demand on shareholders is necessary, however, is governed by the law of the forum. E.g., Oldfield v. Alston, 77 F.R.D. 735, 739 (N.D. Ga. 1978); see 13 W. Fletcher, supra note 12, 5970, at 425. Discussion of the applicability to 36(b) suits of this latter requirement is beyond the scope of this Note. 19. Fed. R. Civ. P Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 946 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Fox v. Reich & Tang, Inc., 692 F.2d 250, (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ); see Grossman v. Johnson, 674 F.2d 115, 120 (1st Cir.) (rejecting plaintiff's contention that because fund has no right of action, Rule 23.1 is inapplicable), cert. denied, 103 S. Ct. 85 (1982). 21. Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 936 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Grossman v. Johnson, 674 F.2d 115, 120 (1st Cir.), cert. denied, 103 S. Ct. 85 (1982); see Markowitz v. Brody, 90 F.R.D. 542, 557 n.12 (S.D.N.Y. 1981) (dictum). 22. See Untermeyer v. Fidelity Daily Income Trust, 580 F.2d 22, 23 (ist Cir. 1978); Evangelist v. Fidelity Mgm't & Research Co., [Current] Fed. See. L. Rep. (CCH) 99,094, at 95,225 (D. Mass. Dec. 6, 1982); Jerozal v. Cash Reserve Mgm't, Inc., [Current] Fed. See. L. Rep. (CCH) 99,019, at 94, (S.D.N.Y. Aug. 10, 1982); Gartenberg v. Merrill Lynch Asset Mgm't, Inc., 91 F.R.D. 524, , complaint dismissed, 528 F. Supp (S.D.N.Y. 1981), aff'd, 694 F.2d 923 (2d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 3, 1983) (No ); Wolfson v. Cooper, [ Transfer Binder] Fed. See. L. Rep. (CCH) 95,634, at 90,152 (S.D.N.Y. June 22, 1976); Galfand v. Chestnutt, 402 F. Supp. 1318, 1331 (S.D.N.Y. 1975), aff'd in part, modified on other grounds sub nom. Galfand v. Chestnutt Corp., 545 F.2d 807 (1976), aff'd mem., 573 F.2d 1290 (2d Cir. 1977), cert. denied, 435 U.S. 943 (1978); Papilsky v. Berndt, 59 F.R.D. 95, (S.D.N.Y. 1973), appeal dismissed per curiam, 503 F.2d 554 (2d Cir.), cert. denied, 419 U.S (1974). 23. Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 936 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No );

6 1983] RULE 23.1 & SUITS UNDER 36(b) 1407 demand must be made on the fund's directors prior to the suit unless the plaintiff can prove that demand would have been futile. 2 4 Grossman v. Johnson, 674 F.2d 115, 120 (1st Cir.), cert. denied, 103 S. Ct. 85 (1982); see Untermeyer v. Fidelity Daily Income Trust, 580 F.2d 22, 23 (1st Cir. 1978); Evangelist v. Fidelity Mgm't & Research Co., [Current] Fed. Sec. L. Rep. (CCH) 99,094, at 95, (D. Mass. Dec. 6, 1982); Jerozal v. Cash Reserve Mgm't Inc., [Current] Fed. See. L. Rep. (CCH) 99,019, at 94, (S.D.N.Y. Aug. 10, 1982); Gartenberg v. Merrill Lynch Asset Mgm't, Inc., 91 F.R.D. 524, 526, complaint dismissed, 528 F. Supp (S.D.N.Y. 1981), aff'd, 694 F.2d 923 (2d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 3, 1983) (No ); Markowitz v. Brody, 90 F.R.D. 542, 561 (S.D.N.Y. 1981); Wolfscn v.- Cooper, [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 95,634, at 90,152 (S.D.N.Y. June 22, 1976); Galfand v. Chestnutt, 402 F. Supp. 1318, 1331 (S.D.N.Y. 1975), aff'd in part, modified on other grounds sub nom. Galfand v. Chestnutt Corp., 545 F.2d 807 (1976), aff'd mem., 573 F.2d 1290 (2d Cir. 1977), cert. denied, 435 U.S. 943 (1978); Papilsky v. Berndt, 59 F.R.D. 95, 97 (S.D.N.Y. 1973), appeal dismissed per curiam, 503 F.2d 554 (2d Cir.), cert. denied, 419 U.S (1974). The court in Boyko v. Reserve Fund, Inc., 68 F.R.D. 692 (S.D.N.Y. 1975), addressed the issue whether the fund had a right of action under 36(b) and concluded that no such right existed. Id. at It used that finding, however, not to show the inapplicability of Rule 23.1, but rather the futility of its demand requirement. Id. at ; cf. Blatt v. Dean Witter Reynolds Intercapital Inc., 528 F. Supp. 1152, 1155 (S.D.N.Y. 1982) (reasoning in dictum that because directors cannot terminate or institute 36(b) action, demand requirement does not apply). 24. E.g., Jerozal v. Cash Reserve Mgm't, Inc., [Current] Fed. See. L. Rep. (CCH) 99,019, at 94, (S.D.N.Y. Aug. 10, 1982); Markowitz v. Brody, 90 F.R.D. 542, 561 (S.D.N.Y. 1981). Courts are divided as to the futility of demand in 36(b) actions. Those finding demand not to be futile have given varying rationales. Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 943 (3d Cir. 1982) (allegations of futility insufficient to excuse demand), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Grossman v. Johnson, 674 F.2d 115, 121 (1st Cir.) (noting that demand gives independent directors time to study merits of claim), cert. denied, 103 S. Ct. 85 (1982); Evangelist v. Fidelity Mgm't & Research Co., [Current] Fed. See. L. Rep. (CCH) 99,094, at 95,225 (D. Mass. Dec. 6, 1982) (holding that demand gives corporation's managers opportunity to sue or remedy the problem); see Untermeyer v. Fidelity Income Trust, 580 F.2d 22, (1st Cir. 1978) (excusing demand when 50% or more of fund's directors are statutorily interested). The court in Fox v. Reich & Tang, Inc., 692 F.2d 250 (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ), concluded that demand was futile. Id. at 262. Lower courts in the Second Circuit have divided on the futility issue. Jerozal v. Cash Reserve Mgm't, Inc., [Current] Fed. See. L. Rep (CCH) 99,019, at 94,824 (S.D.N.Y. Aug. 10, 1982) (noting futility of demand due to management hostility to shareholder claims); Blatt v. Dean Witter Reynolds Intercapital Inc., 528 F. Supp. 1152, (S.D.N.Y. 1982) (finding demand futile, reasoning in dictum that requirement not applicable); Markowitz v. Brody, 90 F.R.D. 542, 559, 561 (S.D.N.Y. 1981) (holding demand not futile when less than 50% of directors are interested); Wolfson v. Cooper, [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 95,634, at 90,152 (S.D.N.Y. June 22, 1976) (holding demand futile due to close relationship between fund and adviser); Boyko v. Reserve Fund, Inc., 68 F.R.D. 692, (S.D.N.Y. 1975) (futility presumed when one interested director on board); Galfand v. Chestnutt, 402 F. Supp. 1318, 1331 (S.D.N.Y. 1975) (demand futile under facts of case), aff'd in part, modified on other grounds sub nom. Galfand v. Chestnutt Corp.,

7 1408 FORDHAM LAW REVIEW [Vol. 51 On the other hand, one court has concluded that a mutual fund has no right of action under section 36(b). In Fox v. Reich & Tang, Inc.,25 the Court of Appeals for the Second Circuit held that the shareholders' right of action is independent of, and not derived from, the fund's right to sue. 26 The court refused to hold that a right of action for the fund could be implied from section 36(b), stating that the advisory fee problem which the 1970 amendments sought to cure was "basically incompatible with a corporate right of action as an effective solution.1 27 In dictum, the court considered the futility of demand under Rule Noting that the ICA, as interpreted by the Supreme Court in Burks v. Lasker, 2 8 precludes the board of directors from terminating a shareholder suit under section 36(b), 29 that the fund's directors may not institute a section 36(b) suit, and that they are unlikely to take other action, the Fox court concluded that demand would be futile. 30 Because section 36(b) is silent with respect to a fund's right of action, 31 this Note applies the implication doctrine set forth in recent Supreme Court cases 32 and contends that a fund does not have a right of action under that section. Rule 23.1 therefore does not apply to section 36(b) shareholder actions because such actions may not "properly be asserted by" the fund. This Note further argues that even if the 545 F.2d 807 (1976), aff'd ner., 573 F.2d 1290 (2d Cir. 1977), cert. denied, 435 U.S. 943 (1978); Papilsky v. Berndt, 59 F.R.D. 95, 97 (S.D.N.Y. 1973) (demand futile because unaffiliated directors were controlled by affiliated directors, and all had acquiesced in alleged wrong), appeal dismissed per curiarn, 503 F.2d 554 (2d Cir.), cert. denied, 419 U.S (1974) F.2d 250 (2d Cir. 1982), cert. granted sub norn. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ). 26. Id. at 255. The court held that the words contained in the statute-on behalf of-"signify only that [the SEC or shareholder bringing] an action under 36(b) must do so to seek return of excessive management fees to the company treasury and not to individual or governmental coffers." Id. The shareholders sue not derivatively, but as "'private attorneys general' to assist in the enforcement of a duty imposed by the statute on investment advisers." Id. 27. Id. at 259. The court said that "it defies logic to conclude [that the directors'] contemplated role included suing their advisers." Id U.S. 471 (1979) F.2d at 261 (construing Burks v. Lasker, 441 U.S. 471, 484 (1979)). 30. See 692 F.2d at U.S.C. 80a-35(b) (1976). 32. See, e.g., Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, (1982); Middlesex County Sewerage Auth. v. National Sea Clammers Ass'n, 453 U.S. 1, (1981); Texas Indus. v. Radcliff Materials, Inc., 451 U.S. 630, (1981); California v. Sierra Club, 451 U.S. 287, (1981); Northwest Airlines v. Transport Workers Union, 451 U.S. 77, (1981); Universities Research Ass'n v. Coutu, 450 U.S. 754, (1981); Transamerica Mtge. Advisors v. Lewis, 444 U.S. 11, (1979); Touche Ross & Co. v. Redington, 442 U.S. 560, (1979).

8 1983] RULE 23.1 & SUITS UNDER 36(b) 1409 implication doctrine supports a fund's right of action under section 36(b), application of the demand requirement to a shareholder suit would subvert Congress' intent in giving mutual fund shareholders an express right of action. I. THE IMPLICATION DOCTRINE AND SECTION 36(b) A. The Mutual Fund Industry and the 1970 Amendments Because of the unique structure of the mutual fund industry, a conflict of interest is inherent in the relationship between a fund and its investment adviser, 33 particularly with respect to advisory fees. 34 A fund's directors have a duty to maximize the fund's assets by paying as small a fee as possible, yet they are wholly dependent for the fund's daily operations upon the adviser, which wants to maximize its own profits. 3 5 Advisers face little or no competition for their services, a circumstance that gives them tremendous bargaining power with respect to fees. 36 Moreover, because investors base their purchase of mutual fund shares upon the adviser's expertise, and the fund cannot exist without continuous management, the directors lack an essential 33. Investment Company Amendments Act of 1969; Hearings on S. 34 and S. 296 Before the Senate Comm. on Banking and Currency, 91st Cong., 1st Sess. 168 (1969) (statement of Abraham Pomerantz, Esq.) (built in conflict of interest of "'extraordinary proportions") [hereinafter cited as 1969 Senate Hearings]; Mutual Fund Legislation of 1967; Hearings on S Before the Senate Comm. on Banking and Currency [pt. 1], 90th Cong., 1st Sess. 5 (1967) (statement of Manuel Cohen, Chairman SEC) (unique structure of industry creating conflict of interest) [hereinafter cited as 1967 Senate Hearings!]; Wharton Report, supra note 3, at 9, See supra notes I- 5 and accompanying text. 34. See 1967 House Hearings [pt. 1], supra note 7, at 31-32, (statement of Manuel Cohen, Chairman SEC) (unaffiliated directors unable to combat excessive fees); PPI, supra note 1, at 131 (same); 114 Cong. Rec. 23,532 (1968) (statement of Sen. Proxmire) (The hearings "demonstrated beyond any doubt that the independent directors have not been able to act effectively to reduce management fees."); 1969 Senate Report, supra note 2, at 2, reprinted in 1970 U.S. Code Cong. & Ad. News at House Hearings [pt. 1], supra note 7, at 34. This problem is particularly acute when the adviser is a publicly owned corporation because the adviser then owes to its shareholders the additional duty to maximize its own profits. Id.; see 1967 Senate Hearings [pt. 1], supra note 33, at 10 (statement of Manuel Cohen, Chairman SEC). 36. See 1967 House Hearings [pt. 1], supra note 7, at 40, 101, 129. One reason for the lack of competition is that advisory fees have so small an impact on the individual shareholder that cost reductions are not a significant consideration in the battle for investor favor. PPI, supra note 1, at 126. Naturally, the industry contends that competition exists Senate Hearings, supra note 33, at 89 (statement of Robert Augenblick, President Inv. Co. Inst.); 1967 House Hearings [pt. 2], supra note 7, at 780 (statement of Harold Bache, Bache & Co.).

9 1410 FORDHAM LAW REVIEW [Vol. 51 bargaining tool-the ability to threaten termination of the fee contract. 37 The situation is aggravated even further by the affiliation that many of the fund's directors have with the adviser, 3 and because the prevalent practice in the industry is to choose directors who are friendly to the adviser 39 Even a director sincere in his efforts to reduce fees is hampered by inadequate or non-existent research staffs, 40 a problem compounded by dependence upon the adviser for financial and other information. 41 For many years, mutual fund shareholders, faced with excessive fees and directors unable to cope with them, had instituted actions against directors and advisers under either state corporation law, which required them to prove "corporate waste" of assets, 42 or former ICA section 36, 43 which required the plaintiff to show a "gross abuse 37. See 1969 House Hearings [pt. 2], supra note 10, at 788 (statement of Abraham Pomerantz, Esq.) (No adviser has ever been fired.); 1967 House Hearings [pt. 1], supra note 7, at (statement of Manuel Cohen, Chairman SEC) (fee negotiations lack essential element of arm's-length bargaining-threat of contract termination); 1967 Senate Hearings [pt. 1], supra note 33, at 19 (statement of Manuel Cohen, Chairman SEC) (contract termination not possible due to dependence of fund upon adviser and lack of competition among advisers); 1969 Senate Report, supra note 2, at 5 (mutual fund, as a practical matter, not able to sever relationship with adviser), reprinted in 1970 U.S. Code Cong. & Ad. News at See 1967 Senate Hearings [pt. 1], supra note 33, at 10 (statement of Manuel Cohen, Chairman SEC); PPI, supra note 1, at House Hearings [pt. 1], supra note 7, at 40 (statement of Manuel Cohen, Chairman SEC) (unaffiliated directors selected by management or affiliated directors); id. [pt. 2] at 635 (statement of Richard Jennings, Professor of Law University of California, Berkeley) (same); 114 Cong. Rec. 23,532 (1968) (statement of Sen. Proxmire) (unaffiliated directors hand-picked by adviser) House Hearings [pt. 1], supra note 7, at 104 (statement of Manuel Cohen, Chairman SEC). The independent director usually has another occupation and cannot spend much time on his directorship. Id.; PPI supra note 1, at 130. Moreover, social pressures prevent independent directors from bargaining with affiliated directors Senate Hearings [pt. 2], supra note 33, at 699 (statement of Abraham Pomerantz); see 1967 House Hearings [pt. 1], supra note 7, at 93 (memorandum of SEC) (independent directors disinclined to engage in active bargaining with colleagues on board). 41. PPI, supra note 1, at The inability of unaffiliated directors to deal with advisory fee problems is demonstrated by the testimony of various directors taken in connection with the SEC's PPI report. See 114 Cong. Rec. 23, (1968), reprinted in 1969 Senate Hearings, supra note,33, at Senate Report, supra note 2, at 5, reprinted in 1970 U.S. Code Cong. & Ad. News at 4901; see PPI, supra note 1, at 142. Most cases were brought in state courts and relied on state law Senate Hearings [pt. 1], supra note 33, at 84 (statement of Philip Loomis, General Counsel SEC). 43. Investment Company Act of 1940, ch. 686, 36, 54 Stat. 789, 841 (currently codified as amended at 15 U.S.C. 80a-35(a) (1976)). Although this Act specifies a right of action only for the SEC, courts prior to the 1970 amendments had recognized an implied right of action in favor of shareholders. See infra note 121.

10 1983] RULE 23.1 & SUITS UNDER 36(b) 1411 of trust.- 44 These actions were uniformly unsuccessful, largely because the courts deferred to prior director and shareholder approval of the advisory contracts. 45 Concern with the inability of fund directors or shareholders to control advisory fees was an overriding factor in Congress' decision to amend the ICA. 46 The industry's fear of strike suits 47 and rate-making by the SEC or the judiciary 48 led initially to a bevy of proposed bills which, in comparison to section 36(b) as enacted, would have given 44. Investment Company Act of 1940, ch. 686, 36, 54 Stat. 789, 841 (currently codified as amended at 15 U.S.C. 80a-35(a) (1976)); see Brown v. Bullock, 194 F. Supp. 207, 213, 215 (S.D.N.Y.) (action brought under state law and sections of the ICA, including 36), aff'd on other grounds, 294 F.2d 415 (2d Cir. 1961). Although theoretically possible as a right of action, the SEC recognized that the "harshness of the sanction [imposed for violations of 36, which is a prohibition against advisers and underwriters serving in those capacities for a period deemed appropriate by the court] impairs its usefulness in modifying advisory fee rates." PPI, supra note 1, at 143; see Survey, supra note 1, at Only three, Acampora v. Birkland, 220 F. Supp. 527 (D. Colo. 1963); Saxe v. Brady, 40 Del. Ch. 474, 184 A.2d 602 (1962); Meiselman v. Eberstadt, 39 Del. Ch. 563, 170 A.2d 720 (1961), of the "50 or so" lawsuits were fully litigated House Hearings [pt. 1], supra note 7, at & nn (statement of Manuel Cohen, Chairman SEC); id. at , (letter from Inv. Co. Inst. to Rep. Keith). Even though two courts questioned the fees, judgment for the defendants was granted in all three cases. Id. at 43. As the Chairman of the SEC noted, the 1940 Act's requirement of shareholder and unaffiliated director approval of fees, intended to protect shareholders, had precisely the opposite result. Id. Most of the remaining lawsuits were settled, resulting in some reduction of fees. In light of the magnitude of the overall problem, however, the effect of the reductions was insiginificant. Id. 46. See 1967 House Hearings [pt. 1], supra note 7, at 29 (statement of Manuel Cohen, Chairman SEC) (management and sales charges major problems to be addressed by the legislation). Some other abuses addressed by the 1970 amendments were insider trading, see 15 U.S.C. 80a-17(j) (1976), excessive sales charges, 15 U.S.C. 80a-22(b) (1976), and front-end loads under periodic payment plans, 15 U.S.C. 80a-27(d) to -27(h) (1976). For a general discussion of the various areas covered by the 1970 amendments, see Manges, The Investment Company Amendments Act of 1970-An Analysis and Appraisal After Two Years, 14 B.C. Indus. & Com. L. Rev. 387 (1973) House Hearings [pt. 2], supra note 10, at 688 (statement of Milton Mound, President First Multifund of America, Inc.) ("[S]trike suits would be greatly encouraged by the bill as it is now drawn."); 1969 Senate Hearings, supra note 33, at 7 (statement of Hugh Owens, Commissioner SEC) (safeguards against shareholder suits added at request of industry); id. at (statement of Robert L. Augenblick, President Inv. Co. Inst.) (industry concerned with need for protection against strike suits); see Grossman v. Johnson, 674 F.2d 115, 122 (1st Cir.) (stating that legislative history demonstrates concern over unjustified derivative suits), cert. denied, 103 S. Ct. 85 (1982) House Hearings [pt. 1], supra note 7, at 242 (statement of John Haire, Chairman-Elect Inv. Co. Inst. ("SEC... proposes a true ratemaking statute."); id. at 262 (statement of Ralph Demmler, former Chairman SEC, on behalf of Inv. Co. Inst.) (noting that bill has "fee fixing provisions [that] go beyond the rate regulation of public utilities").

11 FORDHAM LAW REVIEW [Vol. 51 the shareholders far less ability to bring an excessive fee suit, enhanced the deference to be accorded the directors' actions, or both. 49 Representative of these proposals were bills that allowed shareholder suits only if brought by a bona fide shareholder with justifiable cause 5 or after a fruitless demand on the SEC; 5 ' that instructed the court to give "substantial weight" to prior director approval of the advisory fee contract; 52 or that authorized an action by the fund itself. 53 Congress rejected these proposals and their underlying rationale, H.R. 14,737, 91st Cong., ist Sess. 19, reprinted in 1969 House Hearings [pt. 1], supra note 10, at 113 (reduced shareholder ability to bring suit); S. 296, 91st Cong., 1st Sess. 8(d), reprinted in 1967 Senate Hearings, supra note 33, at (reduced shareholder ability to bring suit, increased deference to director actions); S. 34, 91st Cong., 1st Sess. 8(d), reprinted in 1969 Senate Hearings, supra note 33, at 241 (deference to director decisions); S. 3724, 90th Cong., 2d Sess. 8(d), 114 Cong. Rec. 23, (1968) (same). 50. H.R. 14,737, 91st Cong., 1st Sess. 19, reprinted in 1969 House Hearings [pt. 1], supra note 10, at 113. The standard of proof was that of "clear and convincing evidence." Id., reprinted in 1969 House Hearings [pt. 1], supra note 10, at 114. As Representative Stuckey explained, the bona fide shareholder provision was intended to prevent suit by "someone who buys a few shares in order to bring suit." 116 Cong. Rec. 33,283 (1970) (remarks of Rep. Stuckey). 51. S. 296, 91st Cong., 1st Sess. 8(d), reprinted in 1969 Senate Hearings, supra note 33, at 317; S. 3724, 90th Cong., 2d Sess. 8(d), 114 Cong. Rec. 23,547 (1968). The demand requirement was "intended to reduce the possibility of a multiplicity of suits involving the same management compensation." S. Rep. No. 1351, 90th Cong., 2d Sess. 6 (1968). Other restrictions were favored by the industry. See 1969 Senate Hearings, supra note 33, at 90 (statement of Robert Augenblick, President Inv. Co. Inst.) (amendment barring suit if fee contract approved by certain percentage of shareholders and independent directors); id. at 12, 30 (statement and letter of Hugh Owens, Commissioner SEC) (proposal to restrict suits to shareholders owning certain percentage of outstanding shares). 52. S. 3724, 90th Cong., 2d Sess. 8(d), 114 Cong. Rec. 23,546 (1968). In addition, the bill created certain presumptions of reasonableness which were based on director approval. Id. at 23, S. 296 contained similar provisions. S. 296, 91st Cong., 1st Sess. 8(d), reprinted in 1967 Senate Hearings, supra note 33, at Other deferences to director judgment were proposed by the industry Senate Hearings [pt. 1], supra note 7, at Several bills gave the SEC the power to intervene in an excessive fee suit "brought by or on behalf of a registered investment company." S. 296, 91st Cong., 1st Sess. 22 (emphasis added), reprinted in 1969 Senate Hearings, supra note 33, at 337; S. 34, 91st Cong., 1st Sess. 22 (emphasis added), reprinted in 1969 Senate Hearings, supra note 33, at 266; S. 1659, 90th Cong., ist Sess. 23 (emphasis added), reprinted in 1967 Senate Hearings [pt. 2], supra note 33, at 945. In addition, S. 34 and S. 296 termed the shareholder actions as derivative or representative. S. 296, 91st Cong., 1st Sess. 8(d), reprinted in 1969 Senate Hearings, supra note 33, at 317; S. 34, 91st Cong., 1st Sess. 8(d), reprinted in 1969 Senate Hearings, supra note 33, at Congress' rejection of the proposed bills reflects its perception that the threat of strike suits is illusory and that the shareholders need access to the courts House Hearings [pt. 1], supra note 10, at 163 (memorandum report of SEC) (shareholders need access to courts); id. at 202 (SEC response to questionnaire) ("The

12 1983] RULE 23.1 & SUITS UNDER 36(b) 1413 substituting a carefully balanced, 55 two-level regulatory system. At the first level of this regulatory scheme, Congress sought to solve the advisory fee problem by increasing director ability to negotiate reasonable fees. 56 The 1970 amendments to the ICA ensured that a fund's outside directors would be disinterested by expanding the category of persons deemed "interested" in the fund. 57 In addition to those persons designated as "affiliated" under the 1940 Act, 58 the amendments' definition of "interested person" includes persons having close family, financial or professional relationships with the fund, its adviser, or its underwriter. 59 After having increased the requisite level of disinterest in the disinterested director, the 1970 amendments proceeded to make those same directors the "watchdogs" over all the mutual fund's operations. 60 Certain duties are specified, such as approval of underwriting conspecter of shareholder actions flooding the courts with harassing law suits is a much overworked bogeyman... [T]he realities have never borne out the dire predictions."); id. at 440 (statement of Chairman Moss) (specter of strike suits raised often but rarely happens); id. [pt. 2] at 881 (letter from SEC Commissioner Owens to Chairman Sparkman) (shareholders should not have to meet procedural hurdles); 1967 House Hearings [pt. 2], supra note 7, at 614 (statement of Judge Friendly) ("Plaintiff's lawyers will not wish to spend years litigating against well financed defendants unless there are real prospects of financial reward..."); 116 Cong. Rec. 39,345 (1970) (statement of Rep. Springer) (final bill reflects Congress' "willing- [ness] to rely on the general fairness and the ability of our courts [to provide] adequate protection to fund managers and security holders as well"); see 114 Cong. Rec. 23,532 (1968) (statement of Sen. Proxmire) (amendment proposing to reduce possibility of strike suits jeopardizes the solution to the excessive fee problem, which is the threat of impartial judicial examination). 55. Comment, Director Termination of Mutual Fund Advisory Fee Suits: Grossman v. Johnson, 62 B.U.L. Rev. 601, (1982) [hereinafter cited as Advisory Fee Suits]. 56. See 1969 Senate Report, supra note 2, at 6-7, reprinted in 1970 U.S. Code Cong. & Ad. News at See Burks v. Lasker, 441 U.S. 471, (1979). The ICA requires that 40% of a mutual fund's board be composed of independent outside directors. Prior to the 1970 amendments, these independent directors could not be "affiliated" as defined in the ICA. The 1970 amendments strengthened this definition so that the independent directors could not be "interested." Id. at 482. This Note uses the term "disinterested" to encompass both definitions. 58. Investment Company Act of 1940, ch. 686, 2(a), 54 Stat. 789, 791 (currently codified as amended at 15 U.S.C. 80a-2(a)(3) (1976). 59. Burks v. Lasker, 441 U.S. 471, 482 (1979) (in addition to definition of "affiliated person," 1970 amendments added "interested person"). Compare 15 U.S.C. 80a-2(a)(3), (19) (1976) (definitions of "affiliated" and "interested" persons) with Investment Company Act of 1940, ch. 686, 2(a), 54 Stat. 789, 791 (definition of "affiliated" person) (currently codified as amended at 15 U.S.C. 80a-2(a)(3) (1976)). No more than 60% of the fund's board of directors may consist of such interested persons. 15 U.S.C. 80a-10(a) (1976). 60. Burks v. Lasker, 441 U.S. 471, 484 (1979) (quoting Tannenbaum v. Zeller, 552 F.2d 402, 406 (2d Cir.), cert. denied, 434 U.S. 934 (1977)).

13 1414 FORDHAM LAW REVIEW (Vol. 51 tracts 6 ' and selection of the fund's accountants. 6 2 The disinterested director also serves as an independent check on management by monitoring all of the investment company's affairs. 6 3 With specific reference to advisory fees, 6 4 independent directors have a duty to request from the adviser and to evaluate such information as necessary to approve the fee contract. 6 5 In addition, a majority of this class of directors must approve the contract. 66 Congress realized, however, that because the amendments were unable to eliminate the unique conflict of interest inherent in the adviser-director relationship, 6 7 the expanded role given the directors was insufficient to enable them to negotiate effectively a reasonable advisory fee. 68 Congress therefore sought to supplement the role of U.S.C. 80a-15(c) (1976). A majority vote of disinterested directors is needed to approve the underwriting contract. Id. See supra note U.S.C. 80a-31(a) (1976) (accountants must be selected by a majority of disinterested directors) Senate Report, supra note 2, at 32-33, reprinted in 1970 U.S. Code Cong. & Ad. News at Duties that are part of the directors' watchdog function include overseeing fund portfolio investments, and preventing abuses involving commissions. See generally Radmer, Duties of the Directors of Investment Companies, 3 J. Corp. L. 61 passim (1977) (outlining duties of investment company directors). 64. The legislative history reveals that the tightening of the definition of what constitutes an independent director was regarded as a relatively minor recommendation [which]... will be helpful in strengthening the ability of unaffiliated directors to provide in certain other areas the independent check on management which the Act intends, but... unaffiliated directors cannot effectively deal with problems in the advisory fee area. [The proposal to tighten the unaffiliated director definition], standing alone, would perpetuate the unsatisfactory situation which exists today and, indeed, would confirm the present unwarranted belief of some courts that the business judgment of the directors as to management fees cannot be questioned so long as the statutory procedures for approval are followed House Hearings [pt. 1], supra note 7, at 46 (statement of Manuel Cohen, Chairman SEC) (emphasis added); accord id. at 93 (SEC Memorandum); 1967 Senate Hearings [pt. 1], supra note 33, at 96 (SEC answers to questionnaire) U.S.C. 80a-15(c) (1976). 66. Id House Hearings [pt. 1], supra note 7, at 44; see 1969 Senate Report, supra note 2, at 5, reprinted in 1970 U.S. Code Cong. & Ad. News at 4901 (unique structure of mutual fund industry not conducive to arm's-length bargaining). Suggestions were made in the legislative hearings that the conflict of interest problem could be solved by mandating an " 'internalization' of the management function," rather than by allowing separately owned investment advisers to manage the fund. This suggestion was rejected because of the drastic effect it would have had on existing management companies House Hearings [pt. 1], supra note 7, at 94. Evidence suggests that in addition to the conflict of interest problem, directors still face the same problems they experienced prior to the 1970 amendments. See infra note See Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, (3d Cir. 1982) (Gibbons, J., dissenting) (provision allowing shareholder action illustrative of congressional desire not to leave resolution of fees in hands of unaffiliated directors), petitionfor cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Fox v.

14 1983] RULE 23.1 & SUITS UNDER 36(b) 1415 disinterested directors by adding a second, fallback level of regulation. 69 For the first time, Congress expressly authorized a right of action in favor of mutual fund shareholders to recover excessive fees. 7 0 Section 36(b) as enacted is the exact antithesis of the proposed bills-shareholders are provided an unconditional cause of action, and director involvement in the shareholder action is greatly circumscribed. The procedural hurdles contained in the proposed bills are not present to block the shareholders' right to sue the adviser for breach of fiduciary duty respecting fees. 71 Moreover, as a consequence of section 36(b), the courts, not fund directors, are now the ultimate judges whether a breach of this duty has occurred. 7 2 Director approval of fees is to be accorded only such weight as the court deems proper. 7 3 Finally, the mechanics of the action are carefully detailed. 74 Recovery is allowed only of actual damages, defined as excessive fees paid within one year prior to the initiation of the suit. 75 Burden of proof, 7 6 potential defendants, 77 jurisdiction 7 and the relationship between violations of section 36(b) and other statutory provisions 79 are also specified. These extensive amendments, however, did not include a provision authorizing a right of action under section 36(b) for the mutual fund Reich & Tang, Inc., 692 F.2d 250, 259 (2d Cir. 1982) (provisions "cannot seriously be expected to induce arm's-length bargaining"), cert. granted sub nor. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ). The PPI study by the SEC stated: "[E]ven 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." PPI, supra note 1, at Advisory Fee Suits, supra note 55, at 627 n.131, U.S.C. 80a-35(b) (1976); see 1969 Senate Report, supra note 2, at 5-7, reprinted in 1970 U.S. Code Cong. & Ad. News at Compare 15 U.S.C. 80a-35(b) (1976) (unconditional right of action for shareholder) with H.R. 14,737, 91st Cong., 1st Sess. 19, reprinted in 1969 House Hearings [pt. 1], supra note 10, at 113 (suits allowed only by bona fide security holder acting in good faith and with justifiable cause) and S. 34, 91st Cong., 1st Sess. 8(d), reprinted in 1969 Senate Hearings, supra note 33, at 241 (demand-on-sec requirement) Senate Report, supra note 2, at 6, reprinted in 1970 U.S. Code Cong. & Ad. News at Compare 15 U.S.C. 80a-35(b)(2) (1976) (court decides the weight to be given director approval of fees) with S. 34, 91st Cong., 1st Sess. 8(d), reprinted in 1969 Senate Hearings, supra note 33, at 239 (director approval to be given "substantial weight") U.S.C. 80a-35(b)(2) (1976). 74. See Advisory Fee Suits, supra note 55, at U.S.C. 80a-35(b)(3) (1976). 76. Id. 80a-35(b)(1). 77. Id. 80a-35(b)(3). 78. Id. 80a-35(b)(5). 79. Id. 80a-35(b)(6).

15 1416 FORDHAM LAW REVIEW [Vol.,51 itself. This absence, coupled with a lack of definitive congressional intent, poses the question whether such a right may be implied under current Supreme Court analysis. B. The Supreme Court Standard For Implied Rights of Action In Cort v. Ash, 80 the Supreme Court enunciated four factors to be considered in determining whether a private right of action should be implied from a statute that does not expressly so provide. 8 ' The first two Cort factors are whether the plaintiff is a member of the class "for whose especial benefit the statute was enacted," 8 2 and whether there is any "legislative intent, explicit or implicit, either to create or deny" a federal remedy for that class. 3 Recent decisions of the Court have emphasized the importance of congressional intent, as ascertained from statutory language and legislative history, in determining whether a private federal right of action exists for the class of which the plaintiff is a member. 84 Under the Court's general implication standard, statutory language evinces a congressional intent to create a right if, rather than generally proscribing activities or creating duties, 85 it "unmistakably focus[es] on [a] particular class of beneficiaries" 86 that includes the plaintiff U.S. 66 (1975). 81. Id. at Id. (quoting Texas & Pac. Ry. v. Rigsby, 241 U.S. 33, 39 (1916) (emphasis deleted)) U.S. at 78. The other two factors are whether implying the right is consistent with the legislative scheme and whether "the cause of action [is] one traditionally relegated to state law... so that it would be inappropriate to infer a cause of action based solely on federal law." Id. 84. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, (1982); Middlesex County Sewerage Auth. v. National Sea Clammers Ass'n, 453 U.S. 1, 13 (1981); Texas Indus. v. Radcliff Materials, Inc., 451 U.S. 630, 639 (1981); California v. Sierra Club, 451 U.S. 287, (1981); Northwest Airlines v. Transport Workers Union, 451 U.S. 77, (1981); Universities Research Ass'n v. Coutu, 450 U.S. 754, 770 (1981); Transamerica Mtge. Advisors v. Lewis, 444 U.S. 11, (1979); Touche Ross & Co. v. Redington, 442 U.S. 560, 571 (1979). 85. See, e.g., California v. Sierra Club, 451 U.S. 287, 294 (1981) ( 10 of River and Harbor Appropriation Act of 1899 found merely to proscribe certain activities); Northwest Airlines v. Transport Workers Union, 451 U.S. 77, 92 (1981) (Title VII and Equal Pay Act directed against employers seeking to invoke remedies); Universities Research Ass'n v. Coutu, 450 U.S. 754, (1981) ( 1 of Davis-Bacon Act phrased as directive to federal agencies). 86. California v. Sierra Club, 451 U.S. 287, 294 (1981). For example, 901 of Title IX of the Education Amendments of 1972 has been held to have this focus. Cannon v. University of Chicago, 441 U.S. 677, , 717 (1979). The language of Title IX expressly identifies a class of beneficiaries: "No person in the United States shall, on the basis of sex, be excluded from participation in, be denied the benefits of, or be subjected to discrimination under any education program or activity receiving Federal financial assistance." 20 U.S.C. 1681(a) (1976).

16 1983] RULE 23.1 & SUITS UNDER 36(b) 1417 seeking the implied right. 87 The absence of such focus, 8 accompanied by congressional silence or indications of disapproval of the right, creates a presumption against implication. 8 9 If the statute contains a "comprehensive legislative scheme including an integrated system of procedures for enforcement," 90 the presumption approaches conclusiveness. 9 ' The presumption against implication shifts, however, when the doctrine is applied to certain amended statutes. In the recent case of Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 92 the Court noted that if courts had uniformly recognized an implied right at the time Congress amended a statute, the amendment's legislative history must be examined to determine whether Congress intended to preserve that right. 9 3 In this inquiry, congressional silence weighs in favor of, rather than against, implication. 9 4 C. Application of the Implication Doctrine to the 1970 Amendments After applying the general implication standard used by the Court, 95 including that propounded in Merrill Lynch for an amended 87. Northwest Airlines v. Transport Workers Union, 451 U.S. 77, (1980); Universities Research Ass'n v. Coutu, 450 U.S. 754, (1981); Cannon v. University of Chicago, 441 U.S. 677, & n.13 (1979); see California v. Sierra Club, 451 U.S. 287, 294 (1981). 88. Two recent cases have given no weight to this factor of the implication analysis, focusing solely on the factors of comprehensiveness of the legislative scheme and the legislative history. See Middlesex County Sewerage Auth. v. National Sea Clammers Ass'n, 453 U.S. 1, (1981) (enforcement provision so detailed that Congress could not have implied additional remedies); Texas Indus. v. Radcliff Materials, Inc., 451 U.S. 630, (1981) (relied on legislative history in holding plaintiff was member of class Congress intended to regulate, not benefit). 89. See Middlesex County Sewerage Auth. v. National Sea Clammers Ass'n, 453 U.S. 1, 15 (1981); Northwest Airlines v. Transport Workers Union, 451 U.S. 77, 94 (1981). 90. Northwest Airlines v. Transport Workers Union, 451 U.S. 77, 97 (1981). 91. Middlesex County Sewerage Auth. v. National Sea Clammers Ass'n, 453 U.S. 1, (1981); Texas Indus. v. Radcliff Materials, Inc., 451 U.S. 630, 645 (1981); Transamerica Mtge. Advisors v. Lewis, 444 U.S. 11, (1979); see Note, Implied Private Rights of Action Under Federal Statutes: Congressional Intent, Judicial Deference, or Mutual Abdication?, 50 Fordham L. Rev. 611, (1982) U.S. 353 (1982). 93. Id. at See id. at ("[T]he fact that a comprehensive reexamination and significant amendment of [the statute] left intact the statutory provisions under which the federal courts had implied a cause of action is itself evidence that Congress affirmatively intended to preserve that remedy."); The Supreme Court, 1981 Term, 96 Harv. L. Rev. 62, 238 (1982) (Court regards congressional silence as dispositive). But see 456 U.S. at 398 (Powell, J., dissenting) (majority's reliance upon congressional inaction is "novel legal theory"). 95. See supra notes and accompanying text.

17 1418 FORDHAM LAW REVIEW [Vol. 51 statute, 9 6 the inescapable conclusion is that section 36(b) does not contain an implied action for mutual funds against their advisers. 7 Nevertheless, two recent decisions, Weiss v. Temporary Investment Fund, Inc.,98 and Markowitz v. Brody, 99 have applied the implication doctrine specifically to section 36(b) suits, 00 with both finding a right of action for the fund.' 0 ' These courts relied primarily, however, on the factors enunciated in Cort v. Ash1 02 rather than on more recent Supreme Court analysis In their discussions of the first Cort factor, both courts failed to incorporate the gloss put on that factor by Cannon v. University of Chicago. 0 4 In Cannon, the Supreme Court held that a plaintiff falls into the class for whom a right may be implied if the statutory language "expressly identifies the class Congress intended to benefit." ' 0 5 The Weiss and Markowitz courts simply concluded that because the fund is the ultimate beneficiary of the fiduciary duty created by section 36(b), the fund is a member of the especial class for whose benefit that section was enacted. 0 6 Yet neither court discussed the statutory language of section 36(b). Nowhere in that section does the language expressly identify the fund as a beneficiary of its prescriptions; 10 7 rather it is entirely directed at the adviser's conduct. 08 Sec- 96. See supra notes and accompanying text. 97. See Fox v. Reich & Tang, Inc., 692 F.2d 250, 261 (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ) (finding no legislative intent to create right for fund). The Fox court did not specifically apply the implication doctrine as delineated in either Cort or Merrill Lynch, but did examine the most important factors of the doctrine-the statutory language and legislative history-to find that the fund had no right of action. Id. at F.2d 928 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) F.R.D. 542 (S.D.N.Y. 1981) F.2d at ; 90 F.R.D. at 557 n F.2d at 936; 90 F.R.D. at 557 n U.S. 66 (1975). See supra notes and accompanying text F.2d at ; 90 F.R.D. at 557 n U.S. 677 (1979) Id. at 690. The Court held that "[t]here would be far less reason to infer a private remedy in favor of individual persons if Congress, instead of drafting [the statute] with an unmistakable focus on the benefited class, had written it simply as a ban on... conduct...." Id. at F.2d at ; 90 F.R.D. at 557 n See 15 U.S.C. 80a-35(b) (1976); cf. California v. Sierra Club, 451 U.S. 287, 294 (1981). The Court in Sierra Club noted that the statute in question contained "no more than a general proscription of certain activities; it [did] not unmistakably focus on any particular class of beneficiaries whose welfare Congress intended to further. Such language does not indicate an intent to provide for private rights of action." Id U.S.C. 80a-35(b) (1976) ("The investment adviser... shall be deemed to have a fiduciary duty with respect to the receipt of compensation."). See supra note 10 and accompanying text.

18 1983] RULE 23.1 & SUITS UNDER 36(b) 1419 tion 36(b) therefore lacks the type of language necessary to meet the especial benefit criterion in Cannon.' 9 Even assuming, however, that section 36(b) did meet the Cannon criterion, that is not sufficient to support a finding of a right of action for the fund. As the Supreme Court stated in Transamerica Mortgage Advisors v. Lewis," 0 "the mere fact that [section 36(b)] was designed to protect [the fund and its shareholders] does not require the implication of a private cause of action for damages [in a fund-instituted action]. The dispositive question remains whether Congress intended to create any such remedy.""' In considering this second Cort factor of legislative intent, both the Weiss and Markowitz courts relied in their conclusions on the finding that the legislative history of section 36(b) reveals no intent to deny the fund a right of action.1 2 In so relying, the courts ignored the recent Supreme Court admonition that absent "strong indicia of a contrary congressional intent, [a court is] compelled to conclude that Congress provided precisely the remedies it considered appropriate." " 3 The legislative history of the 1970 amendments reveals no congressional intent to confer a right of action on the fund." 4 Indeed, Congress' rejection of proposals that would have accorded greater deference to director judgment, and its deletion from proposed amendments of language upon which an implied action could clearly 109. Compare 15 U.S.C. 80a-35(b) (1976) (creating fiduciary duty, but focusing upon no specific class of beneficiaries) with 20 U.S.C. 1681(a) (1976) ("no person" within specific class is to be discriminated against), construed in Cannon v. University of Chicago, 441 U.S. 677, (1979) U.S. 11 (1979) Id. at 24 (citations omitted). Transamerica was an action brought against a real estate investment trust adviser under the Investment Advisers Act of 1940, enacted as companion legislation to the ICA. Id. at 13 & n.1, 20. The Court pointed out that Congress' inclusion of express private rights of action under the ICA and other securities statutes was evidence that when Congress wanted to provide private rights of action it did so explicitly. Id. at Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 935 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Markowitz v. Brody, 90 F.R.D. 542, 557 n.12 (S.D.N.Y. 1981) Middlesex County Sewerage Auth. v. National Sea Clammers Ass'n, 453 U.S. 1, 15 (1981); see Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 953 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 935 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Fox v. Reich & Tang, Inc., 692 F.2d 250, 261 (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ); Boyko v. Reserve Fund, Inc., 68 F.R.D. 692, 695 (S.D.N.Y. 1975).

19 1420 FORDHAM LAW REVIEW [Vol. 51 have been based, 15 indicate the contrary. 16 These congressional actions, in conjunction with the legislative scheme in the 1970 amendments, which provides for comprehensive regulation of all aspects of advisory fees, from contract negotiation to detailed enforcement procedures,1 7 are presumptive evidence that Congress' omission of an express right of action for the fund was deliberate. " 8 By giving express rights of action to the SEC and the shareholders, Congress included only those remedies it deemed appropriate." 9 That section 36(b) was an amendment to the ICA does not alter this conclusion. Under the Merrill Lynch analysis, a fund's right of action could be implied only if there had been uniform judicial acceptance of 115. Compare S. 34, 91st Cong., 1st Sess. 22 (words "brought by or on behalf of" included), reprinted in 1969 Senate Hearings, supra note 33, at 266 with 15 U.S.C. 80a-43 (1976) (SEC may intervene in 36(b) action; words "brought by or on behalf of" omitted); compare S. 34, 91st Cong., 1st Sess. 8 (security holder may bring an action "in a derivative or representative capacity"), reprinted in 1969 Senate Hearings, supra note 33, at 241 with 15 U.S.C. 80a-35(b) (1976) (security holder may bring action; not characterized as representative or derivative). See supra note 53 and accompanying text See Transamerica Mtge. Advisors v. Lewis, 444 U.S. 11, 22 (1979) (deletion of language that would have indicated private right of action is evidence Congress did not intend to authorize the cause of action); Burks v. Lasker, 441 U.S. 471, (1979) (attention must be paid to what Congress did not do in enacting ICA): 2A C. Sands, Sutherland's Statutes and Statutory Construction (4th ed. 1973) (defeated legislative proposals can give meaning to legislative intent of statutes) See supra notes 65-70, and accompanying text Fox v. Reich & Tang, Inc., 692 F.2d 250, (2d Cir. 182), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ); cf. Middlesex County Sewerage Auth. v. National Sea Clammers Ass'n, 453 U.S. 1, (1981) (Water Pollution Control Act containing comprehensive legislative scheme; absence of strong legislative intent precludes private right of action); Texas Indus. v. Radcliff Materials, Inc., 451 U.S. 630, 645 (1981) (comprehensive legislative scheme of antitrust laws barring implied private right of action); Northwest Airlines v. Transport Workers Union, 451 U.S. 77, 97 (1981) (Title VII and Equal Pay Act comprise comprehensive legislative schemes barring implied rights of action) In recent decisions, the Supreme Court has applied the maxim expressio unius est exclusio alterius, 2A C. Sands, supra note 116, 47.23, at 123 ("[A]I1 omissions should be understood as exclusions."), holding that "when Congress wished to provide a private damages remedy, it knew how to do so and did so expressly." Touche Ross & Co. v. Redington, 442 U.S. 560, 572 (1979); accord Universities Research Ass'n v. Coutu, 450 U.S. 754, 773 (1981); Transamerica Mtge. Advisors v. Lewis, 444 U.S. 11, (1979); see Fox v. Reich & Tang, Inc., 692 F.2d 250, 256 (2d Cir. 1982), cert. granted sub nora. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ). An example of Congress' express authorization of a right of action to both a corporation and its shareholders in the securities area is 16(b) of the Securities and Exchange Act of U.S.C. 78p(b)(1976). That section also expressly incorporates a demand on directors requirement. Id.

20 1983] RULE 23.1 & SUITS UNDER 36(b) 1421 the right prior to Because not all courts had recognized the right,' 2 ' the Merrill Lynch analysis reinforces the conclusion that section 36(b) does not yield a private right of action for a mutual fund. Although the Weiss court did refer generally to Merrill Lynch in its discussion of the implication doctrine,' 22 the court failed to consider specifically, as required by Merrill Lynch, whether the fund's right of action was uniformly recognized at the time of the amendments. 123 In 120. See Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, (1982) Prior to the 1970 amendments, many courts had recognized a private right of action under the ICA. See 1969 Senate Hearings, supra note 33, at 30 (letter of Hugh Owens, Commissioner SEC to Rep. Sparkman). But see Brouk v. Managed Funds, Inc., 286 F.2d 901, 918 (8th Cir. 1961) (no private right of action under ICA), vacated per curiam as moot, 369 U.S. 424 (1962). The complaints in many of these derivative suits were not for excessive advisory fees or other relief under former 36. E.g., Esplin v. Hirschi, 402 F.2d 94, 103 (10th Cir. 1968) (failure to comply with registration provisions of ICA), cert. denied, 394 U.S. 928 (1969); SEC v. Wong, 42 F.R.D. 599, 601 (D.P.R. 1967) (violations of securities laws); Taussig v. Wellington Fund, Inc., 187 F. Supp. 179, (D. Del. 1960) ( 35, unfair use of name), aff'd, 313 F.2d 472 (3d Cir.), cert. denied, 374 U.S. 806 (1963); Breswick & Co. v. Briggs, 135 F. Supp. 397, 402 (S.D.N.Y. 1955) (unlawful transactions; 17, 21); Lutz v. Boas, 39 Del. Ch. 585, 599, 171 A.2d 381, 390 (1961) (advisory fee contract not approved pursuant to 15(c)). But see Levitt v. Johnson, 334 F.2d 815, 817, 819 (1st Cir. 1964) (excessive fees), cert. denied, 379 U.S. 961 (1965); Chabot v. Empire Trust Co., 301 F.2d 458, 459 & n.3 (2d Cir. 1962) (same, 36, 37); Entel v. Allen, 270 F. Supp. 60, (S.D.N.Y. 1967) (prohibited securities transaction, 36); Brown v. Bullock, 194 F. Supp. 207, 228, 245 (S.D.N.Y.) (overpayment of advisory fees, 36, 37), aff'd on other grounds, 294 F.2d 415 (2d Cir. 1961). Although the majority of pre-amendment cases did recognize an implied right of action under the ICA, and the one decision to the contrary, Brouk, was questioned in its own circuit by a later case, see Greater Iowa Corp. v. McLendon, 378 F.2d 783, 793 (8th Cir. 1967), what is important in a Merrill Lynch analysis is Congress' perception of the law that it was shaping or reshaping. 'Whether that understanding of Congress was in some ultimate sense incorrect is not what is important... For the relevant inquiry is not whether Congress correctly perceived the then state of the law, but rather what its perception of the state of the law was." Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, 378 & n.61 (1982) (quoting Brown v. GSA, 425 U.S. 820, 828 (1976)). The legislative history reveals that Congress perceived a split whether a right of action could be implied under the ICA prior to the 1970 amendments, and that no distinction was made between decisions that dealt with advisory fees and those that did not Senate Hearings, supra note 33, at 30 (letter from Commissioner of SEC to Chairman of House Committee) (courts have generally implied right of action under ICA); 1967 House Hearings [pt. 2], supra note 7, at 636 (statement of Richard Jennings, Professor of Law, University of California, Berkeley) (questioning whether private right of action exists under ICA) Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) See id, Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, (1982) ("contemporary legal context" means determining whether right of action was uniformly recognized). See supra note 93 and accompanying text.

21 1422 FORDHAM LAW REVIEW [Vol. 51 addition, Weiss looked at state common law at the time of the amendments to determine whether a fund had a right of action at that time As Judge Gibbons pointed out in his dissent, however, common-law causes of action are not implied from a federal statute, but rather exist independently as a matter of state law.12 5 Supreme Court implication analysis seeks to determine legislative intent to provide a federal remedy, not whether some remedy exists which can be applied through the vehicle of a federal statute. 126 Weiss found no congressional intent to deprive a mutual fund of the implied right it enjoyed at the time of the 1970 amendments. 27 Even assuming that partial judicial acceptance may be deemed to satisfy the Merrill Lynch criterion of uniformity, congressional action with respect to proposed bills1 28 and Congress' failure to leave intact1 29 the pre-amendment provisions under which the right had been implied strongly indicate congressional intent not to preserve any existing right. 130 Thus, Merrill Lynch provides no foundation for inferring a private right of action for a mutual fund under section 36(b). Notwithstanding the evidence to the contrary, many courts have either assumed or stated that a right of action exists for a mutual fund under section 36(b).13 Because the existence of such a right of action on the part of the fund would automatically bring any shareholder action within the purview of Rule 23.1 generally, these courts have concluded, although erroneously, that the shareholders must make a demand on the fund's directors pursuant to Rule 23.1 before instituting suit. 32 Even assuming a cause of action can be implied for the 124. See 692 F.2d at Id. at 953 (Gibbons, J., dissenting) See Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, 401 (1982) (Powell, J., dissenting) (majority based its finding of uniform judicial acceptance on cases that had erred by finding an implied cause of action under a federal statute on common-law principles). See supra note 83 and accompanying text F.2d at See supra notes and accompanying text Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, (1982); cf. Herman & MacLean v. Huddleston, 103 S. Ct. 683, 689 (1983) (congressional silence with respect to 10(b) action means preservation intended) See 456 U.S. at Congress not only failed to leave intact former 36, but restructured it specifically to make a shareholder action alleging excessive fees more effective than the actions brought under the unamended section or state law. See Fox v. Reich & Tang, Inc., 692 F.2d 250, (2d Cir. 1982), cert. granted sub nom. jdaily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ). The amended 36(b), expressly providing only for an action by the SEC and the shareholder, demonstrates that Congress did not consider that a right of action for the fund would solve this problem. See id See supra notes and accompanying text See supra note 24 and accompanying text.

22 1983] RULE 23.1 & SUITS UNDER 36(b) 1423 fund under the Cort-Merrill Lynch analysis, examination of the demand requirement reveals that it serves no purpose in a section 36(b) action by shareholders. II. APPLICATION OF RULE 23.1 A. Director Involvement in Section 36(b) Suits Rule 23.1 is designed to prevent suits that are not in the best interest of a corporation. 33 This objective is achieved in part1 34 by the Rule's demand requirement, which mandates that before commencing derivative litigation, a shareholder must demand that the corporation's board of directors redress the shareholder's grievance. 35 If the plain Note, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U. Chi. L. Rev. 168, (1976) [hereinafter cited as Standing Requirements]; see H. Henn, supra note 14, 358, at 752. The derivative suit has potential for abuse and can be very expensive and time consuming. Standing Requirements, supra, at A particular target of the Rule is the strike suit. H. Henn, supra note 14, 358, at 752. Originally strike suits were those brought to force an out-of-court settlement which would enrich the plaintiff. Because any recovery from a derivative suit or its settlement must today go to the corporation, this definition of a strike suit is obsolete. The modern motivation to bring a strike suit is to enrich the plaintiff's attorney rather than the plaintiff himself. Id. at 752 n.22; see Dent, The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit?, 75 Nw. U.L. Rev. 96, (1980) There are several devices by which Rule 23.1 protects against suits that are not in the best interests of the corporation. In addition to the demand requirement, three provisions are directed against strike suits: 1) the verification requirement, 13 W. Fletcher, supra note 12, 5943, at 367 n.2; but see 7A C. Wright & A. Miller, Federal Practice and Procedure: Civil 1827, at 333 (1972) (pointing out that the verification requirement's purpose of encouraging truthfulness may not be effective), 2) the contemporaneous ownership requirement, 13 W. Fletcher, supra note 12, 5981, at 467; 3B J. Moore & J. Kennedy, Federal Practice [2], at to -16 (2d ed. 1982); 7A C. Wright & A. Miller, supra, 1828, at , and 3) the requirement that suits will not be dismissed or compromised without judicial approval, H. Henn, supra note 14, 375, at 790; 7A C. Wright & A. Miller, supra, 1839, at ; Dent, supra note 133, at 138. This third provision is one factor that has prompted questioning whether strike suits now exist to any significant degree. Dent, supra note 133, at Moreover, because an attorney usually serves in derivative actions on a contingent fee basis and is therefore unlikely to be paid unless the suit is successful or favorably settled, he will carefully weigh the merits of the suit before undertaking it. Kon Sik Kim, The Demand on Directors Requirement and the Business Judgment Rule in the Shareholder Derivative Suit: An Alternative Framework, 6 J. Corp. L. 511, 521 & n.56 (1981). An additional protection provided for the corporation in Rule 23.1 is the requirement that the shareholders bringing derivative suits fairly and adequately represent the interests of other shareholders. 13 W. Fletcher, supra note 12, This tends to reduce the number of suits that can be brought. Kon Sik Kim, supra, at One commentator recommends that this requirement be utilized more often by courts as a means of preventing lawsuits not in the interests of the corporation. Id Fed. R. Civ. P ("The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors

23 1424 FORDHAM LAW REVIEW [Vol. 51 tiff can show that making a demand would have been futile, however, his failure to make the demand will be excused Demand affords the board an opportunity to act in its role as manager of corporate affairs 13 7 by determining the claim's merits and what action, if any, should be taken on behalf of the corporation. 38 If the board decides that the claim has merit, the corporation may either take over the suit or take measures toward settlement. 39 Alternately, if the board determines that the claim is meritless, it traditionally has the power to decline to pursue the action in court, thus terminating the shareholder's cause of action The traditional standard of review or comparable authority... and the reasons for his failure to obtain the action or for not making the effort.") E.g., Galef v. Alexander, 615 F.2d 51, 59 (2d Cir. 1980); Cramer v. General Tel. & Elecs. Corp., 582 F.2d 259, 276 (3d Cir. 1978), cert. denied, 439 U.S (1979); Nussbacher v. Continental Ill. Nat'l Bank & Trust Co., 518 F.2d 873, 877 (7th Cir. 1975), cert. denied, 424 U.S. 928 (1976); Jerozal v. Cash Reserve Mgm't, Inc., [Current] Fed. See. L. Rep. (CCH) 99,019, at 94,822 (S.D.N.Y. Aug. 10, 1982); see Joy v. North, 692 F.2d 880, 887 (2d. Cir. 1982); Markowitz v. Brody, 90 F.R.D. 542, 561 (S.D.N.Y. 1981) Brody v. Chemical Bank, 517 F.2d 932, 934 (2d Cir. 1975) (per curiam); In re Kauffman Mut. Fund Actions, 479 F.2d 257, 263 (1st Cir.), cert. denied, 414 U.S. 857 (1973); Galfand v. Chestnutt, 402 F. Supp. 1318, 1331 (S.D.N.Y. 1975), aff'd in part, modified on other grounds sub nom. Galfand v. Chestnutt Corp., 545 F.2d 807 (1976), aff'd mem., 573 F.2d 1290 (2d Cir. 1977), cert. denied, 435 U.S. 943 (1978); Standing Requirements, supra note 127, at 171; see Dent, supra note 133, at 99. The demand requirement has the attendant effect of preventing strike suits. Markowitz v. Brody, 90 F.R.D. 542, 561 (S.D.N.Y. 1981); 7A C. Wright & A. Miller, supra note 134, 1831, at ; Standing Requirements, supra note 133, at 172; see Galfand v. Chestnutt, 402 F. Supp. 1318, 1331 (S.D.N.Y. 1975), aff'd in part, modified on other grounds sub nom. Galfand v. Chestnutt Corp., 545 F.2d 807 (1976), aff'd mem., 573 F.2d 1290 (2d Cir. 1977), cert. denied, 435 U.S. 943 (1978). The demand requirement was originally a "judically-created device that forced shareholders to exhaust intracorporate remedies before beginning suit." Weiss v. Temporary Inv. Fund, Inc. 692 F.2d 928, 940 & n.14 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ). In Hawes v. Oakland, 104 U.S. 450 (1881), the Supreme Court set out an early formulation of the demand requirement, stating that the plaintiff must exhaust intracorporate remedies before conducting litigation in his own name; he must make an earnest effort "to induce remedial action" on the part of the managing body of the corporation. Id. at This early formulation was incorporated into various predecessors of Rule 23.1, such as Equity Rule U.S. at ix-x; see Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 940 n.14 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) W. Fletcher, supra note 12, 5963, at 398: Standing Requirements, supra note 133, at Weiss v. Temporary Inv. Fund, Inc. 692 F.2d 928, 941 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Brody v. Chemical Bank, 517 F.2d 932, 934 (2d Cir. 1975) (per curiam); Dent, supra note 133, at ; Standing Requirements, supra note 133, at Joy v. North, 692 F.2d 880, 887 (2d Cir. 1982) ("[D]irectors' decision will be conclusive unless bad faith is proven."); see Auerbach v. Bennett, 47 N.Y.2d 619,

24 1983] RULE 23.1 & SUITS UNDER 36(b) 1425 for such a decision by the board of directors is the common-law business judgment rule. That rule limits judicial scrutiny of a given corporate decision to its procedural aspects: whether the directors made a good faith determination while following procedures suitable to a thorough investigation of the matter in question. The substance of the corporate decision-such as the factors considered by the directors and the relative weight accorded them-is barred from judicial review.14 1 A number of factors indicate that Congress did not intend demand on directors to be a prerequisite to a shareholder suit under section 36(b) for receipt of excessive advisory fees. Rather, Congress intended to confine director involvement in the control of fees to the initial stage of contract negotiation.1 42 First, Congress specifically abrogated , 393 N.E.2d 994, 1000, 419 N.Y.S.2d 920, (1979) (business judgment rule governs directors' decision to terminate derivative suit); Dent, supra note 133, at 100 (whether derivative suit may proceed in face of board's opposition is unclear). Generally a board may not terminate a shareholder suit if a majority of the board is implicated in the wrongdoing that forms the basis for the suit. Recently, however, many courts have upheld termination of a suit by a "special litigation committee" of directors not involved in the alleged wrong, even when the committee did not constitute a majority of the directors. E.g., Abbey v. Control Data Corp., 603 F.2d 724, 727 (8th Cir. 1979), cert. denied, 444 U.S (1980); Auerbach v. Bennett, 47 N.Y.2d 619, 633, 393 N.E.2d 994, 1002, 419 N.Y.S.2d 920, 928 (1979). But see Joy v. North, 692 F.2d 880, 897 (2d Cir. 1982) (decision of special litigation committee to terminate not upheld) Lewis v. Anderson, 615 F.2d 778, (9th Cir. 1979), cert. denied, 449 U.S. 996 (1980); Auerbach v. Bennett, 47 N.Y.2d 619, , 393 N.E.2d 994, , 419 N.Y.S.2d 920, (1979). The derivative suit is "usually barred unless the plaintiff can demonstrate that the board's decision not to sue was ultra vires, or made fraudulently, in bad faith, in breach of trust, or the like." Dent, supra note 133, at 102 (footnote omitted); see United Copper See. Co. v. Amalgamated Copper Co., 244 U.S. 261, (1917) Courts finding demand to be necessary in a 36(b) action have relied in part on language in the Senate report accompanying the enacted bill: [Section 36(b)] is not intended to authorize a court to substitute its business judgment for that of the mutual fund's board of directors in the area of management fees. It does, however, authorize the court to determine whether the investment adviser has committed a breach of fiduciary duty in determining or receiving the fee. Indeed, this section is designed to strengthen the ability of the unaffiliated directors to deal with these matters and to provide a means by which the Federal courts can effectively enforce the federally-created fiduciary duty with respect to management compensation. The section is not intended to shift the responsibility for managing an investment company in the best interest of its shareholders from the directors of such company to the judiciary Senate Report, supra note 2, at 6-7, reprinted in 1970 U.S. Code Cong. & Ad. News at ; accord Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 937 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Grossman v. Johnson, 674 F.2d 115, 122 (1st Cir.), cert. denied, 103 S. Ct. 85 (1982).

25 1426 FORDHAM LAW REVIEW [Vol. 51 When read in the context of the entire report and the legislative history, however, it is clear that this language refers only to the initial stages of negotiating the contract. Advisory Fee Suits, supra note 55, at 627. The report makes clear that the court has the ultimate authority to determine if the adviser has breached its fiduciary duty Senate Report, supra note 2, at 2, reprinted in 1970 U.S. Code Cong. & Ad. News at 4898 (provides effective enforcement method whereby courts can determine whether duty has been breached); id. at 6, reprinted in 1970 U.S. Code Cong. & Ad. News at 4903 (initial responsibility of approval with directors; ultimate responsibility with court); id. at 15, reprinted in 1970 U.S. Code Cong. & Ad. News at 4910 (directors have initial responsibility for approving fees, but judicial remedy exists for breach of fiduciary duty). The report's focus on the conduct of the advisers, rather than on that of the directors, reflects the shift from the reasonable fee standard in earlier bills to an adviser's fiduciary duty standard in the enactment. The change was made at the request of the industry so that the director's conduct would not be put on trial; rather the focus of the litigation would be shifted from the directors of the fund to the adviser House Hearings [pt. 1], supra note 10, at (SEC memorandum); id. at 441 (letter from Robert L. Augenblick, President, Inv. Co. Inst. to Rep. Moss); see Gartenberg v. Merrill Lynch Asset Mgm't, Inc., 694 F.2d 923, 928 (2d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 3, 1983) (No ). The SEC's acquiescence to this request demonstrates its belief that it is unfair to put the directors on trial when they are unable to exercise their business judgment freely in the area of advisory fees. See 1967 House Hearings [pt. 1], supra note 7, at 46; 1967 Senate Hearings [pt. 1], supra note 33, at 96. The argument might be made that directors were intended to have a role when excessive fees are litigated because if they do not respond properly to a demand prior to a 36(b) suit, they could be sued under 36(a). See Note, Termination of Section 36(b) Actions By Mutual Fund Directors: Are the Watchdogs Still the Shareholders' Best Friends?, 50 Fordham L. Rev. 720, 737 (1982) (Section 36(a) provides incentives for disinterested directors to make unbiased decision regarding termination of 36(b) actions.). Section 36(a) allows the SEC to bring an action against directors and others for a breach of fiduciary duty involving personal misconduct and imposes strong sanctions for such a breach. 15 U.S.C. 80a-35(a) (1976). The Senate Report indicates Congress' intent that rights of action be implied under this section Senate Report, supra note 2, at 16, reprinted in 1970 U.S., Code Cong. & Ad. News at Given, however, that the standard for 36(b) actions was changed to avoid subjecting the conduct of directors to trial with respect to advisory fees, it is unlikely this intent can be circumvented by a 36(a) action against those directors. Actions brought under 36(a) for reasons other than excessive fees illustrate that courts feel bound by the business judgment rule in 36(a) actions and therefore defer to director decisions. Tannenbaum v. Zeller, 552 F.2d 402, (2d Cir.) (directors' decision not to recapture brokerage commissions proper exercise of business judgment), cert. denied, 434 U.S. 934 (1977); Herzog v. Russell, 483 F. Supp. 1346, 1350 (E.D.N.Y. 1979) (same); cf. Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598, 623, 627 (S.D.N.Y. 1980) (director did not breach fiduciary duty on indemnification claim because adviser failed to make full disclosure); Advisory Fee Suits, supra note 55, at 621 n.105 (shareholder bringing action under 36(a) "run[s] squarely into the business judgment rule"). Because a plaintiff is not hampered by the business judgment rule under a 36(b) action, see infra pt. II(A)(1) and accompanying text, the two actions do not compare in enforcement potential. Finally, the existence of an implied right to sue under 36(a) for breach of duty regarding fees is questionable, because courts differ whether 36(b) is the exclusive remedy for breaches of fiduciary duty concerning advisory fees. Compare Jerozal v. Cash Reserve Mgm't, Inc., [Current] Fed. Sec. L. Rep. (CCH) 99,019, at 94,824 (S.D.N.Y. Aug. 10, 1982) (implied cause of action against adviser and administrator of fund under 15) with Halligan

26 1983] RULE 23.1 & SUITS UNDER 36(b) 1427 the business judgment rule with respect to judicial scrutiny of director decisions regarding advisory fees. 143 Second, directors have no right to terminate section 36(b) suits for excessive fees, thus giving the shareholder an unhampered right to sue Removal of the Business Judgment Rule In direct contrast to the limitation on independent judicial discretion imposed by the business judgment rule, courts scrutinizing claims under section 36(b) are instructed to "look at all the facts in connection with the determination and receipt of [advisory fees]."' 1 45 In considering director approval of fees the court "might wish to evaluate whether the deliberations of the directors were a matter of substance or a mere formality," 14 but the scope of permissible judicial inquiry is not confined to this consideration. Thus, section 36(b)(2) reverses the normal rule in determining the propriety of corporate decisions-the court, not the directors, is the ultimate arbiter of the reasonableness of advisory fees.' 47 Director approval of the fees is not accorded the deference usually given under the business judgment rule, and does not control the determination whether the adviser breached its fiduciary duty under section 36(b) Director Inability to Terminate Suits Under Section 36(b) Implicit in any decision by mutual fund directors not to pursue a shareholder claim under section 36(b) is their approval of the reasonv. Standard & Poor's/Intercapital, Inc., 434 F. Supp. 1082, 1084 (E.D.N.Y. 1977) ( 36(b) is exclusive remedy; no cause of action against directors or advisers under 15(c)). Most recently, however, one court concluded that 36(b) is the sole remedy for shareholders alleging excessive advisory fees. The court specifically refused to allow the shareholder's action to proceed under 36(a). Tarlow v. Paine Webber Cashfund, Inc., No (D. Conn. Mar. 15, 1983) (available Apr. 21, 1983, on LEXIS, Fedsec library, Cts file) See infra pt. II(A)(1) See infra pt. II(A)(2) Senate Report, supra note 2, at 15, reprinted in 1970 U.S. Code Cong. & Ad. News at The Senate report accompanying the enacted bill is quite specific as to the type of factors the court should consider in determining whether the adviser breached his fiduciary duty. These factors include all services rendered by the adviser to the fund and comparisons to services and fees of other funds. Id Id Id. at 6, reprinted in 1970 U.S. Code Cong. & Ad. News at 4903; see Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 950 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Grossman v. Johnson, 674 F.2d 115, 121 (ist Cir.), cert. denied, 103 S. Ct. 85 (1982) Senate Report, supra note 2, at 15, reprinted in 1970 U.S. Code Cong. & Ad. News at 4910; see 2 T. Frankel, The Regulation of Money Managers B 16.5, at 277 (1978).

27 FORDHAM LAW REVIEW [Vol. 51 ableness of advisory fees. A consequence of removing the business judgment rule in this context, however, is that no reason exists for allowing directors to terminate a section 36(b) action. The Supreme Court apparently recognized this in Burks v. Lasker, 149 in which the Court addressed the issue whether disinterested directors of a mutual fund could properly terminate a shareholder derivative suit brought pursuant to the unamended version of section The Court held that director termination of suits under the ICA generally was permissible only to the extent it was allowed both by state law and by the federal policy underlying the appropriate section of the ICA.' 5 1 Central to the Burks holding was the distinction between section 36(b) as amended and the section of the ICA under which the Burks suit had been brought. 152 As the Court noted, when Congress intended not to allow director termination of shareholder suits "it said so expressly. Section 36(b)[(2)]...performs precisely this function for derivative suits charging breach of fiduciary duty with respect to adviser's fees."' U.S. 471 (1979) Id. at 473. Violations of other sections of the ICA were also alleged in the complaint. Id. & n. 1. The plaintiffs' cause of action accrued prior to the effective date of the 1970 amendments. See id Id. at Compare 15 U.S.C. 80a-35(b)(2) (1976) (court decides weight to be given director approval of fees) with Investment Company Act of 1940, ch. 686, 36, 54 Stat. 789, 841 (no discussion of weight to director approval) (currently codified as amended at 15 U.S.C. 80a-35(a) (1976)) Burks v. Lasker, 441 U.S. 471, 484 (1979); accord Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 939 (3d Cir. 1982) (prudence dictates accession to "strong signal from the Court"), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Fox v. Reich & Tang, Inc., 692 F.2d 250, 261 (2d Cir. 1982) (directors have no power to terminate action), cert. granted sub nor. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ); Grossman v. Johnson, 674 F.2d 115, 121 & n.12 (1st Cir.) (serious reasons for accepting proposition that directors cannot terminate 36(b) suit), cert. denied, 103 S. Ct. 85 (1982); Markowitz v. Brody, 90 F.R.D. 542, 562 (S.D.N.Y. 1981) ("dictum of the most compelling sort"); see Evangelist v. Fidelity Mgm't & Research Co., [Current] Fed. Sec. L. Rep. (CCH) 99,094, at 95,225-3 (D. Mass. Dec. 6, 1982) (Burk s is controlling). Judge Gibbons found that the holding of Burks put the Court's position as to termination of 36(b) suits in context. Termination of a 36(b) suit is inconsistent with the policy of that section and therefore is impermissible under the analysis required by the Court in Burks. Weiss v. Temporary Inv. Fund, Inc. 692 F.2d 928, 952 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ). As one commentator has noted: "[Ilt would be anomalous to place [the] ultimate responsibility in the judiciary to determine whether disinterested directors were successful in preventing the adviser from setting an excessive fee while giving the judiciary a passive role once a litigation committee decided to terminate a suit challenging the fee." Advisory Fee Suits, supra note 55, at 618 (footnote omitted). To

28 1983] RULE 23.1 & SUITS UNDER 36(b) 1429 Because directors are unable to terminate section 36(b) actions, shareholders have "an absolute, indefeasible right to maintain [an] action.' 154 Therefore, even if directors take action on a shareholder demand under section 36(b) by instituting suit or negotiating a settlement with the adviser, they are unable to defeat the shareholder's standing to sue. 55 Director inability to terminate section 36(b) suits removes the principal justification for the demand requirement of Rule Meritless suits can be prevented both by other provisions of the Rule 5 6 and by the limited recovery under section 36(b), which has a chilling effect on the incentive of attorneys to encourage suits for their own pecuniary gain. 57 As Judge Gibbons recognized, any intrusion upon the directors' responsibility to manage the fund as conferred by state law is minimized by the circumscribed nature of the section 36(b) suit. 58 permit director termination would result in a complete shielding of 36(b) actions from judicial scrutiny because special litigation committees are apt to recommend termination and courts are apt to defer to their recommendation. Id. at Markowitz v. Brody, 90 F.R.D. 542, 555 (S.D.N.Y. 1981) See Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 952 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Markowitz v. Brody, 90 F.R.D. 542, 560 & n.18 (S.D.N.Y. 1981) See Markowitz v. Brody, 90 F.R.D. 542, (S.D.N.Y. 1981) (contemporaneous ownership requirement bars suit); Kuzmickey v. Dunmore Corp., 420 F. Supp. 226, (E.D. Pa. 1976) (plaintiff not fairly and adequately representing shareholders; suit dismissed). See supra notes and accompanying text. During the hearings culminating in the 1970 amendments, the Chairman of the SEC commented that restrictions on shareholder ability to sue under 36(b) were not necessary because "there are adequate safeguards under the Federal Rules of Civil Procedure and under this bill to prevent unjustified... litigation." 1969 House Hearings. supra note 10, at 201; accord id. at 860. Both the Weiss and Grossman courts found this statement to be evidence that the demand requirement applies to 36(b) suits. Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 938 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Grossman v. Johnson, 674 F.2d 115, 122 (1st Cir.), cert. denied, 103 S. Ct. 85 (1982). The remarks of one individual, however, are not sufficient to imply the right of action for the fund which would make the Rule applicable. Cf. Texas Indus. v. Radcliff Materials, Inc. 451 U.S. 630, 644 n.17 (1981) ("remarks of a single legislator"). Assuming the Rule to be applicable it is unlikely that the SEC Chairman's statement referred to the demand requirement. None of the various proposals made to restrict shareholder suits during the legislative history of the 1970 amendments contained a demand requirement. If anything, the proposals were analogous to other provisions of Rule For instance, the requirement of proposed bill H.R. 14,747 that the shareholder be bona fide and have justifiable cause to sue is more like the contemporaneous ownership, adequate representation and verification requirements than it is like the demand requirement. See supra notes and accompanying text T. Frankel, supra note 148, at Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 951 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ).

29 1430 FORDHAM LAW REVIEW [Vol. 51 Moreover, directors have authority to negotiate during litigation, with court approval, 5 9 a settlement that will resolve the shareholder claims B. Effects on Shareholders of Requiring Demand In section 36(b) suits, whereas the absence of a demand requirement does not detract from the purposes of Rule 23.1, its presence could gravely undermine the purposes of section 36(b). The legislative history of the 1970 amendments reveals that Congress viewed recovery of fees to be an incentive to bring suit and for that reason rejected proposals that would have restricted section 36(b) to a prospective reduction in fees only Requiring demand, however, removes the incentive to sue by creating the potential that the recovery period finally employed will be one in which the fees paid were not excessive. Section 36(b)(3) allows the recovery of only those excessive fees paid within one year prior to institution of the suit.1 62 Requiring demand delays the shareholder's suit, and hence the beginning of the recovery period, while his demand is being considered. 63 Indeed, while the shareholder waits for board response, sufficient time may elapse that the allegedly excessive fees which prompted the demand will no longer be recoverable. 64 Thus, the recovery will be subject to the vicissitudes of the financial market and the corporate machinery As 159. Fed. R. Civ. P ("The action shall not be dismissed or compromised without the approval of the court...") Blatt v. Dean Witter Reynolds Intercapital Inc., 528 F. Supp. 1152, 1156 (S.D.N.Y. 1982). A forced out-of-court settlement has been condemned as one of the evils of strike suits. See supra note 133 and accompanying text. The provision of Rule 23.1 requiring judicial approval of such settlements, however, eliminates the risk that a settlement will be unfair. See supra note 134 and accompanying text. Settlement has the advantage of avoiding costly litigation. H. Henn, supra note 14, 374, at 789. A number of 36(b) suits have been settled. E.g., Markowitz v. Moneymart Assets Inc., [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 98,360, at 92,208 (S.D.N.Y. Nov. 20, 1981); Krasner v. Dreyfus Corp., 90 F.R.D. 665, 676 (S.D.N.Y. 1981); Boyko v. Reserve Fund, Inc., [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 96,165, at 92,281 (S.D.N.Y. Sept. 8, 1977). Should the directors decide that the shareholder's 36(b) suit has no merit, the directors may litigate on the merits. The one case that has been fully litigated was decided for defendants. See Gartenberg v. Merrill Lynch Asset Mgm't, Inc., 694 F.2d 923 (2d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 3, 1983) (No ) House Hearings [pt.1], supra note 10, at U.S.C. 80a-35(b)(3) (1976) Fox v. Reich & Tang, Inc., 692 F.2d 250, (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ) See id. at See Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 951 (3d Cir. 1982) (Gibbons, J., dissenting) ("normal delays incident to corporate decision-making are

30 1983] RULE 23.1 & SUITS UNDER 36(b) 1431 a result, the damage award may be smaller than it would have been had the shareholder been able to sue without making a demand.' 66 Several scenarios are possible. As noted by the court in Fox v. Reich & Tang, Inc.,' 67 any special one-time payment made outside the oneyear period may not be recovered.' 68 Moreover, Judge Gibbons recognized in Weiss that while considering the demand, the directors could negotiate a prospective reduction in fees, which would yield a recovery smaller than what is due the fund.' 69 Regardless of any such prospective reduction, if the fund's assets declined,' 7 0 even temporarincompatible with a one year period of limitation"), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Zuckerman, Fox v. Reich & Tang-Mutual-Fund Issue Analyzed, N.Y.L.J., Jan. 7, 1983, at 1, col. 2, at 4, col. 5 (discussion of effect of asset fluctuations on recovery). The Weiss court stated that it could "not see why demand cannot be promptly made and expeditiously considered." 692 F.2d at 938. Such an expectation seems unrealistic, as noted by Judge Gibbons in his dissent. Id. at 951 (Gibbons, J., dissenting). The Grossman case offers an example of the delays inherent in corporate decision-making. The district court had allowed the plaintiff to make a belated demand on the directors. The demand was made on June 19, 1979, almost two years after suit was originally instituted. Almost six months later, a special litigation committee voted to terminate the suit. Thus, even though the fund had advance notice of almost two years, it took six months to consider the demand. Grossman v. Johnson, 89 F.R.D. 656, (D. Mass. 1981), aff'd, 674 F.2d 115 (1st Cir.), cert. denied, 103 S. Ct. 85 (1982). The district court upheld the special litigation committee's decision to terminate. Id. at 664. On appeal the defendants moved to dismiss for, among other reasons, failure to make timely demand. 674 F.2d at 118. Ironically, in dismissing for failure to make timely demand, the circuit court noted that if demand is not expeditiously considered, the court could allow the suit to go forward without awaiting a response in order that the shareholders' recovery not be unfairly diminished. Id. at 122. The Weiss court declined to comment on this suggestion. 692 F.2d at 938 n Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 951 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Fox v. Reich & Tang, Inc., 692 F.2d 250, (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ); Blatt v. Dean Witter Reynolds Intercapital, Inc., 528 F. Supp. 1152, 1156 (S.D.N.Y. 1982); see Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 943 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ). But see Grossman v. Johnson, 674 F.2d 115, 122 (1st Cir.) (in usual case recovery would probably not decline), cert. denied, 103 S. Ct. 85 (1982) F.2d 250 (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ) Id. at 262 & n Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 951 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) The current fluctuations in the assets of money market funds illustrate the changes to which mutual funds are subject. Money market fund assets have dropped from a high of $232 billion on December 1, 1982 to $184.3 billion as of March 23, Money-Fund Assets Fell $1.5 Billion During Latest Week, Wall St. J., Mar. 25, 1983, at 35, col. 1. The mutual fund industry experienced a similar dramatic decline

31 1432 FORDHAM LAW REVIEW [Vol. 51 ily, while the demand was being reviewed, any subsequent recovery would correspondingly decline because the fee paid is based on a percentage of average net assets.' 7 ' The courts in Weiss and in Grossman v. Johnson' 72 countered this concern with the cursory statement that any delay would probably not result in a reduced recovery,' 73 apparently a reference to increases in mutual fund assets over past years.' 74 In doing so the courts ignored the effect that a temporary drop could have on a section 36(b) recovery and Congress' intention to encourage shareholder suits by enacting that section. 75 Furthermore, even assuming the assets of mutual funds on an industry-wide basis remain constant or increase,'1 7 the dynamics of the securities market add another perspective to the matter. Although the industry's assets may have remained constant or increased over a given period of time, a particular fund's assets may have decreased, resulting in a reduced recovery for shareholders of that fund who bring a section 36(b) action.1 77 in assets in the 1970's. H. Dougall & F. Corrigan, Investments (10th ed. 1978) See supra note 5 and accompanying text F.2d 115 (1st Cir.), cert. denied, 103 S. Ct. 85 (1982) Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 938 (3d Cir. 1982), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ): Grossman v. Johnson, 674 F.2d 115, 122 (1st Cir.), cert. denied, 103 S. Ct. 85 (1982). The Weiss court seemed to retreat from its statement later in the opinion. 692 F.2d at 943 (application of rule of not allowing demand to be made after suit is filed may seem costly due to one year recovery limitation) See Zuckerman, supra note 165, at 4, col Because the fee is based on the average net assets, a temporary drop the size of that recently experienced in the money market funds might significantly impair recovery. See supra notes 5, 161 and accompanying text Zuckerman, supra note 165, at 4, col As interest rates decline, investors are prone to withdraw their money from money market funds, see G. Christy & J. Clendenin, Introduction to Investments 562 (8th ed. 1982), and transfer it to other types of funds. Similar shifts may occur as the stock market rises and falls. See Scholl, Mutual Funds' Success: A Remembrance of Things Past, Barron's, Feb. 21, 1983, at 37. This phenomenon has been cited as one of the reasons for the recent decline in money market fund assets. Bennett, The Money Funds' Decline, N.Y. Times, Feb. 17, 1983, at Dl, col. 3. In fact, money market funds were an outgrowth of the decline of the stock market in the early 1970's. D. Bellemore, H. Phillips, & J. Ritchie, Investment Analysis and Portfolio Selection: An Integrated Approach (1979). Because most funds today are -'noload" funds that do not make a sales charge when selling shares, investors are not faced with the disincentives to redeeming shares and purchasing new ones that existed in the past. See Advance Notice and Request for Comment on Whether the Commission Should Propose Rules or Recommend Legislation to Enable All or Certain Types of Open-End Investment Companies to Be Organized and Operated Without Shareholder Voting, or Without Either Shareholder Voting or Boards of Directors, Investment Company Act Release No. 12,888, [Current] Fed. See. L. Rep. (CCH) 83,303, at 85, (Dec. 10, 1982).

32 1983] RULE 23.1 & SUITS UNDER 36(b) 1433 Assuming that fees have been excessive from the initial accrual of a cause of action, the fund is foreclosed from recovering fees paid more than one year prior to the suit. Not requiring demand, however, may result in an earlier suit and recovery of those fees, 17 as well as in a prospective reduction in fees 79 1 to avoid future suits. Given Congress' belief that directors are ill-equipped to negotiate reasonable fees, See Krasner v. Dreyfus Corp., 500 F. Supp. 36, (1980), settlement approved, 90 F.R.D. 665 (S.D.N.Y. 1981); cf. Boyko v. Reserve Fund, Inc., [ Transfer Binder] Fed. See. L. Rep. (CCH) 96,165, at 92,281 (S.D.N.Y. Sept. 8, 1977) (arbitration resulted in $850,000 recovery) See, e.g., Markowitz v. Moneymart Assets Inc., [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 98,360, at 92,213 (S.D.N.Y. Nov. 20, 1981); Krasner v. Dreyfus Corp., 500 F. Supp. 36, 40 (1980), settlement approved, 90 F.R.D. 665 (S.D.N.Y. 1981): Boyko v. Reserve Fund, Inc., [ Transfer Binder] Fed. See. L. Rep. (CCH) 4 96,165, at 92,281 (S.D.N.Y. Sept. 8, 1977) See supra notes 33-41, and accompanying text. There are some indications that directors face the same problems they experienced prior to the 1970 amendments. The court in Gartenberg v. Merrill Lynch Asset Mgm't, Inc., 694 F.2d 923 (2d Cir. 1982), petition for cert. filed. 51 U.S.L.W (U.S. Mar. 3, 1983) (No ), found that while money market funds may have competed with each other for shareholder favor, such competition did not lead to competition between advisers for fund business because the advisory fee is a relatively insignificant cost to each individual investor. Id. at In addition, the problem of director dependence on the adviser for information has been litigated, with courts finding that the advisers, in violation of the ICA, failed to furnish information. Galfand v. Chestnutt Corp., 545 F.2d 807, (1976), aff'd mern., 573 F.2d 1290 (2d Cir. 1977), cert. denied, 435 U.S. 943 (1978); Fogel v. Chestnutt, 533 F.2d 731, 745 (2d Cir. 1975), cert. denied, 429 U.S. 824 (1976); First Multifund Advisory Corp., [Current] Fed. Sec. L. Rep. (CCH) 83,313, at 85, (Admin. Proc. File No , Dec. 30, 1982); see SEC v. American Birthright Trust Mgm't Co., [1981 Transfer Binder] Fed. Sec. L. Rep. (CCH) 97,809, at 90, (Litig. Release No. 9266, D.D.C. Dec. 30, 1980). But see Gartenberg v. Merrill Lynch Assets Mgm't, Inc., 694 F.2d 923, 933 (2d Cir. 1982) (board aware of or could obtain information), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 3, 1983) (No ). Two noted commentators differ on the effectiveness of the disinterested director concept. Compare Brudney, The Independent Director-Heavenly City or Potemkin Village?, 95 Harv. L. Rev. 597, & n.59 (1982) (mutual fund disinterested director has played an "essentially passive role") with Phillips, Deregulation Under the Investment Company Act-A Reevaluation of the Corporate Paraphernalia of Shareholder Voting and Boards of Directors, 37 Bus. Law. 903, (1982) (disinterested directors have become increasingly sophisticated and serve as a check on advisers). Other commentators have discussed the social forces which prevent an independent director in any corporation from being truly independent. E.g., Elfin, An Evaluation of a New Trend in Corporate Law: Dismissal of Derivative Suits By Minority Board Committees, 20 Am. Bus. L.J. 179, 197 (1982) (entire board of any corporation bound by various relationships so that special litigation committee is not independent); Hamilton, Commentary, 60 Wash. U.L.Q. 345, 348 (1982) (corporate independent directors are "'too old, too trusting, too cautious, not very intelligent, or so eager to stay on the board that they will accept management's explanation for practically anything").

33 1434 FORDHAM LAW REVIEW [Vol. 51 and the constraints Congress put on the directors' ability to respond to section 36(b) suits, 18 ' it is unlikely that Congress thought directors would overcome their handicaps to take such action as negotiating a settlement upon receipt of demand.' 82 Equally unlikely is that Congress intended the incentive of recovery to be subject to the uncertainties precipitated by a demand requirement.' 8 3 CONCLUSION Rule 23.1 is applicable to shareholder actions under section 36(b) of the ICA only if the right of action may also be exercised by the mutual fund itself. Section 36(b) gives no express right of action to the fund, nor can one be implied under the implication doctrine of recent Supreme Court cases. Even if a right of action could be implied for the fund so as to make section 36(b) actions subject to Rule 23.1, enforcement of its demand requirement would be contrary to congressional intent. Shareholder suits under section 36(b) were authorized because of Congress' belief that fund directors are ineffective protectors against excessive advisory fees. To increase shareholder effectiveness in section 36(b) suits, available director responses to a shareholder demand were limited severely. Congress could not have intended to free shareholder suits under section 36(b) from the pitfalls normally associated with share See supra pt. II(A) Blatt v. Dean Witter Reynolds Intercapital Inc., 528 F. Supp. 1152, 1156 (S.D.N.Y. 1982); see Fox v. Reich & Tang, Inc., 692 F.2d 250, 254 n.7 (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ). The defendants in Fox suggested that upon receipt of demand prior to a 36(b) suit, the board could terminate the advisory fee contract. Id. at 254 n.7; see 15 U.S.C. 80a-15(a)(3) (1976). The court recognized, however, that as a practical matter the adviser-director relationship cannot be severed, and moreover, termination does not serve the purpose of 36(b), which is the recovery of fees already paid. 692 F.2d at 254 n.7. The court in Grossman v. Johnson, 674 F.2d 115 (1st Cir.), cert. denied, 103 S. Ct. 85 (1982), found that the only purpose demand would serve is to give the directors the opportunity to study the claim and make their views known to the court. 674 F.2d at 121; accord Markowitz v. Brody, 90 F.R.D. 542, 559 (S.D.N.Y. 1981). As Judge Gibbons noted, the viewpoints of the directors can be made known during the course of a lawsuit just as effectively without demand. Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ) Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 951 (3d Cir. 1982) (Gibbons, J., dissenting), petition for cert. filed, 51 U.S.L.W (U.S. Mar. 26, 1983) (No ); Fox v. Reich & Tang, Inc., 692 F.2d 250, (2d Cir. 1982), cert. granted sub nom. Daily Income Fund v. Fox, 51 U.S.L.W (U.S. Mar. 7, 1983) (No ); Blatt v. Dean Witter Reynolds Intercapital, Inc., 528 F. Supp. 1152, 1156 (S.D.N.Y. 1982). The requirement that the shareholder make demand on the SEC before bringing an excessive fee suit, incorporated into proposed