depression of share values, from a rights offering that is impermissible because it violates another provision of the ICA. Had a committee of truly independent directors (i.e., those without multiple directorships) approved the Rights Offering, it may have come within the protections of Section 23(b), provided the committee violated no other duties imposed by the ICA (such as the duty of care apparently breached by the Nuveen defendants).
Thus, because the Complaint alleges a breach of the duty of loyalty, section 23(b) does not exempt this Rights Offering from an attack under section 36(a).
4. Breach of Fiduciary Duty Under Maryland Law
Under Maryland law, corporate directors owe a fiduciary duty to the corporation and its shareholders. Waterfall Farm Sys. Inc. v. Craig, 914 F. Supp. 1213, 1228 (D. Md. 1995) ("Maryland law recognizes that an officer and director of a corporation occupies a fiduciary relationship as regards the corporation"); Martin Marietta Corp. v. Bendix Corp., 549 F. Supp. 623, 633 (D. Md. 1982) ("in Maryland, as elsewhere, directors of a corporation occupy a fiduciary relationship to the corporation and its stockholders . . . . Directors have the duty to act in a manner they reasonably believe to be in the best interests of the corporation"). To plead a claim for breach of fiduciary duty, a plaintiff must allege: "(1) the presence of [a] fiduciary relationship between the parties; (2) a duty created in the fiduciary by this relationship, to act on behalf of the other party; (3) a breach of this duty by the fiduciary; and (4) damage to the other party caused by the breach." Diamond v. T. Rowe Price Assocs., Inc., 852 F. Supp. 372, 409 n.175 (D. Md. 1994) (adopting Restatement (Second) of Torts § 874). See also Cramer v. Devon Group, Inc., 774 F. Supp. 176, 184 (S.D.N.Y. 1991) (there are two elements of breach of fiduciary duty claims -- fiduciary relationship and breach).
Defendants contend that Strougo has not alleged a breach of any fiduciary duty.
Maryland Corps. and Assn's Code Ann. Section 2-405.1(a)(1) requires corporate directors to perform their duties in "good faith." "Good faith" is generally synonymous with the duty of loyalty or the duty of fair dealing. James J. Hanks, Maryland Corporation Law, § 6.6(b), at 163 (1995-1 Supp.). Whether a director breached his duties of loyalty and good faith are fact-intensive questions. See, e.g., Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 364 (Del. 1994) ("The question of when director self-interest translates into board disloyalty is a fact-dominated question, the answer to which will necessarily vary from case to case."). It is ordinarily inappropriate to resolve such questions on a motion to dismiss. See Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199 (Del. 1993) (reversing trial court for deciding factual question of good faith on motion for judgment on pleadings under Delaware Chancery Rule 12(c)); Lewis v. Fuqua, 502 A.2d 962, 971 (Del. Ch. 1985) (defendants' good faith is question of fact).
In Desert Equities, a limited partner brought an action against the general partner alleging breach of contract for wrongfully excluding it from participating in various investments, breach of fiduciary duty, and breach of the implied covenant of good faith and fair dealing. The Chancery Court granted the defendant's motion under Chancery Rule 12(c) for judgment on the pleadings, finding that the plaintiff's allegations of wrongdoing were conclusory and insufficient as a matter of law to state a claim for relief.
On appeal, the Delaware Supreme Court reversed, holding that whether a party acted reasonably or in good faith was a mixed question of law and fact, "which cannot be resolved on a motion for judgment on the pleadings." 624 A.2d at 1206. The Delaware Supreme Court went on to hold:
[A] fairly pleaded claim of good faith/bad faith raises essentially a question of fact which generally cannot be resolved on the pleadings or without first granting an adequate opportunity for discovery.
624 A.2d at 1208 (citing Lewis v. Fuqua, 502 A.2d at 971).
Directors seeking the protection of the business judgment rule "can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing, as opposed to a benefit which devolves upon the corporation or all stockholders generally." Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). Thus, to enjoy the benefits of the business judgment rule and avoid judicial inquiry into a director's decision, the director must be independent of the interested director(s). Id. at 815-16 (requirement of director independence from interested persons inheres in business judgment rule). To be independent, the director's decision must be based on the merits of the transaction under consideration rather than extraneous considerations or influences that would "convert an otherwise valid business decision into a faithless act." Id. at 816. A director who is dominated or otherwise controlled by or beholden to an individual or entity interested in the transaction at issue is interested. Id. at 815. A proper allegation that a director has an interest in an action creates a prima facie case that the director did not act in good faith. Hanks, Maryland Corporation Law, § 6.6(b), at 165.
Here, as discussed above, all of the Scudder Defendants are interested in the Rights Offering and three of the four purportedly "independent" directors are alleged to be Scudder's "house" directors, receiving substantial compensation for service given to other Scudder managed funds. This close and financially rewarding relationship with Scudder is sufficient to call into question the independence and disinterestedness of these directors with respect to a Rights Offering that would admittedly benefit Scudder and dilute non-participating shareholders' interests.
Accordingly, the motion to dismiss the Maryland breach of fiduciary duty claims will be denied. However, because defendant Da Costa is not alleged to have received compensation for service on multiple boards of Scudder-managed funds, the state law claims against him will be dismissed.
5. Cognizable Damages
The defendants contend that the Section 36(a) and Maryland breach of fiduciary duty claims should be dismissed because Strougo has failed to articulate a cognizable theory of injury or damage.
Strougo asserts two types of damage: dilution damage and market damage. He contends that shareholders who did not exercise their rights, including those who sold their transferrable rights, suffered a dilution in their proportionate ownership of total outstanding shares at the close of the Rights Offering.
With respect to market damages, it is alleged that the market value of shares in the Fund were depressed by the Rights Offering and thus traded at a lower price at any given time after the offering than the price at which they would have traded had there been no such offering. In essence, Strougo contends that the additional supply of shares on the market depressed the value of existing investors' shares.
Actual damages are a necessary component of a claim for breach of fiduciary duty. See Steinbrenner v. Esquire Reporting Co., 1991 U.S. Dist. LEXIS 7438, 90 Civ. 6419, 1991 WL 102540, *10 (S.D.N.Y. June 3, 1991). Defendants contend that the dilution and market damage theories advanced by Strougo fail to state a claim of "actual" damage, but do not say why dilution damages and market damages are not "actual" damages. Rather, they contend that a shareholder would suffer no cognizable dilution damages in this context because he or she could recoup any loss by selling the shares on the open market, and that the market damage theory is too speculative and not susceptible of calculation.
While it is true that a shareholder who chose not to exercise her rights could receive money by selling the rights on the market, this does not mean that the shareholder's proportionate share of outstanding stock is not diluted. Moreover, although selling the rights may mitigate the financial consequences of a shareholder's dilution, it does not necessarily extinguish the financial loss.
Defendants also attack Strougo's market damage theory, claiming it is too speculative to support a claim under either the ICA or the common law. Specifically, they contend that because Strougo has not alleged that he sold any of his shares, he has realized no loss in share value. They urge an "out-of-pocket" rule of damages, arguing that allowing plaintiffs to proceed on "abstract" theories of damages without out-of-pocket or trading losses is "legally problematic."
In support of their position that only out-of-pocket losses should be cognizable, defendants cite Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975), in which the Supreme Court required that a plaintiff be a purchaser or seller of the securities at issue in order to state a securities fraud claim under Rule 10b-5. The Court noted that permitting claims for damages based on a failure to purchase or sell a security would lead to difficult problems of proof. Id. at 746-47. The virtue of the "purchaser-seller" rule is that it limits the class of plaintiffs to those who have dealt with the security, and thus prevents "bystanders to the securities marketing process [from] awaiting developments on the sidelines without risk, claiming that inaccuracies in disclosure caused nonselling in a falling market and that unduly pessimistic predictions . . . followed by a rising market caused them to allow retrospectively golden opportunities to pass." Id. at 747.
Blue Chip Stamps and the other cases cited by the defendants in support of an out-of-pocket rule involved securities fraud claims, not claims of breach of fiduciary duty. The defendants cite no authority imposing a similar "purchaser-seller" requirement in cases arising under the ICA. Moreover, Blue Chip Stamps was decided under Section 10(b) and Rule 10b-5, which expressly require that the plaintiff be injured "in connection with the purchase or sale of any security." No similar requirement exists in the ICA.
Moreover, Strougo is not Central Bank's "bystander" awaiting the benefit of hindsight to attack offering materials upon which he can claim he relied, but an owner of shares in a corporation whose value he alleges was diminished by an action that breached the directors' and Fund advisor's fiduciary duties. To require a shareholder to sell his shares to maintain a derivative claim for breach of fiduciary duty would also place the plaintiff in a difficult position, for to realize his total loss and recover full damages he would have to sell all of his shares. As a consequence of selling all of his shares, however, he would likely lose standing to bring a derivative suit on behalf of the corporation. See Parish, 242 A.2d at 554 (stockholder cannot sue unless he is stockholder at time derivative suit is instituted and retains stock throughout suit.)
Case law under Section 36(a) does not support defendants' proposed "out-of-pocket" rule. While damages may be more difficult to calculate when there is no out-of-pocket loss or clear and sustained decline in market prices, such difficulty alone will not defeat a claim under Section 36(a). In Fogel I, the Second Circuit remanded to the district court to determine damages under Section 36(a), stating:
The amount for which defendants are to be held liable will depend on the attempt, difficult but ineluctable, of seeking to find what would have been. In deciding this we must mediate between the two principles, given expression in the antitrust laws, that while "a defendant whose wrongful conduct has rendered difficult ascertainment of the precise damages suffered by the plaintiff, is not entitled to complain that they cannot be measured with the same exactness and precision as would otherwise be possible," Eastman Kodak Co. v. Southern Photo Materials Co., 273 U.S. 359, 379, 47 S. Ct. 400, 405, 71 L. Ed. 684 (1927), yet recovery "cannot be had unless it is shown, that, as a result of defendants' acts, damages in some amount susceptible of expression in figures resulted." Keogh v. Chicago & Northwestern Ry., 260 U.S. 156, 165, 43 S. Ct. 47, 50, 67 L. Ed. 183 (1922).
533 F.2d at 755-56.
Determining the value of investors' shares "but for" the Rights Offering may be difficult, but no more difficult than it often is to determine what the price of a product or service would be in the absence of anti-competitive or collusive conduct in antitrust cases. Such market damages are "susceptible of expression in figures," though adequate proof of the appropriate figure may be difficult to muster at trial in this case.
With respect to the common law breach of fiduciary duty claim, it appears that state courts have permitted recovery of damages beyond out-of-pocket loss. See, e.g., 105 East Second Street Assocs. v. Bobrow, 175 A.D.2d 746, 573 N.Y.S.2d 503, 504 (App. Div. 1st Dept. 1991 ("The measure of damages for breach of fiduciary duty is the amount of loss sustained, including lost opportunities for profit on the properties by reason of the faithless fiduciary's conduct").
Accordingly, at this stage of the litigation, plaintiff's allegations of damage are sufficient.
C. Rule 9(b)
The Scudder Defendants have also moved to dismiss on the grounds that the Complaint fails to plead with the specificity required by Fed. R. Civ. P. 9(b).
Because Rule 9(b) "is a special pleading requirement and contrary to the general approach of simplified pleading adopted by the federal rules, its scope of application should be construed narrowly and not extended to other legal theories or defenses." United States v. Rivieccio, 661 F. Supp. 281, 289 (E.D.N.Y. 1987) (quoting 5 C. Wright and A. Miller, Federal Practice & Procedure § 1297, at 405). It is well-established that "Rule 9(b) is not applicable to breach of fiduciary duty . . . claims; it applies only to claims sounding in fraud." Schupak v. Florescue, 1993 U.S. Dist. LEXIS 9485, No. 92 Civ. 1189, 1993 WL 256572, *2-*3 (S.D.N.Y. July 8, 1993). See also Zucker v. Katz, 708 F. Supp. 525, 530 (S.D.N.Y. 1989) (same); Bosio v. Norbay Sec., Inc., 599 F. Supp. 1563, 1570 (E.D.N.Y. 1985).
It is true that when a breach of fiduciary duty claim is, in substance, a claim of fraud, the requirements of Rule 9(b) are triggered. See Frota v. Prudential-Bache Sec., Inc., 639 F. Supp. 1186, 1193 (S.D.N.Y. 1986) ("Rule 9(b) extends to all averments of fraud or mistake whatever may be the theory of legal duty -- statutory, common law, tort, contractual, or fiduciary"). Here, however, Strougo's claims do not sound in fraud.
A fraud is "an intentional perversion of the truth for the purpose of inducing another in reliance upon it to part with some valuable thing belonging to him" or "[a] false representation of a matter of fact, whether by words or conduct, by false and misleading allegations, or by concealment of that which should have been disclosed, which deceives and is intended to deceive another so that he shall act upon it to his legal injury." Black's Law Dictionary at 455 (Abridged 6th Ed. 1991). See also Bartels v. Clayton Bros. 10., 631 F. Supp. 442, 448 (S.D.N.Y. 1986). Strougo alleges that defendants breached their fiduciary obligations to act in the best interests of the Fund and its shareholders, not that they attempted to induce action or inaction on the part of investors by means of falsehoods or material omissions. See McCoy v. Goldberg, 810 F. Supp. 539, 548 (S.D.N.Y. 1993) ("the principle articulated by Justice Cardozo in Meinhard -- that a fiduciary may be held liable without proof of deceitful intent -- has long remained the uniform law of New York").
Here, in contrast to a securities fraud claim, the shareholders were informed that the Rights Offering would dilute their shares if they did not exercise their rights and that Scudder would benefit from increased fees. To the extent that defendants misrepresented their motives for engaging in the Rights Offering, that misrepresentation is not alleged to have induced any particular action or inaction on the part of investors. In fact, the Complaint alleges that the Rights Offering was "coercive," in that it forced them to subscribe when they would not otherwise have chosen to, not that they were deceived into exercising or selling their rights.
Because Strougo's claim does not sound in fraud, Rule 9(b)'s particularity requirements do not apply.
IV. The Excessive Fees Claim
Strougo has alleged that the decision to initiate the Rights Offering, by increasing the assets under Scudder's management, had the effect of increasing Scudder's fees in violation of the fiduciary obligations imposed by Section 36(b) of the ICA.
Section 36(b) provides, in pertinent part:
For the purposes of this subsection, the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser. An action may be brought under this subsection by ... a security holder of such registered investment company on behalf of such company, against such investment adviser ... for breach of fiduciary duty in respect of such compensation or payments ... .
15 U.S.C. § 80a-35(b).
Section 36(b) was addressed to the problem that "adviser's fees, generally stated as a percentage of the market value of the managed assets, which had been altogether reasonable when a fund was launched, may have become unreasonably high when the fund grew to enormous size." Fogel II, 668 F.2d at 111.
However, Section 36(b) was enacted "to address a narrow area of concern: the negotiation and enforcement of payment arrangements between the investment adviser and its fund," Nuveen IV, 1996 U.S. Dist. LEXIS 8071, 1996 WL 328006, at *13, not to provide a cause of action separate from 36(a) to govern the adviser's general performance or financial advice with respect to particular transactions. Id. at *12, *15.
Accordingly, to be found liable for a violation of § 36(b), "the adviser-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." Gartenberg v. Merrill Lynch Asset Mgmt, Inc., 694 F.2d 923, 928 (2d Cir. 1982) citing Fogel II, 668 F.2d at 112; see also Kalish v. Franklin Advisers, Inc., 928 F.2d 590, 592 (2d Cir. 1992).
Strougo has pleaded no facts to support the conclusory allegation that Scudder's compensation after the Rights Offering was unreasonably disproportionate to the value of Scudder's services. He has not alleged that Scudder failed to provide services in connection with the Rights Offering itself, or that Scudder has not actively managed the securities purchased with the capital obtained through the Offering. Indeed, it appears that the Fund has performed well subsequent to the Rights Offering,
suggesting that Scudder has invested the new capital with some degree of competence. The allegation that Scudder's fee increased substantially as a result of a Rights Offering in violation of Section 36(a) does not, in itself, support an excessive fee claim under Section 36(b). See Nuveen IV, 1996 U.S. Dist. LEXIS 8071, 1996 WL 328006, at *15 (allegation that adviser devised rights offering to generate fees regardless of consequences to fund states claim under 36(a), not 36(b)); see also Gartenberg, 694 F.2d at 930-31 (increase in manager's fee from $ 1.6 million to $ 39.4 million not violative of section 36(b), where increase resulted from "tremendous increase" in size of fund that led to greater number of transactions, customers and other activities of manager).
Therefore, the Section 36(b) claim against Scudder will be dismissed.
V. The Control Person Claim
Strougo also alleges that the Scudder Defendants caused violations of the ICA by the other directors, in violation of Section 48(a) of the ICA, which provides:
It shall be unlawful for any person, directly or indirectly, to cause to be done any act or thing through or by means of any other person which it would be unlawful for such person to do under the provisions of this subchapter or any rule, regulation, or order thereunder.
15 U.S.C. § 80a-47(a).
Strougo contends that the purportedly "independent" directors of the Fund were in fact controlled by the Scudder Defendants, who "caused" the independent directors to approve the Rights Offering. In support of this contention, he alleges that three of the four independent directors earned very substantial compensation from various Scudder-managed funds, and thus could exert control over their votes.
In Harriman v. E.I. DuPont de Nemours & Co., 372 F. Supp. 101 (D. Del. 1974), a case alleging control person liability under both Section 48(a) of the ICA and Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t, the court observed that the "control person" provision of the Securities Exchange Act "is remedial and is to be construed liberally. It has been interpreted as requiring only some indirect means of discipline or influence short of actual direction." Id. at 105, quoting Myzel v. Fields, 386 F.2d 718, 738 (8th Cir. 1967). Such indirect means of discipline or influence may include "business relationships [other than stock ownership], interlocking directors, family relationships and a myriad of other factors." Id.
The allegation that, through their control of the substantial payments made for service on the boards of multiple Scudder funds, the Scudder Defendants had the means to indirectly discipline or influence Fieldler, Nolen and Nogueira is sufficient to survive a motion to dismiss.
For the reasons set forth above, defendants' motions are hereby granted in part and denied in part. Specifically:
1. The Complaint as to Da Costa is dismissed in its entirety;