FAILURE TO MAKE DEMAND ON INDEPENDENT DIRECTORS LEADS TO DISMISSAL OF CLAIMS AGAINST FUND ADVISER AND ITS AFFILIATES

June 26, 1992 TO: SEC RULES MEMBERS NO. 27-92 RE: FAILURE TO MAKE DEMAND ON INDEPENDENT DIRECTORS LEADS TO DISMISSAL OF CLAIMS AGAINST FUND ADVISER AND ITS AFFILIATES __________________________________________________________ The United States District Court for the Western District of Missouri recently dismissed two state law claims brought by an investment company shareholder against the company’s investment adviser and certain affiliates, because the shareholder did not make a pre-trial demand for relief on the investment company’s directors and shareholders, as required under Maryland law. A copy of the court’s Memorandum and Order is attached. The shareholder’s state law claims involved allegations that the defendants converted confidential information paid for by the investment company for the benefit of all of their advisory clients and that the directors violated their fiduciary duties to the investment company by servicing other clients of the adviser at the investment company’s expense and paying excessive management fees to the adviser. In his complaint, the shareholder contended that his obligation to make demand on the directors was excused because it would have been futile. The court agreed with the shareholder that demanding relief from the directors who are affiliated with the investment company and its adviser would have been futile, but noted that such directors did not constitute a majority of the board. In the case of the independent directors, the court relied on Kamen v. Kemper Financial Services, Inc., 939 F.2d 458 (7th Cir. 1991), cert. denied, ___ U.S. ___, 112 S. Ct. 454 (1991) in finding that the fact that they were financially compensated for acting as directors and that they were nominated by the corporate insiders did not excuse demand. Nor, in the court’s view, did any of the other reasons advanced by the shareholder (including the independent directors’ approval of the management contract, their alleged failure to negotiate for a proper allocation of fees, their serving as directors of a second investment company with the same investment adviser and the fact that the shareholder sought judgment against them) excuse him from making demand on the independent directors. Furthermore, the court disagreed with the shareholder’s suggestion that he was excused from demanding remedial action from the investment company’s shareholders because all of the directors acted wrongfully. In dismissing the state law claims, the court stated that in light of its holding that a majority of the directors did not act wrongfully for demand purposes, the shareholder’s failure to demand relief from the investment company’s shareholders precluded the assertion of those claims. A federal claim of excessive advisory fees under Section 36(b) of the Investment Company Act is still pending in this case. Interestingly, a footnote in the attached Order indicates that although the court did not rely on this reasoning, "a review of the briefing and authorities relied upon [by the defendants] suggests that Section 36(b) preempts state law claims relating to breach of fiduciary duty with respect to excessive management fees, including the majority if not all of plaintiff’s claims." As we previously informed you, in an earlier ruling in the same lawsuit, the court held that 1) the shareholder’s standing to bring suit under Section 36(b) was not limited to the series of the investment company in which he held shares, and 2) he was not required to remain a shareholder of the series he owned when the lawsuit was initiated throughout the litigation because through his ownership of shares in another series he retained a financial interest in the outcome of the case. (See Memorandum to SEC Rules Members No. 50-91, dated October 17, 1991.) We will keep you informed of further developments. Frances M. Stadler Assistant Counsel Attachment