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White v. Auerbach

decided: July 24, 1974.


Appeal from order of United States District Court for the Southern District of New York, Robert J. Ward, Judge, denying applications of objectors-appellants for attorney and accountant fees in settlement of consolidated stock-holders' derivative actions.

Lumbard and Hays, Circuit Judges, and Jameson,*fn* District Judge.

Author: Jameson

JAMESON, District Judge.

Objectors-appellants appeal from an order denying their applications for attorneys' and accountants' fees and disbursements, submitted in connection with the settlement of consolidated stockholders' derivative actions brought on behalf of defendant-appellee, Manhattan Fund Incorporated (the Fund), a diversified open-end investment company registered under the Investment Company Act of 1940.*fn1

The defendants in the consolidated action were Tsai Management & Research Corporation (TMR), the investment adviser and principal distributor of the Fund, the directors of the Fund, the original stockholders of TMR, and CNA Financial Corporation (CNA) and its wholly-owned subsidiary, also named Tsai Management & Research Corporation (new TMR).*fn2 The original stockholders of TMR sold their stock to CNA in 1968 in exchange for CNA stock, whereupon TMR was merged into CNA, and CNA's wholly-owned subsidiary, new TMR, took over the business of TMR. The principal charges alleged in the complaint were that (1) TMR had mismanaged the Fund;*fn3 (2) TMR wrongfully acquired the right to use the name "Manhattan Fund"; and (3) the sale of TMR to CNA in effect involved the sale of the investment advisory contract with the Fund,*fn4 which plaintiffs contended was a corporate opportunity for which the Fund, rather than defendants, should receive compensation.

Proceedings Leading to Approval of Amended Settlement Agreement

On November 30, 1970 the parties entered into a "Stipulation and Agreement of Settlement and Compromise" whereby TMR agreed to relinquish to the Fund all "right, title and interest" in the use of the words "Manhattan" and "Manhattan Fund", and new TMR agreed to reduce the Fund's management fees for a ten year period commencing January 1, 1971. The settlement agreement was submitted to Judge McLean, who entered an order setting a hearing for March 19, 1971. His order provided that notice be given to all stockholders of the Fund, and that stockholders who object to the settlement "may appear at the hearing and show cause why the settlement and compromise * * * should not be approved as fair, reasonable and adequate * * *".

Appellants Kornreich, Julien and Levine filed written objections and memoranda and appeared at the hearing to protest approval of the settlement. In substance they argued that the settlement was inadequate on the grounds that (1) it gave no recognition to the charge that defendants had wrongfully profited from the sale of the Fund's management contract with TMR; and (2) the proposed reduction in management fees was illusory.

Counsel for plaintiffs stated that the charge with respect to the sale of the Fund's management contract was not specifically addressed in the settlement because there were indications that the Securities and Exchange Commission had changed its previous position that the management contract was an asset of the Fund, and because there were "a number of decisions * * * indicating that when stockholders of an advisory management fund sell their stock it is their own profit and no part of it belongs to the "Fund". In considering the "problems of success or failure" on this issue, it was decided that it would be in the best interests of the Fund and its stockholders to agree to the settlement, which in substance provided only for a ten year reduction in management fees.*fn5

In contending that the proposed reduction in management fees was illusory, appellants first argued that the reduction in fees would be offset by refunds which the investment adviser would be required to make to the Fund if management expenses exceeded the amounts allowable under the blue sky laws of several states, most notably California. Appellants pointed out that blue sky refunds for 1970 totalled $410,643, whereas the estimated proposed reduction in management fees for 1971 was only $92,000.*fn6

The parties to the settlement agreement did not deny that blue sky refunds would constitute an offset to the proposed management fee reduction, but contended that (1) if the refunds became burdensome, the Fund "may have to withdraw entirely" from the states that exact expense limitations; and (2) in any event, it was highly unlikely that the "unusual, unprecedented and extraordinary market conditions" which made the expense limitations operative in 1970 would recur during the ten year period of the fee reduction.

In order to insure that the parties were sincere in their statements that there will no longer be any liability on the part of the Advisor to repay the Fund because of the operation of the Blue Sky Laws", counsel for appellants Julien and Levine, by letter dated March 30, 1971 addressed to Judge McLean, recommended that "the stipulation of settlement be amended to provide that the reduction of the management fee * * * shall be in addition to any repayments required under the provisions of the blue sky laws". The suggested amendment was not incorporated in the settlement agreement.

Pointing out that under paragraph 10 of the settlement agreement the guaranteed reduction was contingent on the existence of a management contract with a subsidiary of CNA or its parent corporation, appellants contended that the possibilities of a termination of the contract*fn7 or sale of TMR or assignment of the contract to a non-subsidiary of CNA or its parent made the ten year guarantee "illusory and a hoax", and that the proposed guarantee could only be satisfied by an unconditional promise to reduce management fees by a specified dollar amount. The parties admitted, under questioning by the court, that there was no guarantee of a specified dollar reduction, but argued that there was "a real reduction" in terms of percentages "as long as the contract continues".

At the hearing counsel for appellant Kornreich cited Judge McLean's approval of the settlement proposal in the Dreyfus case, reported as Kurach v. Weissman, 49 F.R.D. 304 (S.D.N.Y. 1970). In Dreyfus the original settlement provided that the management fee reduction was contingent upon the continued legality of a brokerage arrangement between the Dreyfus Fund and a subsidiary of the managing corporation. The Securities and Exchange Commission objected to the settlement, contending, inter alia, that the contingent nature of the fee reduction rendered it illusory. Counsel for the parties decided to amend the settlement to provide ...

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