Before FRIENDLY and SMITH, Circuit Judges, and BLUMENFELD, District Judge*fn* .
The affairs of Alleghany Corporation, from its founding by the Van Sweringen brothers in 1929, have given rise to a flood of litigation that must be unparalleled in American corporation law. Even a single phase of its activity, its relationship with Investors Diversified Services, Inc. (IDS), of which Alleghany obtained control in 1949, has been a bounteous provider for the Securities and Exchange Commission and the courts, especially the District Court for the Southern District of New York and this court. This appeal concerns a chapter of Alleghany ten years after the one that recently occupied our attention in Alleghany Corp. v. Kirby, 333 F.2d 327 (2 Cir. 1964), court equally divided on rehearing in banc, 340 F.2d 311 (1965); the present case concerns the dislodgment in 1961 of the Kirby management by its quondam ally, the Murchison brothers, and the effect of this on the contracts between IDS and one of the investment companies for which IDS acts as investment adviser and underwriter.
Alleghany bought a controlling interest in IDS in 1949; though its holdings have varied, it has held 47.6% of IDS's voting stock during the period in 1960 and 1961 here relevant. As of January 1, 1960, Allan P. Kirby and two corporations controlled by him owned 571,200 shares of Alleghany common stock and 143,210 shares of 6% preferred, each convertible into 4.7 shares of common on payment of $3.75 per common share. The next largest stockholding was that of Robert R. Young's widow, who individually and as executrix owned 250,717 shares of common and 160,320 shares of 6% convertible preferred. Kirby's nominees were elected as directors at the Alleghany annual meeting on May 2, 1960.
In September, 1960, the Murchison brothers, with two other Alleghany stockholders, organized a committee to elect a new board of directors at the annual meeting of stockholders on May 1, 1961. Earlier in 1960, they had contracted to acquire Mrs. Young's holdings, on which they immediately obtained the voting rights; as a result of the purchase of her common stock and the conversion of preferred stock acquired from her, they obtained 1,004,221 common shares*fn1 Before the record date for the Alleghany annual meeting in 1961, they and their participants and associates had acquired by miscellaneous purchases of common stock (or by conversion of preferred stock or exercise of warrants similarly purchased) another 1,132,117 shares of common, and other members of their committee with participants and associates owned or had similarly acquired a further 717,632 common shares. These three items totaled 2,853,970 shares of the common stock. Meanwhile Kirby had been fighting fire with fire; on the record date he and the other participants and associates with him owned 3,303,289 shares of Alleghany common. 3,043,746 common shares represented at the 1961 meeting were not owned by either side*fn2 Approximately 71% of these "free" shares were voted for the Murchison slate, which won by some 854,000 votes. The tellers certified the victory on May 23, 1961; on that day the newly chosen directors elected John D. Murchison as president and chief executive officer of Alleghany. At a special meeting of IDS stockholders on July 18, 1961, Alleghany caused the election of eight new directors while retaining two others as holdovers from the IDS board that Kirby had selected; the new IDS board was under Murchison control and Clint W. Murchison, Jr. became chairman.
Sections 15(a) and (b) of the Investment Company Act of 1940 (15 U.S.C. §§ 80a-1 to 80a-52), make it unlawful to act as investment adviser for a registered investment company or as principal underwriter for a registered open-end company except pursuant to a written contract, approved by a majority of the outstanding voting securities in the case of the investment adviser and by a disinterested majority of the directors in the case of the underwriter, which must provide, inter alia, "for its automatic termination in the event of its assignment" by the investment adviser or underwriter. In May, 1961, IDS was acting as investment adviser and as principal underwriter to Investors Mutual Inc., an open-end company, under contracts with such termination provisions. Section 15(d) ties the knot by making it unlawful to act as investment adviser or principal underwriter under a written contract after assignment thereof. Finally, § 2(a) (4) instructs us that:
"(4) 'Assignment' includes any direct or indirect transfer or hypothecation of a contract or chose in action by the assignor, or of a controlling block of the assignor's outstanding voting securities by a security holder of the assignor * * *."
The gravamen of the complaint in the instant derivative action, brought by two stockholders of Investors Mutual in the District Court for the Southern District of New York, as authorized by § 44 of the Act, is that IDS continued to act as investment adviser and principal underwriter for Investors Mutual although, allegedly, the events here recounted were an "assignment." The principal relief asked was an injunction preventing further performance of the contracts allegedly terminated*fn3 and repayment to Investors Mutual of profits and damages that had accrued since the assignment. See, e.g., Lutz v. Boas, 39 Del.Ch. 585, 171 A.2d 381 (1961). Contending that on the undisputed facts there was no assignment, IDS and the Murchisons made motions for summary judgment dismissing the complaint, which Judge Dawson granted, 231 F. Supp. 142 (1964). Although we consider the case closer than he did, we affirm*fn4
There is little dispute that certain of the possible forms of "assignment" listed in § 2(a) (4) must be eliminated straight away. There was no "hypothecation of a contract or chose in action by the assignor." Likewise there was no "direct * * * transfer" of a contract; IDS made no attempt to substitute another as holder of its contracts for investment advisory and underwriting services with Investors Mutual. Neither was there a "direct * * * transfer * * * of a controlling block of the assignor's outstanding voting securities by a security holder of the assignor." In the context of § 15 the "assignor" is the person rendering investment advisory or underwriting services - here IDS; and the "controlling block" of IDS has remained where it had been for over a decade - in Alleghany's treasury. The serious questions are whether there was an "indirect transfer," either of a "controlling block" or of the contracts themselves.
Since the statute requires transfer "of a controlling block of the assignor's outstanding voting securities by a security holder of the assignor ," the absence of any transfer of IDS stock by Alleghany would thus, on a literal reading, be as complete an obstacle on the "indirect" as it is on the "direct" path.Yet this conclusion, it can well be argued, shows the need for avoiding such literalism in order to give some effect to the possibility, envisioned by the statute, of an "indirect" transfer of a controlling block by means such as there described. An answer might be that sufficient effect would be given by considering "indirect" to have been included to cover cases where a separate corporate layer was interposed, or some other device was used, in the absence of any significant business purpose, e.g., if ownership of IDS had been vested in a company created for the sole object of holding its stock, and a controlling block of stock in the holding company was transferred - a situation not contended to be present here, where Alleghany had existed long before its purchase of a controlling interest in IDS in 1949 and continued to have many other interests. We by no means reject this possible construction. Serious problems are created, particularly as regards stockholders having no connection with the transfer of a controlling block, if the Draconian sanctions of § 15(d) are visited upon a company, having many other purposes, that has acquired a controlling interest in an investment adviser or underwriter. Although minority stockholders in a company of the latter sort are likely to be familiar with the Investment Company Act - or may fairly be treated as if they were, it is somewhat unrealistic to suggest that the public stockholders of Alleghany, who voted predominantly with the Murchisons in the proxy contest, were on notice that a Murchison victory might impair the value of the brightest jewel in Alleghany's crown, and consequently unfair to penalize them for having done so.
However, we shall here assume, arguendo, that the definition is broad enough to include the transfer of a controlling block of the voting securities of an owner of a controlling block of the assignor's voting securities by a security holder of that owner, even when the owner is not a company created to hold the assignor's stock. In making that assumption we in no way accept appellants' further contention that whenever a group controlling Alleghany lost control to another group, this would inevitably constitute an indirect transfer of a controlling block of IDS by its security holders within the meaning of § 2(a) (4). Shortly we will set down in another context our reasons for believing that Congress did not mean that the mere change in management or control of an investment adviser or underwriter was an "assignment" terminating its contract. While those reasons are equally applicable on the issue here considered, it is even more certain that Congress did not intend that such a change, occurring as the result of a proxy contest in a parent corporation controlling the adviser but without transfer of a controlling block of the parent's stock, could constitute an "indirect transfer * * * of a controlling block of the assignor's securities." If such a change took place through a similar proxy fight among the immediate owners of the adviser itself, no one could conclude that any "controlling block" had been transferred directly or otherwise, and it would be a contradiction to treat a transaction more harshly when it occurs in the company controlling the adviser than in the adviser itself. We stretch the word "indirectly" as far as permissible - if not indeed too far - when we treat the case as if Alleghany itself were the investment adviser. Hence we proceed to consider whether the transfer of a controlling block of Alleghany stock has been shown.
The only transaction in the present record that might constitute such a transfer would be Mrs. Young's sale of her stock to the Murchisons. Viewing the matter as of the first of January, 1960, the month in which she committed to sell and vest the Murchisons with voting rights, her stock, assuming complete conversion of her preferred shares, would have represented 1,004,221 common shares. At the same time, on a similar assumption, Kirby would have had 1,244,287 common shares.The total outstanding common shares, giving effect to both assumed conversions, would have been 6,717,968. The Young stock would thus have been slightly less than 15% and the Kirby stock somewhat more than 18% of the total. If the figures of Young and Kirby ownership in January, 1960, are related to the 9,884,970 common shares outstanding on the record date in 1961 as a result of further conversions and the exercise of warrants - probably a more realistic test - the proportions are reduced to almost 11% for the Young stock and 13% for the Kirby stock.
Section 2(a) (9) of the Investment Company Act contains provisions as to "control" which we quote in the margin*fn5 It is clear that Kirby and Young together had controlled Alleghany for twenty years, until Young's death in 1958, and it could hardly be doubted that a sale of their combined holdings would have been the transfer of a controlling block. Very likely a sale of Kirby's shares alone in 1960 would have been such a transfer even though these were considerably less than 25% of Alleghany's voting securities, for Kirby had nominated the Alleghany board and presumably could have procured their resignations in favor of a transferee. This dual transfer of the single largest block along with the board of directors and the important corporate proxy machinery could reasonably be said to overcome the negative presumption of § 2(a) (9) that less than 25% ownership does not control*fn6 But is the same true of the block held by Mrs. Young?
In giving a negative answer we do not underestimate the strategic character of the Young holdings. So far as the record shows, these were by far the largest block of Alleghany common shares save for the Kirby holdings, and those were only slightly larger if the Young preferred was converted, as it was likely to be in a contest for control since the preferred was selling at a price reflecting the price of the common. It must have been, and quite obviously was, apparent to the Murchisons that the first step in a successful bid to oust the Kirby management was to prevent any possibility of Kirby's getting the vote of the Young stock by putting this securely in their own corner. The correctness of this judgment is shown ...