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GARTENBERG v. MERRILL LYNCH ASSET MGMT.

September 1, 1983

IRVING L. GARTENBERG, Plaintiff, against MERRILL LYNCH ASSET MANAGEMENT, INC. MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, MERRILL LYNCH & CO., and MERRILL LYNCH READY ASSETS TRUST, Defendants; SIMONE C. ANDRE, Plaintiff, against MERRILL LYNCH READY ASSETS TRUST, MERRILL LYNCH ASSET MANAGEMENT, INC., MERRILL LYNCH FUNDS DISTRIBUTOR, INC., MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED and MERRILL LYNCH & CO., INC. Defendants.


The opinion of the court was delivered by: POLLACK

DECISION AND OPINION

Milton Pollack, District Judge.

 The same parties sue, and are sued again, on the same type of claim as was tried at a Bench trial before this Court in 1981, which resulted in a judgment of dismissal on the merits on December 28, 1981 in favor of the defendants, 528 F. Supp. 1038, aff'd 694 F.2d 923 (2d Cir. December 3, 1982), cert. denied, 51 U.S.L.W. 3774 (U.S. April 25, 1983) (No. 82-1483, petition filed by plaintiff Andre alone).

 These are suits under the Investment Company Act of 1940 (the "Act") by Gartenberg and Andre as shareholders in a money market fund, the Merrill Lynch Ready Assets Trust (the "Fund," or "MLRAT") challenging as excessive, the management and advisory fees received from the Fund in 1982 by Merrill Lynch Asset Management, Inc. ("MLAM") in violation of its fiduciary duty prescribed by Section 36(b) of the Act, 15 U.S.C. § 80a-35(b). MLAM's affiliate, Merrill Lynch Pierce Fenner & Smith, Inc. (the "Broker" or "MLPFS"), which processed more than 7,300,000 orders for the Fund's shareholders in 1981, is also again named as a defendant, as is Merrill Lynch & Co., MLAM's parent corporation.

 At the trial of Gartenberg I, Andre attempted to add to the suit, claims under Sections 15(a), 15(b), 15(c), and 20(a) of the Act, 15 U.S.C. §§ 80a-15(a) to 15(c), -20(a). Those claims were considered and found to be improperly asserted and at all events wanting in legal substance. 528 F. Supp. at 1067, aff'd 694 F.2d at 934. *fn1"

 In the present suit, Gartenberg also asserts a Section 20(a) claim that MLAM is liable for false and misleading proxy statements made to Fund shareholders. *fn2"

 Plaintiffs, having unsuccessfully attacked MLAM's compensation for 1980-81 as excessive and in violation of its fiduciary duty, filed "new" similar claims against the compensation for 1982 within three days after the affirmance of the judgment dismissing their claims for 1980-81.

 The "new claims" assert that the Fund, in 1982, was substantially larger, that the 1982 compensation received by MLAM was excessive and receipt thereof violated its fiduciary duty and that two misrepresentations made by MLAM to the trustees were of "possible significance to the trustees in negotiating the fees," pertaining to fall-out benefits to be considered as constructive additions to the advisory fees and to the actual processing costs incurred by Merrill Lynch. These matters will be discussed infra.

 Virtually all fundamentals of the present claims are foreclosed by the doctrines res judicata and/or collateral estoppel, and the affirmed findings on the earlier claims make it unnecessary to consider them de novo.

 In the Spring of 1983, just before consideration of the annual renewal of the management contract for 1983-84, a study, ordered by the trustees of the Fund, was completed by the firm of Peat, Marwick, Mitchell & Co. (PMM), the outside independent accountants, which established and quantified a constructive addition to MLAM's fees by reason of so-called "float" interest benefits obtained by MLPFS, the broker affiliate, from proceeds of sales and redemptions of Fund shares.

 The Second Circuit had dealt specifically with fallout benefits from float and fall-out commission revenue in affirming the lower Court's finding that plaintiffs had not carried their burden of proof under § 36(b) of showing that MLAM's fee was so disproportionately large that it was beyond the range of what would have been agreed to after arm's length bargaining. The Appellate Court noted, however:

 "These benefits to an affiliate in the Merrill Lynch organization, to the extent quantifiable, should be taken into account in determining whether the Manager's fee meets the standard of § 36(b).

 ". . . It would not seem impossible, through use of today's sophisticated computer equipment and statistical techniques, to obtain estimates of such "fall-out" and "float" benefits which, while not precise, could be a factor of sufficient substance to give the Funds' trustees a sound basis for negotiating a lower Manager's fee. . . . Indeed, the independent trustees of the Fund might be well advised, in the interests of Fund investors to initiate such studies." 694 F.2d at 932-33.

 As will be shown hereafter, the experts on both sides agreed that it was either not possible or practically not feasible to quantify fall-out commission benefits to MLPFS even with the use of today's sophisticated computer equipment and statistical techniques.

 In his "new" complaint, Gartenberg also repeats his allegations that the trustees should, in addition to realizing the existence of float benefits, have been advised of the dollar amount of such benefits when they approved the management contract in May, 1982 (some seven months prior to the opinion of the Court of Appeals quoted above, and almost a year prior to the quantification of the float). Instead, the plaintiff charges, the trustees were misled by indications from Merrill Lynch, or MLAM, that such additional benefits to MLPFS were not significant overall.

 A connected study was conducted by PMM, the results of which became available to the trustees of the Fund in May, 1983, and consisted of an in-depth reexamination and quantification of the costs of the services supplied to the Fund and its shareholders by the Merrill Lynch organization. The impetus for the study derived from the suggestion of the Court of Appeals in the earlier case. MLAM's expenses and costs so quantified were then compared with the sum of all of the quantifiable fall-out benefits added to the fees received by MLAM to determine whether there was any excessiveness in MLAM's compensation, actual and constructive, in 1982, in violation of Section 36(b).

 The evidence in this case firmly established that the compensation received by MLAM was not in violation of Section 36(b) of the Act; that the independent trustees of the Fund were not dominated but rather were properly and adequately informed so that they were able to evaluate MLAM's contract and the benefits actually and constructively obtained therefrom by MLAM and its affiliates, and that the trustees disinterestedly and in good faith scrutinized that compensation and the realization of constructive side benefits to MLPFS and reached a reasonable business decision, satisfying an arm's-length standard of bargaining, that there was no excessiveness or unreasonableness or breach of fiduciary duty involved in such compensation received from and through the Fund. Hindsight results have amply vindicated their judgment. Plaintiff failed to carry his burden of credibly demonstrating that the trustees were imposed upon by any misrepresentation to them by the advisor or through any lack of appreciation of concepts or associated benefits of the overall enterprise, essential to an exercise of a practical informed reasonable business judgment. Similarly, plaintiff failed to establish with credible evidence that the proxy materials to the Fund's shareholders were false, misleading or inadequate.

 In more detail, the facts follow:

 Res Judicata and Collateral Estoppel Considerations

 Defendants strongly maintain that doctrines of res judicata and/or collateral estoppel bar the present action. They urge that no new material facts, changed circumstances or conduct have developed since the previous complaints were dismissed on the merits. They say that plaintiffs charge merely a continuation of the allegedly violative conduct asserted in the earlier suits, and that since the judgment therein is a final determination of the same conduct under the same management contract and what might have been in issue had it been raised therein, the present suits legally state only the same claims and merely a continuation of conduct under the same contract previously adjudicated as not violative of Section 36(b). The so-called additions to the compensation through float and fall-out benefits to the Broker were matters raised but not proved by the plaintiffs in the earlier cases. The defendants contend that plaintiffs' claim that circumstances have changed is merely their attempt to submit proof on those matters unsuccessfully litigated in the earlier cases.

 The plaintiffs, however, contend that they are not precluded from maintaining the present suits under either doctrine of law based on allegations that the amount in controversy here is larger; that defendants have instituted new procedures for reimbursement of the Broker's processing costs; that estimates of processing costs have been audited, by independent Certified Public Accountants, which furnish the type of probative evidence recommended by the Court of Appeals; that since 1981 the Manager's fees have increased while the number of orders processed by the Broker has declined; that the Manager's expenses have declined, while compensation increased by 25%; and that economies of scale have not been shared.

 Further, plaintiffs assert that they here charge the defendants with new misrepresentations and nondisclosures to the trustees which occurred since January 1, 1982, concerning "net float" benefits and inability to quantify fall-out commission benefits. Plaintiffs also urge that it was not previously determined that the fee contract was fair and reasonable, and that, for all these reasons, the current action is not precluded by the prior determination.

 The short answer here is that under Section 36(b), 15 U.S.C. § 35(b), MLAM and the independent trustees have an ongoing obligation to see that MLAM's compensation does not become a breach of fiduciary duty by reason of excessiveness.Changes in circumstances that increase the advisory fee or the benefits associated therewith, or decrease the costs to MLAm and its affiliates associated with earning the fee could result in a finding that the advisory fee violates the fiduciary duty of the manager, even when a fee previously generated by the same advisory agreement was found not to breach that duty.

 The doctrine of res judicata provides that a valid and final judgment rendered in favor of the defendant bars another action by the plaintiff on the same claim. See Montana v. United States, 440 U.S. 147, 59 L. Ed. 2d 210, 99 S. Ct. 970 (1979). The doctrine of collateral estoppel provides that a final judgment is conclusive in a subsequent action as to issues of fact or law that were actually litigated in the first trial and were essential to the determination in the first trial. See, e.g., Winters v. Lavine, 574 F.2d 46, 57 (2d Cir. 1978). The purpose of these doctrines is to protect litigants from the burden of relitigating identical issues and to promote judicial economy be preventing needless litigation. See Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326, 58 L. Ed. 2d 552, 99 S. Ct. 645 (1979).

 These doctrines of preclusion should be applied warily when Congress has acted to create an ongoing duty, such as the fiduciary duty to avoid excessive fees that is created by Section 36(b) of the Act. The fact that a Fund's advisor has received a favorable judicial determination that the advisory fee was not excessive does not insulate the advisor from future claims under changed circumstances that future fees are excessive and in violation of Section 36(b). An advisor would be entitled to the preclusive effects of a final judgment dismissing a claim that the advisory fee was excessive, if the costs and benefits to the advisor of the fee arrangement were no more favorable to the advisor in the subsequent suit than they were in the suit that was dismissed. Where a plaintiff makes a good faith claim that the fee has increased, that the operating costs have decreased, or that the benefits associated with the fee have increased, the doctrines of res judicata and collateral estoppel should not be used to bar an evidentiary determination of whether the fee is in violation of Section 36(b). In this case, application of the doctrines of preclusion would be particularly inappropriate, in light of the Second Circuit's suggestion that the trustees might initiate studies of float and fall-out benefits in preparation for a determination of whether the advisory fee was excessive.

 Cases cited by defendant do not suggest a different result. The fact that a party who failed to prove an antitrust conspiracy is precluded from basing a subsequent conspiracy claim on a continuation of the conduct that was the basis for the first suit, see Engelhardt v. Bell & Howell Co., 327 F.2d 30 (8th Cir. 1964), is inapposite. While private entities are continuously subject to the antitrust laws, these laws do not impose an ongoing fiduciary duty. Moreover, plaintiffs herein do not merely allege a continuation of the conduct that was the subject of the first suit; rather they claim that charges in circumstances in 1982 made the advisory fee excessive even if it had not been found excessive under the same contract in 1981. Thus cases where courts have barred subsequent claims on the ground that they were collaterally estopped because the identical issue had been litigated are also inapplicable here. See, e.g., Exhibitors Poster Exchange, Inc. v. National Screen Service Corp., 517 F.2d 110, 114 (5th Cir. 1975), cert. denied, 423 U.S. 1054, 46 L. Ed. 2d 643, 96 S. Ct. 784 (1976). Similarly, Walsh v. International Longshoremen's Ass'n, AFL-CIO, 630 F.2d 864(1st Cir. 1980), which accorded preclusive effect to the denial of an injunction against a secondary boycott of cargoes bound for or arriving from the Soviet Union, is not dispositive here. In Walsh, the First Circuit was addressing conduct that was simultaneously engaged in by different ILA local unions and the Court held that the conduct sought to be enjoined was identical in the two cases.

 The Section 36(b) cases where Courts in this District have barred claims attacking advisory fees under the doctrine of res judicata are also inapplicable because they involve lawsuits by plaintiffs who were attempting to undermine valid settlements of class action shareholder derivative suits. See Ashare v. Brill, 560 F. Supp. 18 S.D.N.Y. 1983), appeal pending No. 82-7276 (2d Cir. filed April 18, 1983); Lerner v. Reserve Management Co., [1981 Transfer Binder] Fed.Sec.L.Rep. (CCH) P98,036 (S.D.N.Y.1981). In each of these cases, District Courts refused to overturn advisory fee schedules that had been established in the settlement of earlier derivative actions. Obviously much stronger considerations of fairness to defendants are present in a case where a shareholder derivative suit challenges fees that were created as a result of the settlement of a previous shareholder derivative suit. Plaintiffs herein do not seek to challenge as excessive a fee resulting from a contract that they have agreed to.

 While the outcome in Gartenberg I does not bar the present case, the prior determination has a strong affect on the present action due to the doctrine of stare decisis. The findings of fact made by this Court in Gartenberg I, which were accepted by the Court of Appeals, are controlling in this case on all issues where a change in circumstances is not demonstrated by the parties. Similarly, the standard of law to be applied under Section 36(b) is well defined by the opinions in Gartenberg I and the present case does not require a duplicative analysis of the statute or its legislative history.

 In analyzing Section 36(b), the Court of Appeals in Gartenberg I stated that "the test is essentially whether the fee schedule represents a charge within the range of what would have been negotiated at arm's-length in the light of all the surrounding circumstances" 694 F.2d at 928. The Court of Appeals further stated that "[t]o be guilty of a violation of § 36(b), therefore, the advisor-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could . . . not have been the product of arm's-length bargaining. To make this determination all pertinent facts must be weighed." 694 F.2d at 928.

 Recognizing the precedential impact of the prior litigation, the parties have stipulated that the record in Gartenberg I, including the Court's opinions therein, is made part of the record herein. Issues proven in the earlier action require no additional proof. Accordingly, familiarity with the Circuit and District Courts' opinions in Gartenberg I is assumed.

 The Money Market Industrya and MLRAT

 At the time of Gartenberg I, in December, 1981, money market funds and the Merrill Lynch Ready Assets Trust in particular were experiencing continued and substantial growth in both shareholders and assets and commensurate increases in the costs and processing of shareholder orders. Total money market assets had reached $185 billion, which represented a twenty-five fold increase in less than four years. See Gartenberg I, 528 F. Supp. 1038, 1042. The MLRAT had grown from its inception in 1975 to become the largest money market fund with almost $20 billion in assets at the time of trial in September, 1981, and over $22.6 billion in assets in December, 1981, when the decision in Gartenberg I was rendered.

 The growth of the MLRAT and the industry as a whole continued in the early months of 1982. The number of MLRAT shareholders peaked in March, 1982, at 1,458,128 and MLRAT net assets peaked at $23,235,350,821, in August, 1982. Through the end of November, 1982, the size of the Fund remained relatively constant, with assets in excess of 22 billion dollars. The growth of the Fund paralleled that of the industry as a whole, which peaked in assets at $232.6 billion on December 1, 1982. *fn3" The leadership of Merrill Lynch in the money market field was due in large part to the availability of the Merrill Lynch system and its vast organization which could supply the processing services required to satisfy the daily orders and other demands of the shareholders. In November, 1982, Merrill Lynch was processing over 25,000 orders per day on behalf of the MLRAT.

 Another reason for the relative success of the MLRAT in attracting shareholders and assets was the strong performance record of the fund. Of the fourteen domestic prime money market funds *fn4" in existence for the five-year period beginning in 1978 and ending in 1982, the MLRAT had the fourth best overall performance, with an average rate of return of 11.98% over the five-year period, as compared to the industry average of 11.77%.In 1982, the MLRAT had the seventh best performance out of 51 domestic prime funds, with an annual rate of return of 12.67% as compared to the industry average of 12.30%. *fn5" The spectacular rise in the success of money market funds came to a dramatic end in December, 1982. As the result of Federal action deregulating rates which could be offered by banks and other financial institutions, banking institutions, on December 10, 1982, began to offer "money market deposit accounts" which in some cases afforded rates of return comparable to those offered by the traditional money market funds. These new bank funds were aggressively marketed and this, combined with the rise in stock prices and the dramatic reduction in interest rates, led to a precipitous liquidation and fall in the level of money market assets. In six months the MLRAT lost almost 36% of its assets and 15% of its shareholders. The decline experienced by MLRAT is as follows: Net Assets No. No. Accounts (millions) Shareholders Closed November 1982 $22,499 1,410,390 37,359 December 1982 19,332 1,338,440 ...


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