The opinion of the court was delivered by: STEWART
The action was tried to this court, without a jury, on nine trial days, commencing July 23, 1979 and ending August 17, 1979. This opinion constitutes our findings of fact and conclusions of law.
Plaintiff, the Cambridge Fund, Inc. (the "Fund"), seeks in Counts One and Five of its complaint to recover from defendants Frank J. Abella, Jr., University Management Corporation ("Management") and University Capital Corporation ("Capital"), (collectively the "Abella defendants"), and from defendant Robert Fredricks, for certain monies paid by the Fund to Management and Abella as indemnification for legal expenses incurred in connection with a Securities and Exchange Commission ("SEC") administrative proceeding, and to recover from defendant Abella for certain monies paid to the law firm of Kass, Goodkind, Wechsler & Gerstein ("Kass, Goodkind") for legal expenses incurred in connection with an SEC investigation (the "legal expenses claim"). The Fund also seeks in Count Four of its complaint to recover from Abella for certain transactions by him and members of his immediate family in securities which plaintiff alleges were simultaneously being bought, sold or held by the Fund (the "joint-trading claim"). Plaintiff alleges that defendants violated Sections 17, 36 and 37 of the Investment Company Act of 1940 ("the Act"), 15 U.S.C. §§ 80a-17, 80a-35 and 80a-36; Rule 17d-1, 17 C.F.R. § 270-17d-1; and the common law.
Count Three was dismissed after defendants moved for summary judgment and Counts Two and Six were dismissed upon the motion of plaintiff.
1. The Legal Expenses Claims
The relevant events begin in late 1968 when the plaintiff Fund was formed. Tr. at 560-563. The Fund, a Delaware corporation, is a publicly held, closed-end, nondiversified, management investment company registered with the SEC pursuant to the provisions of the Act. P.T.O. P 1. At the time of the initial public offering of its shares in January, 1969, the Fund was known as "The Jaffee Fund, Inc.": Wilton Jaffee was its president and a director; Stanley DuBoff was Secretary and a director; Howard Herman was Treasurer; and Stuart D. Wechsler, of the law firm of Kass, Goodkind, was a director. P.T.O. PP 2, 3, 12-15. The adviser to the Fund at that time was Jaffee Management Company, Inc.: Jaffee was director, president and sole stockholder of Jaffee Management Company, Inc.; DuBoff was Secretary and a director, and Herman was Treasurer. P.T.O. PP 4, 5, 12 and 13. The Fund was Jaffee Management Company, Inc."s sole client. P.T.O. P 9. Defendant Frank Abella was employed in 1969 by Jaffee Management Company, Inc. as the portfolio manager for the Fund. Id. Prior thereto he had been employed by Union Carbide Corp. ("Union Carbide"). P.T.O. P 11. As portfolio manager, his duties included analyzing corporations to ascertain whether the purchase of their securities should be recommended to the Fund by Jaffee Management Company, Inc., and making recommendations to Jaffee Management Company, Inc.'s officers concerning purchases of such securities by the Fund. Id.
By an agreement dated November 9, 1970, Jaffee agreed to sell all the outstanding stock of Jaffee Management Company, Inc. to defendant Capital, a New Jersey corporation wholly owned by defendant Frank Abella. P.T.O. P 6. Wechsler represented Abella in the acquisition of the management company. Tr. 170-172. The agreement provided, in part, that Jaffee would sell the shares "for the consideration of one dollar with additional consideration of $ 5,000 to be payable only in the event the net assets of the Fund equals the receipt of $ 7.50 per share as of the last day of any quarter during the next five years." Tr. at 144; Plaintiff's Exhibit 61. Capital, in fact, paid $ 2,501 to Jaffee for the purchase of Jaffee Management Company, Inc. Tr. at 469. In November, 1970, Abella became Secretary and Treasurer of Jaffee Fund, and Treasurer and a director of Jaffee Management Company, Inc., while Herman, DuBoff and Wechsler relinquished their respective positions. P.T.O. PP 10, 12-14.
At an annual meeting of the shareholders of the Fund on February 5, 1971, the Fund's name was changed to the Cambridge Fund, Inc. The shareholders elected defendant Abella and Dr. Marvin Moser, John F. Galbraith and John Powers as directors of the Fund; the latter two had been co-workers with Abella at Union Carbide, and although neither had previously served as an officer or director of a corporation and neither had any special expertise in the area of investments, they had been asked to serve as directors because the Fund was going to focus upon "technologically based" companies and Galbraith had experience investigating and evaluating small companies for Union Carbide "both technologically and financially", while Powers had been engaged, for approximately 10 to 15 years with evaluating technical projects for Union Carbide to determine whether there was a business relevancy. Tr. at 19-20, 72-74. The directors then elected defendant Frank Abella as President and Treasurer of the Fund, and Mary Ann Abella, defendant Frank Abella's wife, as Secretary of the Fund. P.T.O. paras. 16, 19, 20. The law firm of Kass, Goodkind also became general counsel to the Fund. P.T.O. para. 15. In February, 1971, the name of Jaffee Management Company, Inc. was also changed to University Management Corporation and defendant Abella became president and a director of Management. P.T.O. paras. 6, 10.
In 1971, the SEC commenced an investigation into possible violations by Jaffee Management Company, Inc., Wilton Jaffee, Howard Herman, Stanley DuBoff and Frank Abella, of the Investment Company Act of 1940, the Investment Advisers Act of 1940 and the Securities and Exchange Act of 1934, in connection with certain portfolio transactions of the Fund during the period from March, 1969 through May, 1970. P.T.O. para. 23. The SEC was investigating the purchase by the Fund of certain securities from Jaffee & Co. a brokerage firm in which Jaffee and Herman were partners and DuBoff a registered representative. P.T.O. paras. 4, 12, 13, 32. The SEC was investigating possible violations of statutory provisions which prohibited "principal transactions between a registered investment company and its affiliate and prohibits a Fund from purchasing securities during the existence of an underwriting from any affiliate which is the principal underwriter of the issuer". P.T.O. para. 31.
Abella was subpoenaed in connection with this investigation. P.T.O. 26, tr. at 473. Abella testified before the SEC for the first time on August 17, 1971. At that time he was accompanied by Mr. Wechsler. The SEC transcript dated August 17, 1971, read into the record at trial, indicates that the following colloquy occurred at the beginning of the hearing between Mr. Lanzotti the SEC investigator, and Mr. Wechsler:
"(MR. LANZOTTI:) Are you representing the Fund, Mr. Wechsler, or are you representing Mr. Abella personally?
"MR. WECHSLER: At this time I am representing Mr. Abella personally for the purpose of this hearing and Mr. Abella.
"MR. LANZOTTI: The difficulty, Stuart-
"MR. WECHSLER: Go off the record.
"MR. LANZOTTI: I would like, Mr. Wechsler, an answer on the record.
"Are you representing Mr. Abella personally or would you like to discuss this with your client prior to replying to my question?
"MR. WECHSLER: I am representing Mr. Abella personally. The question in my own mind at this point am I also representing Mr. Abella, management company. The management company and the Fund but at this time Frank, I am representing you as a witness here personally."
Kass, Goodkind submitted to the Fund (directed to the attention of Mr. Abella, tr. at 180) a "statement for services rendered" dated February 11, 1972 in the amount of $ 6,037.32 which included charges for "services and advice with respect to private SEC investigation, including research, numerous conferences with Mr. Abella and David Butowsky (counsel for Mr. Jaffee), attendance at Mr. Abella's SEC testimony and review of the transcripts". Plaintiff's Exhibit 20. This billing was apparently based on a time record sheet (Plaintiff's Exhibit 23) that had initially indicated that Abella and Management were the clients, Tr. at 178. Their names were crossed out and "Fund" was listed as the client. The Fund issued a check for this amount dated April 24, 1972 made payable to Kass, Goodkind. Plaintiff's Exhibit 22. The parties submitted to us the minutes of two regular board meetings held during this period. The first is the minutes of the meeting held on February 4, 1972 (Defendants' Exhibit P) which contains the following reference to the SEC investigation:
Dr. Moser then reported on the testimony he had given in connection with the Commission's continuing investigation into the affairs of the Corporation and certain of its former officers and directors. There ensued a discussion of some of the problems in which the Commission appeared to be most interested. The directors questioned Dr. Moser, and Messrs. Abella and Wechsler concerning some of these areas of investigation. In particular, it was noted that the Commission seemed to be focusing a good deal of its attention on the activities of Wilton Jaffee, Howard Herman and Stanley DuBoff, and on possible transactions with Jaffee and Co.
Id. at 5. At this meeting Dr. Moser also submitted his resignation. Id. The second is the next meeting held on March 28, 1972 (Plaintiff's Exhibit 6, see at p. 2) which contained the following reference to the SEC investigation:
Mr. Wechsler then discussed the S.E.C.'s continuing private investigation into the affairs of the Corporation. Mr. Wechsler had given testimony with respect to the investigation subsequent to the prior Meeting of the Board of Directors. Mr. Wechsler indicated that he thought some areas which are bothering the S.E.C. were trades between the Corporation and Jaffee & Company, as principal, in certain cases where Jaffee & Company had acted as an underwriter. Mr. Wechsler also believed the S.E.C. was concerned with the possibility of problems involving interpositioning.
Id. at 9-10. At this meeting defendant Fredricks was elected as a director of the Fund. Wechsler was also elected Secretary of the Fund after the Board accepted the resignation of Mary Ann Abella. Id. at 2.
Abella testified again on May 15, 1972 and he was again accompanied by Wechsler. Kass, Goodkind submitted to the Fund a statement for services rendered (again to the attention of defendant Abella) dated August 1, 1972 in the amount of $ 10,949.25, which included charges for "appearance before SEC with Frank Abella on May 15, 1972". Plaintiff's Exhibit 21. The minutes of a special meeting of the Board held on May 22, 1972 (Plaintiff's Exhibit 7), a week after Abella's testimony, indicated only the following:
There then followed a short review of the continuing private investigation of the S.E.C. into the affairs of the Fund. The directors were thereupon shown a copy of the Order of Investigation, with a warning not to exhibit its contents to any other party. Mr. Wechsler stated that he expected to receive a letter shortly from David M. Butowsky, counsel to Wilton Jaffee, discussing some of the problems involved as seen by Butowsky.
Id. at 4. A letter, dated May 24, 1972 was sent from Butowsky to the Cambridge Fund c/o Stuart Wechsler. Plaintiff's Exhibit 12. This was apparently part of the negotiations between the Fund and Jaffee with respect to settling any claims that the Fund might have had against Jaffee. The contents of the Butowsky letter is summarized in its first paragraph:
As you know, the Securities and Exchange Commission ("SEC") has been conducting an investigation involving, among other things, possible violations of sections 17(a) and 10(f) of the Investment Company Act of 1940 ("1940 Act"). This firm represents Wilton L. Jaffee who was president and a director of the Jaffee Fund, Inc. ("Fund") when the transactions under inquiry occurred. This letter discusses the applicable law and the relevant facts with a view to establishing whether and to what extent a right of action may exist on behalf of Cambridge Fund, Inc. (previously Jaffee Fund, Inc.).
Butowsky, reviewing each transaction, concluded that most of the transactions did not violate Section 10(f) "because Jaffee & Co. does not appear to have been the principal underwriter with respect to them". Butowsky further concluded that Jaffee did not violate Section 10(f) or 17(a) because "by no standard" could Jaffee be said to have acted "knowingly":
Indeed, Mr. Jaffee attempted to ascertain the legality of such transactions under the Act through counsel, and through those persons to whom he entrusted the administration of the Fund. In this regard it is entirely fitting to note that the use of common control to reduce tiers of affiliation from 3rd level to 2nd level affiliation is an extremely sophisticated concept not generally known to attorneys or even to attorneys who are familiar with the 1940 Act. Moreover, some of these transactions were conducted by persons other than Mr. Jaffee and without the knowledge and consent of Mr. Jaffee who was completely unaware that they had been consummated until they were first brought to his attention by the SEC during the taking of his testimony.
Id. at 8. Butowsky also focused upon the issue of damages:
Lastly, there is to be considered the question of damage to the Fund. In a number of the transactions which may be alleged to have violated the Act there were profits and in others there were losses; in yet others there were failures to sell when although we have not made the computations involved, it may be that damages would have been less had a sale been made. Although we recognize that the Fund's board of directors may well take the position that profits on one security should not be set off against losses in another security; we do believe that all activity in a particular security should be dealt with on a net basis.
Id. at 8-9. Wechsler testified as to this correspondence that:
I read the letter and I reviewed its contents. I read it against the Act and I think there was some checking of the facts and the statutes described.
Tr. at 256. Wechsler concluded that certain of the trades violated Section 17(a) despite Butowsky's argument to the contrary. Tr. at 272.
In July 1972 the SEC ordered the commencement of an administrative proceeding under the federal securities laws concerning the securities transactions which were the subject of the SEC investigation. Named as respondents in that proceeding were Frank Abella, University Management Corp., Wilton Jaffee, Howard Herman and Stanley DuBoff. P.T.O. P 31. Abella and Management retained the firm of Spear and Hill to represent them in the SEC proceeding. P.T.O. P 38.
On September 12, 1972 a special meeting of the board of directors was held. The minutes indicate that this was the first meeting of the board since May 22, 1972. Id. In the course of the meeting:
Mr. Abella indicated to the Board that he thought it should discuss the present status of the Securities Exchange Commission Administrative Proceeding presently pending against him and certain former officers and/or directors of the Fund. He indicated that he thought that the discussion should be conducted in his absence and he left the room.
Mr. Wechsler then distributed copies of a letter from David M. Butowsky of the law firm of Butowsky, Schwenke & Devine, counsel for Wilton L. Jaffee, dated May 24, 1972 and copies of a letter dated September 11, 1972 from Mr. Abella's attorneys in connection with the Administrative Proceeding.
The May 24, 1972 Butowsky letter is Plaintiff's Exhibit 12 discussed above. The reference to the "letter dated September 11, 1972 from Abella's attorneys," is to a letter by Spear and Hill (Defendants' Exhibit R). It first summarizes the charges made by the SEC and then sets out various facts which focused upon Abella's lack of authority and responsibility and the absence of personal gain:
Such securities transactions occurred between March, 1969 and May, 1970, a period during which you were only an employee, and neither in control of nor acting in a decision-making capacity with your then employer (and predecessor of Management), Jaffee Management Company. You did not, at the earliest, acquire the stock of Jaffee Management Company, become an officer of the Jaffee Fund and an officer and director of Jaffee Management Company, or assume a decision-making capacity with respect to Jaffee Management Company until November, 1970, six months after the last security transaction questioned by the Commission. You did not become a director of the Cambridge Fund until February 5, 1971.
You have testified (before the SEC) that you had no responsibility for effecting any of the securities transactions constituting the alleged violations referred to in (a) and (b) above; that you did not make the investment decision with respect to any of these securities transactions; and that you did not execute any of such transactions. You further testified that the only role you played with respect to these securities transactions was, on certain occasions, to present a recommendation to certain of the other respondents (the individuals who did have responsibility and authority with respect to securities transactions) as to whether the transaction would constitute a good investment on behalf of the Jaffee Fund.
You have advised us that you did not during this period personally purchase or sell any securities purchased by the Jaffee Fund. Further, you were not an officer, director, partner, employee or shareholder of Jaffee & Co., the brokerage firm with which most of the other respondents were affiliated. You received no profits or commissions with respect to any of the securities transactions in question.
Spear and Hill concluded "based upon the foregoing" that there is no "basis for liability on your part (under Sections 10(f) and 17(a)) to the Cambridge Fund". In light of Abella's limited authority as an employee the letter further concluded that Abella was not liable on the other charges as well: failure to disclose the transactions which violated Section 10(f) and 17(a); failure to adequately maintain books and records; and failure to supervise persons so as to prevent these violations.
The minutes of the September 12 meeting indicate that after distributing these letters:
Mr. Wechsler attempted to summarize the letters distributed (see also tr. at 146-147) and to bring the directors up-to-date on the status of the Administrative Proceeding. There was a lengthy discussion amongst the directors as to whether the Corporation might have a claim against any of the persons named in the SEC Administrative Proceeding. Various questions were asked of Mr. Wechsler regarding the measure of "damages" and the cost of litigation. Mr. Wechsler suggested that there might be various methods of measuring "damages". He further pointed out that there were numerous unresolved legal and factual issues which were as yet unresolved. He suggested that it might be impossible to obtain counsel to represent the Fund on a contingent basis in light of the questionable amount of damages and the various possible defenses. Mr. Wechsler suggested that the Board table the question of whether it should attempt to bring suit against any of those named in the SEC proceeding until the next meeting of the Board.
The minutes indicated that Wechsler then presented to the board an "opinion" letter of Carro, Spanbock & Londin, written in 1969 to the Corporation. Carro, Spanbock was counsel to the Fund in 1969 and 1970. Tr. at 243. The Carro, Spanbock letter (Plaintiff's Exhibit 60), addressed to the Jaffee Fund, is only a half of a page long and sets out in an obviously inadequate (and incorrect) manner the following which will be quoted in toto:
You have requested our opinion in connection with the question of whether or not The Jaffee Fund, Inc. ("the Fund") may purchase securities from Jaffee & Co. ("Jaffee") when Jaffee is an underwriter of an offering and as such, proposes to sell a portion of its commitment to the Fund at the initial public offering price.
We have examined such documents as we deem necessary to render this opinion, including the Prospectus of the Fund dated January 3, 1969 and based on the foregoing and our conferences with members of the staff of the Securities and Exchange Commission, it is our opinion that if the management of the Fund believes the transaction will result in the best price and execution of the order, the Fund may purchase the Securities from Jaffee where Jaffee is an underwriter of the issue provided that such purchase does not violate any of the investment restrictions of the Fund.
Abella and Wechsler testified that Abella called Wechsler a few weeks before the September 12, 1972 meeting and told Wechsler that while cleaning out some file cabinets (or desk bought by the Fund from Jaffee & Co. -- the testimony was conflicting, Compare tr. at 228 with tr. at 478) he found this letter at the bottom of a drawer (or in the bottom drawer-again the testimony is conflicting). Mr. Jaffee had previously insisted that such a letter existed. Tr. at 201. The minutes of the September 12, 1972 meeting show that at this meeting:
Mr. Wechsler pointed out that the opinion might have misled the management of the Corporation and caused the purchases alleged by the SEC to be violations of the Investment Company Act of 1940. After some discussion the Board instructed Mr. Wechsler to send a copy of the letter to the SEC immediately.
Finally, the minutes record that:
The Board discussed the possibility of approaching the SEC with regard to the possibility of terminating the Administrative Proceeding as to Mr. Abella and University Management Corporation. Mr. Wechsler was instructed to discuss this possibility with the SEC.
Wechsler testified that at the time this request was made "I think it was the consensus that Mr. Abella's involvement was peripheral enough to make and the facts well known enough to make such an attempt desirable." Tr. at 329.
Wechsler then spoke with Marvin Jacob at the Regional Office of the SEC for the purpose of carrying out the instructions of the Board. Mr. Wechsler's deposition testimony indicates that Mr. Jacob declined to terminate the proceedings against Abella because he believed that Abella was in a position where he could have stopped the transaction. Tr. at 230-232. Abella, in his deposition, states that with respect to the Carro, Spanbock letter he was informed that the SEC's view was first, that the letter was not authentic; second, that it was a bad opinion and should not have been relied upon; and third, that it did not change anything with regard to their proceeding. Tr. at 480. Wechsler testified that he also had discussions with Butowsky as to the Carro, Spanbock letter:
I think I said how could they have written this opinion and Mr. Butowsky indicated to me that he had spoken to Mr. Londin and if I can recall the words correctly I believe Mr. Butowsky reported to me that Mr. Londin had said facetiously it was one of his $ 25 opinions.
The annual meeting of the Board of Directors was held on October 10, 1972. The minutes of that meeting record the following:
The Chairman then stated that it would be in the best interest of the Corporation to have Mr. Wechsler attempt to negotiate a settlement with Wilton Jaffee with respect to possible claims which the Corporation may have against Mr. Jaffee resulting from alleged violations of Section 10f and 17a (10(f) and 17(a)) of the Investment Company Act of 1940, in connection with Securities and Exchange Commission Administrative Proceeding File No. 3-3817. Upon motion duly made and seconded, it was unanimously
RESOLVED, that the Secretary of the Corporation, Stuart D. Wechsler, is authorized and instructed to negotiate a settlement with Wilton Jaffee arising out of possible claims which the Corporation may have against him resulting from alleged violations of Section 10f and 17a of the Investment Company Act of 1940, in connection with Securities and Exchange Commission Administrative Proceeding File No. 3-3817, for (a) cash consideration of a minimum amount of $ 15,000 and (b) a waiver of any possible claims for indemnification for legal fees by Mr. Wilton Jaffe against the Corporation.
Abella stated in his deposition that he sat in on the early part of the board meeting but "what the minutes of that meeting do not reflect is that I was excused from that meeting and there was a further discussion amongst all the attorneys and the directors who were present." Tr. at 476. Abella further stated in his deposition that:
I did make a statement ... that I thought that settlement at some point would be in order for the fund.
What I can recall I said was that I believed that based on my review of the transactions that took place and the information that was contained in a letter of opinion that was brought to the Fund by Carro, Spanbock & Londin that I found when I moved that the Fund's then directors or officers have adequate defenses in the event we were to try and bring about litigation for the claims of losses that the Fund had incurred from the purchase of those securities.
The testimony also indicates that at one of these two meetings, Abella, reading from either Exhibit 46 or 47 (from the evidence it appears that it was probably Exhibit 47) discussed each transaction in terms of the amounts involved, the commissions earned by Jaffee & Co., and whether the Fund realized a profit or loss on those shares it subsequently sold and what the unrealized loss or profit was on the shares not yet sold. Tr. at 29-31, 93, 107, 975-978. The net figures on the chart indicate that the Fund had a realized profit of approximately $ 81,400 and a realized loss of approximately $ 77,300, and an unrealized loss of somewhere between $ 56,350 in February 1971 and $ 49,000 in September 1972. We note that the charts list, as to each issue, the underwriter (referred to in Exhibit 47 as "Underwriter Principal or Managing") but nowhere does it list Jaffee & Co. as such an underwriter.
Butowsky mailed a letter to the Fund, c/o Mr. Wechsler, dated October 16, 1972, (Plaintiff's Exhibit 13) which is identical to the May 24, 1972 letter except that it makes specific reference to the Carro, Spanbock letter, and to the net profit and loss figures discussed above and set out in Exhibit 47. See also tr. at 976-978. Jaffee was ultimately released for $ 16,500.
On or about July 5, 1973, defendants Abella and Management executed and delivered to the SEC an "Offer of Settlement and Consent" with respect to the administrative proceeding. P.T.O. para. 39. By letter dated July 20, 1973 (Plaintiffs' Exhibit 36) Management and Abella wrote to Powers, Galbraith and Fredricks to advise them of the proposed settlement of the SEC proceeding against them. P.T.O. para. 41. Special reference was made in that letter to four pages in the attached "draft" settlement offer "which have to do with the mitigating factors surrounding my settlement". See Plaintiff's Exhibit 36. This letter was apparently discussed by the board shortly after July 20, 1973. Tr. at 115. The SEC administrative proceeding against Abella and Management was resolved pursuant to an Order and Findings dated August 1, 1973. P.T.O. para. 40.
In August, 1973, Abella and Management requested indemnification from the Fund for the legal fees which they had incurred in connection with their defense of the SEC proceeding. P.T.O. para. 42. At a directors meeting on August 20, 1973 the directors discussed an opinion letter written by Spear & Hill and dated August 17, 1973 (Plaintiff's Exhibit 38) Tr. 299-300. This letter, like the Spear and Hill letter of September 11, 1972 (Defendants' Exhibit R) which was discussed at the September 12, 1972 meeting, summarized the charges in the SEC proceeding and then sets out various "facts" given to them by Abella. Many of these "facts" were the same as those set out in the September 11, 1972 letter which dealt with Abella's lack of authority and responsibility, and with the absence of personal gain:
3. You were employed as portfolio manager of Jaffee Management from January 1969 to February 1971.
a. You were only an employee of Jaffee Management, and neither in control by nor acting in a decision-making capacity with respect to Jaffee Management, until you became an officer of Jaffee Management in November 1970.
b. You did not make the investment decisions with respect to the securities transactions ...