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ROSENFELD v. BLACK

January 6, 1972

Judah ROSENFELD, as custodian for Joel B. Rosenfeld, et al., Plaintiffs,
v.
E.R. BLACK et al., Defendants


Gurfein, District Judge.


The opinion of the court was delivered by: GURFEIN

GURFEIN, District Judge.

A settlement of this derivative stockholders' action is presented to the Court for approval pursuant to Fed. R. Civ. P. 23.1. The settlement was effected after the decision of the Court of Appeals for the Second Circuit, reversing the grant of summary judgment for the defendants in the District Court, thus sending the case back for trial. The opinion of the Court of Appeals is reported at 445 F.2d 1337 and the earlier opinion of the District Court at 319 F. Supp. 891. Since these reported opinions discuss the allegations of the complaint and the affidavits on the motion for summary judgment at some length, it is unnecessary to repeat them again in detail. A brief resume of the facts will suffice to put the discussion of the matter in proper perspective.

 THE FACTS

 In 1967, The Lazard Fund, Inc. (Fund) merged into Moody's Capital Fund, Inc. (Moody's Capital), and the shareholders of the fund selected Moody's Advisors and Distributors, Inc. (Advisors) as the successor to Lazard Freres & Co. (Lazard) as investment adviser.

 The Fund had been founded in 1958 and became, by the terms of its initial offering, a registered open-end investment company or mutual fund. *fn1" Lazard had organized the Fund and served as its investment adviser. Unlike most mutual funds the Fund did not engage in continuous offering of its shares. The Fund experienced a significant shrinkage because of redemptions, and by 1966 Lazard determined, since it was unwilling to engage in continuous selling, to transfer the Fund to someone who could engage in such activity. At that time, Dun & Bradstreet, Inc. (D&B), through its subsidiary, Moody's Investors Service, Inc. (Moody's Service), was independently considering the possibility of entering the mutual fund field. Accordingly, Lazard and D&B entered into discussions which led to the Fund's proposed merger with Moody's Capital (a fund organized by D&B for the purpose of the merger). It was proposed that Advisors, a subsidiary of Moody's Service, would become investment adviser and principal underwriter to the successor fund and, in the latter capacity, would engage in continuous selling.

 The merger agreement was submitted to the shareholders of the Fund with an accompanying proxy statement. There was also submitted to the shareholders for approval, in accordance with Section 15(a) of the Investment Company Act of 1940 (15 U.S.C. § 80a-15(a)), the underwriting and advisory agreements. An agreement between Lazard and D&B, discussed later, was disclosed but not submitted for approval. The merger was approved on May 5, 1967 by a vote of 99% of the stock; less than 1% of the stock voted was cast in opposition.

 Contemporaneous with the merger agreement, there was executed on April 5, 1967 an agreement between Lazard and D&B, mentioned above, in which Lazard gave certain commitments to D&B and was to receive in return 75,000 shares of D&B stock under conditions to be noted later. The Lazard commitments were essentially the following: (1) Lazard agreed not to compete with D&B in the entire investment business -- not to become associated in a management or advisory capacity with any other registered investment company or to permit any such company, manager or adviser to use the name "Lazard" and not to act as principal distributor for any open-end investment company which makes a continuous offering of its shares and which is subject to registration; (2) Lazard agreed to provide the services of its partner, Albert J. Hettinger, Jr. to serve for five years as a consultant to D&B and its subsidiaries, and as a director of Moody's Capital and/or Moody's Fund, Inc.; (3) Lazard agreed to consult for one year on the administrative structure and operation of Moody's Capital; (4) Lazard agreed to use "best efforts" to induce certain persons performing services for the Fund to perform similarly for Moody's Capital; and (5) Lazard agreed to make available to D&B and subsidiaries all research reports and analyses that Lazard had prepared during the past nine years.

 In return, Lazard was to receive 75,000 shares of restricted D&B stock to be placed in escrow, and paid to Lazard over a period of five years, provided Lazard performed all its undertakings. The last payment of 35,000 shares is to be made April 30, 1972. While in escrow, the shares were to pay no dividends and could not be sold. The stock was not registered under the Securities Act and was subject to Lazard's representation that it was acquired for investment, except that Lazard had the right, during certain periods, to require D&B to file a registration statement permitting such sale; and the right to require, subject to certain qualifications, a "piggy-back" registration if D&B should file a registration statement on its own. This agreement was disclosed in the proxy statement, but the plaintiffs have contended that the alleged failure to disclose that the 75,000 shares were really for the "sale of office" made the proxy statement misleading. *fn2"

 THE ISSUES

 The thrust of the attack has been on the receipt of the 75,000 D&B shares by Lazard. Plaintiff Rosenfeld first sought to enjoin the stockholders meeting in the State Court, then withdrew the motion. A Federal Court action continued. It culminated in the motion for summary judgment previously described and finally in the reversal of its granting by the Court of Appeals.

 The theory of the action was that the Lazard-D&B agreement was a fraud designed to cover an unlawful sale of Lazard's advisory contract, with a secret undertaking by Lazard to use its influence to induce Fund stockholders to approve D&B's subsidiary as the new investment adviser.

 Judge Mansfield, then in the District Court, held that since the stockholders had approved the new advisory contract, "the management's conduct in arranging such a substitution does not violate the Act, regardless how it is labelled" (319 F. Supp. at 897). He ruled that the advisory contract was not a fund asset. In view of his conclusion that there was no cause of action as a matter of law, he did not specifically rule on whether there were disputed questions of fact, although he intimated that the plaintiffs had revealed a weak case.

 Chief Judge Friendly in the Court of Appeals, on the contrary, held that the Investment Company Act incorporated by implication the common law rule that a fiduciary may not sell its office for personal gain. The Court laid down a prophylactic rule forbidding the investment adviser from receiving "personal gain" on a transfer of the advisory contract. The use of the proxy machinery in favor of the successor was apparently enough to prevent the retiring adviser from being paid a consideration in connection therewith. The Court of Appeals did not, of course, consider the question whether the various covenants undertaken by Lazard were a mere sham to conceal the true nature of the payment, as the plaintiffs contended. That is a question of fact which has been remanded for trial. The Court of Appeals also held that there was a triable issue of fact with respect to the alleged deficiencies of the proxy statement.

 In the meantime, Mr. Justice Marshall had extended the time for filing a petition for a writ of certiorari to afford this Court an opportunity to consider the reasonableness of the settlement. At the end of the extension, on December ...


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