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Midwest Technical Development Corp., et al.," the Commission brought an injunctive action alleging that the directors and officers of the defendant investment company had caused it to violate various provisions of the Investment Company Act and were committing gross misconduct and gross abuse of trust. The complaint contains detailed charges of simultaneous personal investments by several of the officers and directors in the portfolio companies in which Midwest invested, resulting in large private profits for them to the detriment of the fund's interests.
The Commission seeks not only to enjoin the various violations, but to freeze the private investments of the individual defendants to prevent further deterioration of the situation, to obtain an accounting for profits and to have a receiver appointed to preserve the public interest in Midwest.
All of the individual defendants have entered stipulations agreeing not to change their present investment position in the portfolio companies, pending trial on the merits. Upon the filing of these stipulations, the Commission withdrew its motion for a preliminary injunction. The Commission has dismissed the case against two corporate defendants which have entered final stipulations undertaking not to engage in any transactions with Midwest without first obtaining an exemption under Section 17(a) of the Investment Company Act. The case with respect to the remaining defendants was pending at the close of the fiscal year.
In Chabot v. Empire Trust Co. and Schwartz v. National Securities Service,^2 the shareholders of a mutual fund, organized as a common law trust, brought an action against the trustee and others for restoration to the fund of fees paid to the trustee. The trustee moved to stay the proceedings until the plaintiffs had delivered a bond to indemnify it against the cost and expenses of defending the action. The District Court 43 held applicable the provision of the trust agreement to the effect that no shareholder of the fund should have the right to an accounting except upon furnishing indemnity to the trustee against costs and expenses, with such indemnity to be payable unless it should be established that the trustee had been guilty of fraud, misfeasance, or gross negligence. The District Court therefore stayed the action pending the posting of security.
On appeal from that decision, the Court of Appeals for the Second Circuit upheld the right of appeal from the order of the District Court. Subsequently, the Commission filed a brief as amicus
4 D.C. Minn., No. 4-62 Civ. 142. 12 301 F.2d 458 (C.A. 2, 1962). 43 189 F. Supp. 666 (S.D.N.Y., 1960). * 290 F. 2d 657 (C.A. 2, 1961).
curiae expressing the view that the provision of the trust agreement requiring the posting of the security before the shareholders could commence their action was void under Section 17(h) of the Investment Company Act, which prohibits an investment company from operating under any instrument which contains "any provision which protects or purports to protect any director. ..." The Court of Appeals agreed with the Commission's position and reversed the District Court, holding that the indemnity provision was violative of Section 17(h) and further stating that “any provision that renders litigation substantially less likely 'protects or purports to protect directors and officers from liability under the Act,” and is therefore invalid.45
During the year progress was made in another case involving implied private rights of action under the Investment Company Act.
At the time of the last Annual Report, the Commission had filed a brief supporting the petition for certiorari in Brouk v. Managed Funds, contending that the Court of Appeals decision in that case was in conflict with numerous court of appeals and district court decisions holding that the Investment Company Act gives rise to implied private rights of action.46 Subsequently the Supreme Court granted certiorari,a? and the Commission filed a brief on the merits. However, before oral argument in the Supreme Court, the companion state court case 48 was settled by, among others, the respondents before the Supreme Court, for an amount in excess of $1 million. The Supreme Court, in a per curiam opinion, mooted the case, vacated the judgment of the Court of Appeals for the Eighth Circuit (whose reversal the Commission had urged), and remanded the case to the District Court for dismissal as to the respondents who were before the Supreme Court on certiorari.“ While no final Supreme Court decision on the existence of implied rights of action was obtained, the opinion of the Court of Appeals to the contrary was vacated, and its value as contrary precedent nullified.
Willheim v. Murchison 50 was a case brought both derivatively and representatively by two stockholders of Investors Mutual, Inc., a registered investment company, seeking to enjoin Investors Diversified Services, Inc. (IDS) from acting as principal underwriter and investment adviser to Investors Mutual pursuant to written contracts. The plaintiffs contended that these contracts were "assigned"
45 301 F. 2d at 461.
60 203 F. Supp. 478 (S.D.N.Y.), af'd sub nom. Willheim v. Investors Diversified Services, Inc., 303 F. 2d 276 (C.A. 2, 1962).
within the meaning of the Investment Company Act and therefore automatically terminated when control of Alleghany Corporation, which held approximately 47.6 percent of the voting stock of IDS, passed from Allan P. Kirby to John D. Murchison and his associates as a result of a proxy contest. The District Court, in denying the request for a preliminary injunction, rejected this contention and, while not grounding its decision on this point, indicated that a transfer of a controlling block of Alleghany voting stock would be insufficient to cause termination of the contracts.
Plaintiffs took an appeal from this decision, and the Commission filed a brief amicus curiae urging the Court of Appeals, if it should reach the merits, to hold that an investment advisory contract is automatically terminated whenever a controlling block of stock of the investment adviser or of a corporation which controls the investment adviser is transferred.
The Court of Appeals affirmed the denial of the preliminary injunction, holding that neither the plantiff nor the corporation would suffer irreparable injury by delay until a hearing on the merits, but that a sudden termination of the service contracts would precipitate corporate chaos. Since the merits were not reached, the Court reserved its decision with respect to the position urged by the Commission.
In Nadler v. S.E.C., the earlier history of which is discussed in the 1961 Annual Report,51 the Court of Appeals for the Second Circuit 62 affirmed in a per curiam opinion the Commission's order refusing to revoke a previous order granting an exemption pursuant to Section 17(b) of the Investment Company Act for transactions between a registered investment company and certain affiliates and permitting it to acquire its own preferred stock pursuant to Section 23(c)(3) of the Act.
A stockholder had sought review of the Commission's second order on the ground that the investment company's directors who had authorized the filing of the application for the exemption had not been elected in accordance with the provisions of Section 16(a) of the Act, contending that this made the application and the Commission order void. The Commission had held that the acts of the directors were voidable only and that under all the circumstances the order should not be revoked.
The Court, in affirming, held that there is no basis for declaring void all acts by a board not chosen as required by Section 16(a), and that “it would be an unsound policy, fraught with harm to the shareholders, to have everything done by such a board to carry on the corporation's normal business, especially within the statutory period, declared invalid."
a 27th Annual Report, p. 186.
296 F. 2d 68 (1961), certiorari denied, 869 U.S. 849 (1962).
T'aussig et al. v. Wellington Fund, Inc. et al.53 is a suit by stockholders of an investment company, Wellington Fund, Inc., against its corporate investment adviser and another investment company, Wellington Equity Fund and its adviser, in which the District Court enjoined the advisers and Wellington Equity Fund from employing the name "Wellington" in the investment company field, but denied damages.54 The District Court ruled that the goodwill attached to the word "Wellington” resulting from the successful operation of Wellington Fund, Inc., was the property of that fund and that the use of the name by Wellington Equity Fund was likely to confuse investors, constituted trading on the success and goodwill of Wellington Fund, Inc., and would hinder that fund should it desire to change its investment policies to those followed by Wellington Equity Fund. Diversity jurisdiction being questionable, the District Court found pendent jurisdiction, stating that Section 35(d) of the Investment Company Act conferred an implied private right of action, and based its decision on common law principles of unfair competition. Both sides have appealed. The plaintiffs assert that the facts show violations of Sections 15, 20(a), 4(b), 35(d), 36 and 37 of the Investment Company Act, and claim that implied rights of action and appropriate remedies including damages should flow therefrom. The defendants urge that the goodwill resulting from the successful operation of the investment company is the property of the adviser, that the use of "Wellington" by the second investment company does not mislead investors and that neither common law unfair competition nor violations of the prohibitions of the various sections of the Investment Company Act are shown by the facts. The Commission is appearing in this appeal as amicus curiae, and has filed a brief which takes the position that implied rights of action flow from violations of provisions of the Investment Company Act, including Section 36. The brief also points out that no inferences should be drawn from the nonaction of the Commission or from its acceleration of the reg. istration of shares as to whether names, proxy material or other material is deceptive or misleading. The Commission takes no position on the merits of the case.
63 C.A. 3 Nos. 13702, 13703, 13704 and 18705. 54 T'aussig v. Wellington Fund, Inc., 187 F. Supp. 179 (Del. 1960).
The statutes administered by the Commission provide that the Commission may transmit evidence of violations of these statutes to the Attorney General, who, in turn, may institute criminal proceedings. The regional offices and, at times, the main office of the Commission prepare, after investigation, detailed reports where the facts appear to warrant criminal prosecution. After careful review by the General Counsel's Office, the recommendations of the regional offices and the General Counsel's Office are considered by the Commission and, if the Commission believes criminal prosecution is appropriate, the case is referred to the Attorney General and to the appropriate United States Attorney. Commission employees familiar with the case generally assist the United States Attorney in the presentation of the facts to the Grand Jury, the preparation of legal memoranda for use in the trial, the conduct of the trial, and the preparation of briefs on appeal.
The Commission also submits parole reports prepared by its staff relating to convicted offenders.
During fiscal 1962, the Commission referred more cases to the Department of Justice for prosecution than in any other year in the Commission's history. In addition to the 60 cases referred for prosecution, 4 cases were referred for institution of criminal contempt proceedings for violations of injunctive decrees secured by the Commission in civil actions. As a result of these and prior referrals, 42 indictments were returned against 205 defendants during the fiscal year. There were also 67 convictions in 20 cases. Convictions were affirmed in 2 cases, and appeals were still pending in 13 other criminal cases at the close of the period. Of 4 criminal contempt cases handled during the year, 1 case was dismissed and 3 cases are still pending.
From 1934, when the Commission was established, until June 30, 1962, 3,187 defendants have been indicted in the United States District Courts in 710 cases developed by the Commission and 1,577 convictions have been obtained. The record of convictions obtained and upheld in completed cases is over 86 percent for the 28-year life of the Commission.55
As in prior years, the majority of the criminal cases prosecuted involved the offer and sales of securities by fraudulent representations and other fraudulent practices. These activities included high-pressure long-distance telephone "boiler-room” frauds, conversion of
A condensed statistical summary of all criminal cases developed by the Commission from the fiscal year 1934 through the fiscal year 1962, is set forth in Appendix Table 25. The status of criminal cases developed by the Commission which were pending at the end of the fiscal year is set forth in Appendix Table 16.