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February 4, 1999


The opinion of the court was delivered by: Whitman Knapp, Senior District Judge.


Defendant Blackrock Financial Management, Inc. has moved, pursuant to Federal Rule of Civil Procedure 12(b)(6), to dismiss plaintiffs First Amended Complaint for failure to state a claim upon which relief can be granted. For reasons which follow, defendant's motion is granted.


The facts are here presented as alleged in the complaint. Plaintiff T. Robert Verkouteren ("plaintiff") is a shareholder of The Blackrock Target Term Trust Inc., one of twenty-one funds within a fund complex that is advised by defendant Blackrock Financial Management ("defendant"). He brings this action pursuant to the Investment Company Act of 1940 (the as amended, 15 U.S.C. § 80a-35(b). Defendant is a registered investment adviser specializing in fixed income securities. Defendant receives an advisory fee, measured as a fixed percentage of the average weekly net assets in the fund complex, for its services to the funds. Through this action, plaintiff seeks to recover the fees received by defendant pursuant to investment advisory agreements between it and the funds within the complex.

The crux of the complaint is as follows. Plaintiff claims that, contrary to the requirements of Section 10(a) of the ICA, 15 U.S.C. § 80a-10(a),*fn1 more than 60% of the directors who sit on the boards managing the funds within the complex are "interested" persons within the meaning of the ICA. As a result, Section 15(c)'s requirement that every agreement with an investment adviser be approved by a majority of the independent directors cannot be met due to the fact that all of the fund managers are "interested" under that term's definition in the ICA.*fn2 The import of the absence of independent directors serving within the fund complex is that the share-holders' interests cannot be adequately safeguarded as contemplated by the ICA.

The complaint further claims that because 40% of the directors of the funds within the complex are not independent, the advisory agreements between the funds and the defendant, pursuant to which defendant receives its advisory fees, are invalid. Plaintiff seeks recovery of those fees under Section 36(b) of the ICA, 15 U.S.C. § 80a-35(b), on behalf of all the funds within the complex.

Finally, the complaint alleges that defendant, by reason of its receipt of funds from invalid advisory agreements, has breached its fiduciary duty to negotiate at arm's-length with the funds in the complex. See 15 U.S.C. § 80a-35(b). Accordingly, plaintiff seeks judgment: (1) declaring that defendant violated Sections 10(a), 15(c) and 36(b) of the ICA, and that the advisory agreements are void; (2) awarding damages against defendant, including the return of all fees paid to it by each of the funds as well as related relief; and (3) providing any other relief deemed just and proper by the Court.

As is apparent, the crux of all charges in the complaint is that the seven supposedly independent directors are not truly independent, but actually controlled by defendant.


A. The ICA and the mutual fund industry

Mindful of those potential conflicts, Congress crafted a regulatory scheme in the ICA that placed quantitative and qualitative limits on the relations between advisers and investment companies. Subsequent to the Act's passage, investment companies enjoyed enormous growth, prompting studies on the Act's effectiveness in protecting the interests of investors. Daily Income, 464 U.S. at 537, 104 S.Ct. 831. The SEC, having sponsored or authored several such studies, concluded that the Act did not prevent advisers from receiving extraordinary compensation from mutual funds relative to moneys received from other clients. Id. The SEC also concluded that unaffiliated directors were "of restricted value as an instrument for providing effective representation of mutual fund shareholders in dealings between the fund and its investment adviser." Id. (quoting Wharton School Study of Mutual Funds (1962), H.R.Rep. No. 2274, 87th Cong., 2d Sess., at 34).

These realities prompted Congress to take further action. In response to legislative proposals submitted by the SEC, the ICA was amended in 1970. Among the amendments was 15 U.S.C. § 80a-10(a), which sought to make the outside directors of investment companies more independent from advisers. Id. at 538, 104 S.Ct. 831. Congress rejected an SEC proposal which would have required advisers to accept only "reasonable" fees; it opted instead to impose a fiduciary duty on advisers. Id. at 538-39, 104 S.Ct. 831.

Neither Congress (which amended the ICA in 1970) nor the SEC (which often asserts its views regarding the susceptibility of outside directors to the influence of advisers) has taken any action proscribing the use of interlocking boards within mutual fund complexes. In 1994, the SEC amended the proxy rules for registered investment companies to require disclosure of the aggregate compensation received by directors who serve on multiple fund boards. See Amendments to Proxy Rules for Registered Investment Companies (1994) SEC Release No. IC-20614, 1994 SEC Levis 3098. There is no other regulation regarding interlocking boards. Congress and the SEC are both undoubtedly aware that such schemes are rife in the industry, as they are also aware that the shareholders of mutual funds have the authority to set levels of director compensation and to remove directors from office. It is therefore apparent ...

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