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Marquit v. Dobson

January 3, 2000


The opinion of the court was delivered by: John S. Martin, Jr., District Judge:


Plaintiff brought these three class actions against three closed end mutual funds - The Central European Equity Fund, The Spain Fund, and The New Germany Fund - and their respective managers, investment advisors, and directors. The Central European Equity Fund and The New Germany Fund are managed by Deutsche Bank and The Spain Fund is managed by Alliance Capital. These three funds have been trading at a discount to their respective net asset values ("NAVs") for years. Plaintiff claims that defendants have failed to take adequate steps to reduce this discount, because such steps would reduce the number of shares outstanding in the fund, thereby reducing the amount of fees paid to the funds' investment advisors and managers.

Plaintiff has filed a class action on behalf of each of the three funds' shareholders alleging that defendants have breached their fiduciary duties to the funds' shareholders pursuant to the Investment Company Act of 1940 and Maryland common law. Each complaint seeks, inter alia, a declaration that the defendants have breached their fiduciary duties, monetary damages, punitive damages and an order "Directing the defendants to forthwith take serious steps to reduce the discount to the NAV at which the Fund trades."

Defendants move to dismiss the complaints on the grounds that (1) plaintiff's claims are derivative and she has failed to exhaust intra-corporate remedies or plead futility; (2) plaintiff has failed to overcome the business judgment rule presumption; and (3) plaintiff has failed to allege personal misconduct against the directors who are not interested. Since the court concludes that the complaint must be dismissed because the claims asserted are derivative, it will not consider the other grounds for dismissal.


Under the Investment Company Act, the law of the state in which the corporation is incorporated governs whether a claim is derivative or direct. Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 97-99, 111 S. Ct. 1711, 1716-18 (1991). Since all three funds were incorporated in Maryland, Maryland law determines whether plaintiff's claims are derivative or direct in nature. Under Maryland law, where the directors are alleged to have violated a right that belongs to the corporation and it affects the rights of all shareholders, the action is derivative and not direct. Waller v. Waller, 49 A.2d 449, 453-54 (Md. 1946).

In Strougo v. Scudder, Stevens & Clark, Inc., 964 F. Supp. 783 (S.D.N.Y. 1997), Judge Sweet applied Maryland law to a case where a closed end mutual fund's NAV price declined as the result of a rights offering. The plaintiff alleged that the fund's manager and directors made the rights offering to increase the net assets of the fund, thereby increasing the management and advisory fees paid to the manager. Judge Sweet held that such a claim was derivative and not direct, because the claims related to defendants' manipulation of the fund's overall capitalization and, therefore, belonged to the corporation. Id. at 791.

Strougo is directly on point. Although plaintiff claims, that the Second Circuit's decision in Eisenberg v. Flying Tiger Line, Inc., 451 F.2d 267 (2d Cir. 1971) compels a different result, that case is distinguishable. The Second Circuit in Eisenberg held that under New York law, an action to overturn a reorganization and merger was representative and not derivative.

In Eisenberg, plaintiff held shares in a corporation, Flying Tiger, that was merged into an affiliated entity, FTL. The shareholders of Flying Tiger approved the merger and in exchange for their Flying Tiger shares received shares of FTL. Plaintiff claimed that the Flying Tiger shareholders were relegated to a minority holding in FTL with no voting influence. The circuit court held that this was a representative action, because the right to vote on the affairs of Flying Tiger never belonged to the corporation and, therefore, the corporation was not enforcing its right. Id. at 269.

In this case, there is simply no right that runs directly to the shareholders or that is distinct from the corporation's right. Plaintiff claims that because the remedy she seeks is dissolution of the funds, her claim can not be derivative since this would not benefit the corporation. It is true that a derivative claim must typically benefit the corporation, Eisenberg at 270, but the plaintiff's complaints do not seek the dissolution of the funds. Rather, the complaints ask the Court to become involved in the day-to-day management of the funds and to determine what steps the funds should take to bring the share price in line with the NAV. These are decisions which are generally left to management under the direction of the board of directors. The consequences effect all shareholders equally and management's failure to take appropriate action harms the corporation not the individual shareholders.

Because plaintiff's claims are derivative, they must be pled in accordance with FRCP 23.1. Rule 23.1 requires plaintiff to first seek action from the board of directors or to show that such a request would be futile. See also Parish v. Maryland and Virginia Milk Producers Assoc., 242 A.2d 512, 545 (Md. 1968) (holding that Maryland law requires the same). In this case, plaintiff did not seek action from the funds' boards before instituting these actions, and she has not pled that such a request would be futile.

Nor does it appear from the face of any of the complaints that a demand would be futile. Under Maryland law, at least two disinterested directors are necessary to consider a shareholder demand. Strougo, 964 F. Supp. at 795. Therefore, a shareholder demand would not be futile if the fund had at least two disinterested directors.

A director is interested if he is employed by the fund's manager or investment advisor. Strougo, 964 F. Supp. at 794; see also Rales v. Blasband, 634 A.2d 927, 936-37 (Del. 1993).

However, the fact that the investment advisor and/or manager appointed the director or the fact that the director receives remuneration from the fund is not enough to make a director interested. Id. Nor is the fact that there are other business relationships among the directors sufficient to compel the conclusion that the directors are not disinterested. Strougo, 964 F.Supp. at 794. While Judge Sweet found in Strougo that allegations that the directors received substantial remuneration from their service on the boards of other funds managed by the same adviser would constitute interest, there are no such allegations here. The New Germany Fund and The Spain Fund both have more than two disinterested directors who have no association with any other fund managed by Deutsche Bank. While the Central European Equity Fund has no director who does not serve on the board of at least one other fund managed by Deutsche Bank more than two of these serve only on one other board and there is no allegation ...

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