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ROSENFELD v. BLACK

October 15, 1970

Judah ROSENFELD, as Custodian for Joel B. Rosenfeld, Plaintiff,
v.
E.R. BLACK et al., Defendants. Hyman SAMINSKY, Plaintiff, v. G. GUND et al., Defendants. Beatrice S. FRANK, Plaintiff, v. LAZARD FRERES & COMPANY et al., Defendants. Jack FARBER, Plaintiff, v. Richard H. MANSFIELD et al., Defendants


Mansfield, District Judge.


The opinion of the court was delivered by: MANSFIELD

MANSFIELD, District Judge.

In these consolidated derivative actions by some shareholders of what was formerly The Lazard Fund, Inc. ("Fund" herein), an open-end mutual investment company registered under The Investment Company Act of 1940, 15 U.S.C. § 80a-1 et seq., against its former individual directors, the Fund itself, Dun & Bradstreet, Inc. ("D & B" herein), and others, the defendants -- other than Alan H. Temple, Lazard Fund, Inc., and its successor Moody's Capital Fund, Inc. -- move for summary judgment. For the reasons stated below the motion is granted.

 Plaintiffs claim

 
(1) that Lazard Freres & Co. ("Lazard" herein), the investment adviser to the Fund, sold its advisory office to D & B in return for 75,000 shares of D & B stock;
 
(2) that this sale was contrary to the Investment Company Act of 1940, 15 U.S.C. § 80a-15(a)(4) ("the Act" herein), which provides that any attempt to assign such a contract automatically terminates it, and violated defendants' fiduciary duty to the Fund's shareholders;
 
(3) that if the Fund's shareholders approved the sale, it was contrary to the Act, and the approval was ineffective because it was fraudulently obtained by means of a proxy statement which failed to disclose Lazard's "true motives" in accepting the 75,000 shares of D & B stock and the true value of that stock.

 Defendants deny each of plaintiffs' charges, contending that there is no genuine factual issue and that even on plaintiffs' version of the facts they are entitled to judgment.

 Certain facts are not controverted. *fn1" In 1958 Lazard organized the Fund, an open-end mutual investment company subject to and registered under the provisions of the Investment Company Act of 1940, 15 U.S.C. § 80a-1 et seq. Thereafter and until May 5, 1967, Lazard served as the Fund's investment adviser in return for fees, which are not claimed to have been excessive. As required by the Act the contract between the parties provided that it was not assignable and that any attempt to assign it would automatically result in its termination. The contract further provided that it could be terminated by either party upon sixty (60) days' notice.

 The Fund, unlike many other mutual funds, did not engage in continuous public offering of additional Fund shares. Lazard knew that there would be redemptions of shares and a consequent shrinkage of the Fund, but thought that any such shrinkage would be offset by an additional offering. However, the shrinkage became so substantial that it was unlikely that an offering would offset it. Moreover, Lazard was unwilling to engage in continuous public offering of the Fund's shares, which would have required salesmen, branch offices, and promotion.

 In 1966 Lazard learned that a subsidiary of D & B, Moody's Investors Service, Inc. ("Moody's Service" herein), a prominent firm engaged in the management of very substantial investments for which it served as an investment advisor, was considering entry into the mutual fund field. Lazard approached D & B and after negotiations both agreed, subject to approval of the Fund's shareholders, to merge the Fund into Moody's Capital Fund, Inc. ("Moody's Capital" herein), a wholly owned subsidiary of Moody's Service, and that Moody's Advisers and Distributors, Inc. ("Moody's A & D" herein), another wholly owned subsidiary of Moody's Service, would serve as investment adviser to the successor fund and engage in the necessary continuous selling of its shares. The successor fund proposed not only to offer its shares continuously but also to offer new varied investment programs (such as periodic payment plans), to permit stockholders to reinvest dividends (in addition to capital gains), and not to charge any fee to stockholders upon redemption.

 On April 5, 1967, D & B and Lazard entered into a written contract providing that for a period of five years from the effective date of the proposed merger Lazard, which had been the Fund's investment adviser, (1) would not become associated, either in a management or advisory capacity, with any other investment company subject to registration under the Act, (2) would not permit the name "Lazard" to be used by any such investment company or adviser, and (3) would not act as a principal distributor for any open-end investment company making a continuous offering of shares, which was subject to registration under the Act.

 Under the contract Lazard further agreed for a period of five years (1) to make available one of its partners, A.J. Hettinger, Jr., who had served as president and a director of the Fund, to review and advise with respect to European economic conditions and serve as a director of Moody's Capital, (2) to use its best efforts to induce certain key Fund personnel to perform similar services for Moody's Capital, and (3) to make available for D & B's unrestricted use a library of research reports and analyses previously prepared by Lazard. In addition the agreement provided that Lazard would consult with respect to the administrative operations of Moody's Capital for a period of up to one year.

 The agreement of April 5, 1967, further provided that in consideration of Lazard's agreeing to the foregoing, D & B would transfer to Lazard 75,000 shares of D & B stock over a five-year period. The stock was to be held in escrow, with 10,000 shares to be released each year and 35,000 shares to be released at the end of the period. None of these shares could be sold during the first two years and thereafter only the stock which had been released could be transferred. Cash dividends would not be paid on such shares as from time to time remained unreleased from escrow but those shares could be voted by Lazard while subject to escrow. See generally, Lazard-Dun & Bradstreet Agreement, Moving Affidavit of Simon H. Rifkind, Ex. 2, RA 26-49. The par value of the D & B stock was $1.00 per share. Defendants claim that at the time when the agreement was negotiated unencumbered D & B stock was being publicly traded at $28 per share. (Aff. of Walter Fried, a Lazard partner, para. 28). When plaintiffs commenced their lawsuit in April, 1967, they claimed that D & B was then selling for $37.50 per share. (Compl., Rosenfeld v. Black, para. 8). According to plaintiffs' figure, the total value of the 75,000 shares of unencumbered D & B stock was about $2.8 million. Defendants claim that since the shares were encumbered for a period up to five years their value at the time of the agreement was far less than the current market price. In view of the basis for our decision, however, the issue as to the value of the shares becomes immaterial.

 It is the payment of the 75,000 D & B shares to Lazard that forms the basis of the present lawsuit. Plaintiffs claim that the true consideration for the shares was the sale or transfer of Lazard's position as investment adviser to the Fund rather than the various obligations undertaken by Lazard under the terms of the agreement itself. Plaintiffs further contend that while the Lazard-D & B contract of April 5, 1967, did not result in any out-of-pocket loss to the Fund, Lazard's position as investment adviser to the Fund nevertheless represented an asset of the Fund requiring Lazard to turn over to the Fund the 75,000 shares allegedly received for that Fund asset.

 Defendants assert that the true consideration for the 75,000 shares was the various aforementioned obligations undertaken by Lazard in the contract itself, which were of considerable value to D & B; and that the Fund suffered no loss but on the contrary benefited from the merger, since the new mutual fund has (pursuant to the agreement) engaged in continuous selling of Fund shares, has permitted stockholders to reinvest dividends, does not charge any fee to stockholders on redemption, and has not increased the advisory fee paid by the Fund. Defendants make the further contention, which is the more important one for purposes of their motion, that, even accepting arguendo plaintiffs' claims as to the consideration paid for the 75,000 shares, Lazard's office as investment adviser did not constitute an asset of the Fund and neither Lazard nor D & B were under an obligation to turn over the shares to the Fund.

 Before considering these respective contentions a few more undisputed facts bearing upon stockholder approval of the merger should be mentioned. By notice and proxy statement dated April 6, 1967, the Fund's shareholders were advised that its directors had approved the merger of the Fund into Moody's Capital, subject to approval by the Fund's shareholders. By a proxy statement dated April 6, 1967, the Fund's directors advised its stockholders that the board had approved the merger into Moody's Capital, subject to stockholder approval, and that the proposed merger would be submitted to the stockholders for their approval or rejection at a special meeting to be held on May 5, 1967. The proxy statement attached copies of the proposed merger agreement and the investment advisory agreement between Moody's Capital and Moody's A & D. It also set forth (at p. 7) a description of all of the material terms of the April 5, 1967, Lazard-D & B agreement, including the undertaking that "As consideration for such agreements, Dun & Bradstreet, Inc. will deliver to Lazard Freres & Co. 75,000 shares of its common stock, par value $1 per share," with a description of the terms with respect to the escrowing of the 75,000 shares, payment of dividends, etc.

 On April 11 and 12, 1967, certain stockholders of the Fund commenced the present suit in this court and a similar action in the Supreme Court, New York County, seeking to enjoin the merger and delivery of the 75,000 shares of D & B stock on the grounds already described by us above. Thereupon, by letter dated April 14, 1967, the President of the Fund advised its stockholders of the institution of the suits and of the substance of the allegations of the complaints, including specifically the charge "that Lazard Freres dominates and controls the Fund and its board of directors, that the agreements described in the proxy statement would constitute a sale by Lazard Freres of its investment advisory contract with the Fund and a sale by defendants of their fiduciary offices * * * and that the transactions described in the proxy statement are unlawful and would constitute a gross abuse of trust." *fn2" ...


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