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Rosenfeld v. Black

decided: June 22, 1971.


Friendly, Chief Judge, and Waterman and Hays, Circuit Judges.

Author: Friendly

FRIENDLY, Chief Judge:

The appeal here is by plaintiffs, stockholders in what was The Lazard Fund, Inc. ("the Fund"), a mutual fund organized in 1958 and registered under the Investment Company Act of 1940 ("the Act"). Their complaints, brought in the District Court for the Southern District of New York, sought, inter alia, an accounting of profits allegedly realized by Lazard Freres ("Lazard"), the organizer and investment adviser of the Fund, when, in 1967, it ceased to be the adviser and was replaced by Moody's Advisors & Distributors, Inc. ("Moody's A & D"), a wholly-owned subsidiary of Moody's Investors Service, Inc., which in turn was a wholly-owned subsidiary of Dun & Bradstreet, Inc. ("D & B"). The district court granted defendants' motion for summary judgment. The appeal raises an important question with respect to the obligations of an investment adviser that wishes to terminate its services to an investment company.


As noted, Lazard, a highly reputed investment banking firm, had organized the Fund in 1958. The initial offering was of 8,500,000 shares at a price to the public of $15 per share.*fn1 Although originally organized as a closed-end investment company, the terms of the initial public offering made the Fund "openend" within § 5(a) (1) of the Act in the sense that the shares were redeemable, at a charge of 1% of the net asset value of the shares tendered for redemption. The Fund employed Lazard as investment adviser. The advisory contract, which conformed to the requirements of § 15(a) of the Act and was renewed on one occasion with directors' and thereafter with stockholders' approval, provided for quarterly fees which, translated to an annual basis, amounted to 1/2 of 1% on the first $100,000,000 of the Fund's average daily net assets, 3/8 of 1% on the next $50,000,000, and 1/4 of 1% on any excess over $150,000,000. In return, Lazard was obligated not only to advise the Fund in respect of investments but also to provide necessary office facilities and personnel including corporate officers; its compensation was to be reduced by any amounts up to $50,000 per year paid by the Fund to members of its board of directors, executive committee or consultants.

The principal moving affidavit, by a Lazard partner, set forth the following: In contrast to most open-end investment companies, the Fund did not engage in a continuous public offering of its shares. The shrinkage attendant upon redemptions unaccompanied by sales was expected to be counteracted by an additional offering. However, developments in the mutual fund industry accelerated the shrinkage to such an extent that it would not likely be offset by such an offering. By the time of the events here in question, the number of shares had decreased to 5,304,711 and net assets had declined to some $85,000,000. In light of this, Lazard concluded that the best interests of the Fund's stockholders would be served if the Fund were to engage in a continuous offering of its shares and institute various new investment plans and programs of the type provided by competing funds. However, it would have been contrary to Lazard's traditional policies and mode of operation to create the organization needed to that end. In 1966, when Lazard learned that Moody's Investors Service, Inc., which managed more than $4 billion worth of investments for customers as investment adviser, was considering the possibility of entering the mutual fund area, it felt that an ideal solution to the Fund's problem might be in sight.

With the knowledge and approval of the Fund's directors, Lazard approached D & B. The result was a series of agreements. One provided for the "merger" of the Fund into Moody's Capital Fund, which Moody's Investors Service would organize with a capital of $100,000 in cash and Government securities. Each share of the Lazard Fund was exchangeable for one share of the Capital Fund having the same net asset value as one share of the Lazard Fund, and the shares of the Capital Fund owned by Moody's Investors Service prior to merger would also be converted into shares of the surviving corporation having the same net asset value as the shares issued to Lazard Fund stockholders.*fn2 The Capital Fund would employ Moody's A & D both as investment adviser, on substantially the same terms previously provided with respect to Lazard, and as exclusive agent for the sale of Capital Fund stock at net asset value, plus a scale of sales charges payable to Moody's A & D. Approval of the merger by the Fund's stockholders would constitute approval of the new advisory contract between Capital Fund and Moody's A & D. Thus, as a result of the proposed transactions, the Fund would evolve into an open-end company which offered special investment services and engaged in continuous offering of its shares through the Moody's A & D distributor.

The aspect of the Lazard-D & B negotiations most important for our purposes, was an agreement dated April 5, 1967 between Lazard and D & B, which was to become effective upon the effective date of the merger if the advisory contract between Capital Fund and Moody's A & D were approved at that time. The proxy statement sent to stockholders of the Fund described this as follows:

Agreement between Dun & Bradstreet, Inc. and Lazard Freres & Co.

Dun & Bradstreet, Inc. of which Moody's Investors is a wholly-owned subsidiary has entered into an agreement with Lazard Freres & Co., investment adviser of the Corporation, to take effect upon the consummation of the merger, pursuant to which Lazard Freres & Co. has agreed for a period of five years from the effectiveness of the merger not (a) to become associated, either in a management or advisory capacity, with another investment company subject to registration under the Investment Company Act of 1940; (b) to permit the use of the name "Lazard", or any combination including such name, by any such investment company or investment company manager or adviser; and (c) to act as principal distributor for any openend investment company making a continuous offering of its shares, and which is subject to registration under the Investment Company Act of 1940.

Lazard Freres & Co. has also agreed for a period of five years from the effectiveness of the merger unless otherwise specified (a) to make available Mr. Hettinger (or others) for the purpose of (1) reviewing and advising with respect to European economic and monetary conditions and (2) serving as a director of Moody's Capital Fund and/or Moody's Fund, Inc.; (b) to consult for a transitional period not in excess of one year with respect to the administrative operations of Moody's Capital Fund; (c) to use its best efforts to induce certain persons presently performing services for the Corporation to similarly perform for Moody's Capital Fund; and (d) to make available certain research reports and analyses prepared by them during the existence of the Corporation.

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. The 75,000 shares will be placed in escrow by Lazard Freres & Co. to secure performance of its obligations set forth in the first paragraph of this subsection and, subject to such performance, will be released at the rate of 10,000 shares annually for the next four years with the remaining 35,000 shares to be released at the end of the fifth year. Cash dividends will not be paid on such shares as from time to time remain unreleased from escrow, but such shares may be voted by Lazard Freres & Co. while they are subject to the escrow.

Plaintiffs allege, and defendants do not dispute, that D & B stock was selling over the counter at more than $37 per share at the time the contract was signed, although it had been selling at a lower price earlier during the negotiating period.*fn3

On April 6, 1967, the Fund sent to stockholders a letter, a notice of special meeting of stockholders, a proxy and a proxy statement. The notice stated the chief business of the meeting to be approval of the merger of the Fund with Moody's Capital Fund and consequent adoption of the advisory contract between Capital Fund and Moody's A & D. While the stockholders were told of the agreement between Lazard and D & B in the manner already set forth, they were not asked to approve it. The letter, signed by Mr. Hettinger, a partner of Lazard and president of the Fund, informed the stockholders that the Fund's board of directors*fn4 recommended approval of the merger largely because it would cure the disadvantages which the Fund suffered by not engaging in continuous offering of its shares and by not making available ...

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