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STROUGO v. BEA ASSOCIATES

February 21, 2002

ROBERT STROUGO, PLAINTIFF,
V.
BEA ASSOCIATES, DEFENDANT, AND THE BRAZILIAN EQUITY FUND, INC., NOMINAL DEFENDANT.



The opinion of the court was delivered by: Sweet, District Judge.

OPINION

Defendant Credit Suisse Asset Management LLC ("CSAM"), formerly known as BEA Associates, the investment adviser for the Brazilian Equity Fund, Inc. (the "Fund"), has moved under Rule 56, Fed. R. Civ. P., to dismiss the Second Amended Complaint (the "Complaint") of plaintiff Robert Strougo ("Strougo"), a shareholder in the Fund, which alleged violations of Section 36(a) and 36(b) of the Investment Company Act of 1940 ("ICA"), as amended, 15 U.S.C. § 80a-35 (a), (b). For the reasons set forth below, the motion is granted.

Strougo has been a determined litigant, attacking various practices of the Fund and related entities in an effort to remedy what he perceives as the "abysmal" performance of the Fund and its continued existence despite a market value consistently below its net asset value ("NAV"), sometimes referred to as its discount. These efforts have included, in addition to the instant action, a shareholder derivative claim against BEA Associates and the Fund's directors for alleged violations of the ICA in the Fund's 1996 rights offering, see Strougo v. Bassini, 112 F. Supp.2d 355 (S.D.N.Y. 2000), and a similar action challenging a 1995 rights offering by the Brazil Fund, a separate closed-end fund, see Strougo v. Padegs, 27 F. Supp.2d 442 (S.D.N.Y. 1998).

Despite a preliminary success in the Padegs action, see Strougo v. Padegs, 964 F. Supp. 783 (S.D.N.Y. 1997) (denying motion to dismiss fiduciary duty and ICA "control person" claims, except with regard to certain defendants), the decisions have not been favorable to the investor against whom the authorities are currently stacked. While the current revelations concerning the Enron Corporation challenge the validity of many of the precepts of corporate governance, the precedents remain in favor of the board of directors and the adviser.

Prior Proceedings

The original complaint was filed on May 21, 1998. It alleged violation of ICA Section 36(b) based upon the non-employee directors' lack of independence. The complaint was dismissed with leave to replead. Strougo v. BEA Assoc., No. 98 Civ. 3725 (RWS), 1999 WL 147737, at *2 (S.D.N.Y. Mar. 18, 1999)

On April 2, 1999, Strougo filed his first amended complaint. This complaint restated the sole claim in the original complaint, i.e., that the agreement between the Fund and CSAM is void because the Fund failed to maintain the requisite number of independent directors, but pursuant to ICA Section 36(a), rather than ICA Section 36(b). Strougo's claim was based on the lack of independence of the directors as a result of their multiple directorships, their substantial compensation, and their conduct in seeking to prevent the Fund's shareholders from voting to remove CSAM as the Fund's investment adviser. The first amended complaint contained allegations describing: (i) the duties borne by independent directors of a registered investment company; (ii) industry and professional literature cautioning against multiple directorships; (iii) the resulting practical inability of directors serving on multiple boards to fulfill their roles as "watchdogs"; (iv) structural reasons why the "independent" directors serve at the pleasure of the defendant, rather than the Fund's shareholders; and (v) specific examples of these directors' docility in the face of CSAM's overreaching. It added a second claim under ICA Section 36(b), alleging "excessive or inappropriate compensation."

Following CSAM's second motion to dismiss, this Court sustained the first amended complaint, subject to Strougo adding the Fund as a nominal defendant. Strougo v. BEA Assoc., No. 98 Civ. 3725 (RWS), 2000 WL 45714 (S.D.N.Y. Jan. 19, 2000), and the Second Amended Complaint was filed on February 3, 2000, which added the Fund as a nominal defendant.

Discovery commenced and certain disputes were resolved. Strougo v. BEA Assoc., 199 F.R.D. 515 (S.D.N.Y. 2001). The instant motion for summary judgment was heard on November 7, 2001, and marked fully submitted at that time.

The Facts

The facts are taken from CSAM's Statement of Undisputed Facts pursuant to Rule 56.1 of the Local Rules, Strougo's Statement of Disputed Issues, and the affidavits, depositions, and exhibits submitted by the parties. These facts are undisputed except as noted.

CSAM, then known as BEA Associates, established the Fund as a non-diversified, closed-end investment company, organized under the laws of the State of Maryland. It is a registered investment company under the Investment. Company Act of 1940 ("ICA"), 15 U.S.C. § 80a-1 et seq., with an investment objective of long-term capital appreciation, and its investment mandate requires it to invest primarily in Brazilian securities. The Fund's shares trade on the New York Stock Exchange.

Although the Fund is "non-diversified," it is subject to Brazilian regulations limiting investments in any single issuer, and the Internal Revenue Code, which prohibits the Fund from investing, with respect to fifty percent of its assets, any more than five percent in any one issuer. Brazilian regulations require that the Fund retain a local administrator, and impose certain taxes on the Fund.

The Fund's performance has largely moved with the Brazilian stock market. During 1998, the main Brazilian exchange, the Sao Paulo Exchange, had its worst performance in over twenty-five years, with a loss of 33.5 percent. For the six months ending September 30, 1998, the Morgan Stanley Capital International Brazil Index fell 44.3 percent.

CSAM serves as the Fund's investment adviser under a contract between the Fund and CSAM known as the Investment Advisory Agreement (the "Agreement"). CSAM manages assets of over $300 billion and serves as adviser to fifty-four open-end and eight closed-end funds, including the Fund. Pursuant to the Agreement, CSAM, among other things, manages the Fund's assets in accordance with the Fund's investment mandate and all applicable laws and regulations, provides research, makes investment decisions, and exercises voting rights with respect to securities held by the Fund.

Previously, CSAM and Garantia Adminisdracao de Recursos ("Garantia"), the Fund's subadviser, were paid a fee equivalent to 1.35 percent of the first $100 million of the Fund's net assets. Garantia resigned as the Fund's subadviser in 1994, and CSAM assumed Garantia's responsibilities but declined to charge the portion of the fees that would have been otherwise payable to Garantia. The fee of one percent of the first one hundred million of Fund assets, which CSAM continued to receive under that structure, is within the median of fees received by managers of world equity funds.

As of 2000, under a new fee structure, CSAM's fee is based on the lesser of the Fund's average net assets or the market value of the Fund's shares. CSAM charges lower fees to institutional clients. These fees are negotiated at arm's length.

For the fiscal years ending March 31, 1997, 1998, 1999, 2000, and 2001, CSAM earned $914,200, $1,020,507, $420,08, $364,721, and $341,921, respectively, in fees. CSAM's profit margin for the years 1996, 1997, 1998, 1999 and 2000 was 18 percent, 57 percent, 11 percent, negative 102 percent, and negative 24 percent, respectively.

The Fund's operating expenses include expenses associated with investments in Brazil. The Fund's expense ratio is affected by the small size of the Fund and certain expenses associated with its closed-end structure, such as exchange listing fees and fees associated with the annual proxy solicitation, and the significant fees associated with the present litigation, as well as expenses related to Brazilian investment including higher custodian, accounting, and audit fees, the mandatory retention of a Brazilian administrator, and a Brazilian transaction fee of up to .38 percent. For the Fund's fiscal years 1996, 1997, 1998, 1999, 2000 and 2001, its expense ratios were 1.76%, 1.76%, 2.07%, 5.17%, 3.80% and 2.38%. Strougo's litigation has attributed 0.09%, 2.34%, 0.87% and 0.28% respectively to those amounts. CSAM also provides, at cost, administrative services to the Fund under an Administrative Services Agreement, including internal executive and administrative services, responds to shareholder inquiries, a closed-end fund website, and corporate secretarial services.

During the relevant time period, the Fund's board of directors was composed of eight directors. The six outside directors have been Dr. Enrique Arzac ("Arzac"), James J. Cattano ("Cattano"), George W. Landau ("Landau"), Robert J. McGuire ("McGuire"), Martin M. Torino ("Torino") and Miklos A. Vasarhelyi ("Vasarhelyi"). None of the outside directors are disqualified from being a non-interested director under Section 2(a) (9)(b) of the ICA by virtue of family relationship, having an interest in any security issued by CSAM, acting as legal counsel to CSAM, or having been determined by the SEC to be an interested person.

Arzac is a professor of finance and economics at the Graduate School of Business of Columbia University. Landau is a senior adviser to the President of the Latin American Group of the Coca-Cola Corporation, and a former U.S. Ambassador to Venezuela, Chili and Paraguay. Torino is the chairman of the board of directors of Ingenio y Refineria San Martin Del Tabacal S.A., an Argentine sugar refinery, and an executive director of TAU S.A., an Argentine commodities trading firm. Cattano is the president of Primary Resources Inc., a trading firm that specializes in Latin American agricultural commodities. Cattano and Torino were formerly colleagues at Marc Rich & Co., along with Michael Pignataro, Chief Financial Officer and Secretary of the Fund, and Bassini, a former member of the board and current Chief Executive Officer of the Fund.

The Fund utilizes a staggered board divided into three classes, each class having a term of no more than three years. Except for the addition of McGuire and Vasarhelyi, who constituted the Litigation Committee, the membership has been constant.

Arzac, Landau, Cattano, and Torino currently serve as directors of eight, five, four, and three CSAM-affiliated funds, respectively. The board meetings as a rule take two to three hours and are held jointly with the other CSAM affiliated ...


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