The report analyzes governance forms (primarily organization and financing) for the planning and realization of cross-border transport infrastructure projects in the Öresund region. The study is nased on analyses related to the current Öresund Bridge and the planned and proposed new fixed links in the Öresund Region; the Helsingborg-Elsinore-connection (HH-link) and the metro-line extension Copenhagen-Malmoe. The project has been financed by Region Skåne as part of the EU-funded Baltic Sea Region TransGovernance-project.QC 20140613</p

Hasselgren, Björn

Lundgren, Anna

English

Digitala Vetenskapliga Arkivet - Academic Archive On-line

TransGovernance Öresund : Experiences and future development in transport infrastructure development and governance in the Öresund Region

Academic Archive On-line (KTH, Sweden)

Publikationer från KTH

Duke Law Scholarship Repository

SECURITIES REGULATION: SEC BRANDS SALES REWARDINTERPOSITIONING A BREACH OF FIDUCIARY DUTYAND ANTIFRAUD VIOLATIONDelaware Management Company1 extends the antifraud pro-visions of the securities acts to eliminate a heretofore common mutualfund practice, the interpositioning of a broker-dealer, now deemed bythe Securities and Exchange Commission to be a fraudulent breachof fiduciary duties. Delaware Management Company, the invest-ment adviser and principal underwriter for two mutual funds, inter-posed Mutual Funds Associates, Incorporated, a retail broker offund shares, between the funds and the best market in the purchasingof over-the-counter securities for the funds' portfolios. Purchasingfrom Associates rather than directly from the wholesale market causedthe funds to incur additional brokerage fees in excess of $200,000over a five-year period. Management allowed this interpositioningto reward Associates for its efforts in making retail sales of the mutualfunds' shares. Management's profits as adviser-underwriter wereincreased by the additional fund share sales, but the funds them-selves did not profit significantly from such sales increases, since theratio of assets per share, and thus the book value of each share, wasnot enhanced. 2 The Commission found that Management and itsofficers, who also served as officers of the funds, breached theirfiduciary duty in violation of the antifraud provisions of the se-curities acts. The Commission, however, did not clearly indicatewhether the officers' breach occurred in their capacity as investmentadvisers or as corporate officers, raising again the question faced inO'Neill v. Maytag.3The problems of interpositioning and another sales reward calledthe "give up"-an order by a fund to its purchasing broker torelinquish part of his commission to a fund share retailer-werebrought to light by recent congressional reports dealing with mutualfunds.4 The sales reward originated on the New York Stock Ex-1 CCH FED. SEc. L. REP. 77,458 (SEC Exchange Act Release No. 8128, July 19,1967).2 Id. at 82,886. See generally H.R. REP. No. 2337, 89th Cong., 2d Sess. 172 (1966).3 339 F.2d 764 (2d Cir. 1964). See also 50 CORNELL L.Q. 545 (1965).'H.R. REP. No. 2337, supra note 2; H.R. Doc. No. 95, pts. 2, 4, 88th Cong., 1stSess. (1963); H.R. Doc. No. 2274, 87th Cong., 2d Sess. (1962).change where a minimum commission rate is required. 5 Since ex-change brokers will transact the large fund purchases at less than therate required by exchange rules, management companies order theexcess to be paid out in "give ups" to fund share retailers. On the ex-change, this practice does not injure the funds since they are chargedthe minimum rate anyway, but injury does occur in the over-the-counter market, where there is no minimum rate. When inter-positioning or a "give up" occurs in the over-the-counter market,it is reasonable to assume that the fund is paying excessive brokeragefees, and thereby wasting assets, since brokers are given commis-sions for unnecessary or unrelated services, or are given a "padded"amount with the understanding that part must be given up. TheCommission has given considerable attention to these practices inits recent studies," but Delaware marks the initial use of the antifraudprovisions in controlling such abuses. The Commission found vio-lations of the three major antifraud provisions, section 17 (a) of theSecurities Act,7 which authorizes administrative and injunctive actionand is directed toward sellers; section 108 and Rule lOb-59 under theSecurities Exchange Act, which have been interpreted to provide civilremedies' ° and are directed toward purchasers and sellers; and section206 of the Investment Advisers Act," which is specifically directed atthe regulation of advisers. These provisions employ similar lan-gauge, essentially forbidding the use of any device, scheme, artifice,practice, or course of business which would operate as a fraud in thepurchase and sale of securities.The antifraud provisions have been broadly construed to pro-tect the investor, and elements constituting fraud under the actshave not been limited to the strict common law requirements 2 ofmisrepresentation or falsehood, scienter, justifiable reliance, proxi-mate cause, and injury.'3 Half-truths, omissions, and nondisclosures5 N.Y. STocK EXCHANGE CONST. art. XV, appearing in 2 CCH NEw YonX STocKEXCHANGE GUIDE 1701-12.6 See note 4 supra."Securities Act of 1933 § 17 (a), 15 U.S.C. § 77q (1964).' Securities Exchange Act of 1934 § 10, 15 U.S.C. § 78j (1964).'17 C.F.R. § 240.10b-5 (1967).10 See, e.g., Kardon v. National Gypsum Co., 69 F. Supp. 512 (E.D. Pa. 1946).21 Investment Advisers Act § 206, 15 U.S.C. § 80b-6 (1964).22 See, e.g., SEC v. Van Horn, 371 F.2d 181 (7th Cir. 1966); Stevens v. Vowell, 343 F.2d374 (10th Cir. 1965). See also 3 L. Loss, SEcUvrrmS REGULATION 1430-44 (2d ed. 1961).18 See generally W. PROSSER, THE LAW OF TORTs §§ 101-105 (3d ed. 1964).DUKE LAW JOURNAL [Vol. 1967: 10591060SECURITIES REGULATIONhave all been termed fraud under the acts,1 4 as has the typical inter-positioning arrangement in which the broker or adviser profits di-rectly from the client's payment of excess brokerage fees either byinterpositioning himself or by requiring a "kick-back" from an inter-posed third party.15 As a general rule, the antifraud provisionshave not been applied to breaches of fiduciary duty by corporateofficers in the purchase or sale of the corporation's securities unlessthe element of deceit was present.' 6 The Commission and thecourts, however, have consistently held that a breach of the fiduciaryduty owed a client by his investment adviser or broker is a specialsituation and does constitute an antifraud violation under the acts.' 7In SEC v. Capital Gains Research Bureau, Incorporated,' the UnitedStates Supreme Court noted that "equitable" fraud is sufficient tosatisfy the antifraud provisions, and that a breach of the fiduciaryduty which Congress recognized in its passage of the InvestmentAdvisers Act constituted such equitable fraud. 19 Indeed, in O'Neillv. Maytag,20 the principal decision holding that breaches of corporatefiduciary duty without deceit are not antifraud violations, the courtspecified that the duty of a broker or advisor to his client was notunder consideration, and that a breach of this duty might well con-stitute actionable fraud under Rule lOb-5. 21In Delaware the SEC found that the officers involved owed aduty to the mutual funds to seek the most advantageous transactionsfor the funds' portfolios, and that Management, as adviser, had asimliar responsibility. The Commission held that both Managementand the officers breached their fiduciary duties by interposing Associ-ates, and that this breach constituted a "fraud upon the funds and" See, e.g., Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949).15 See, e.g., Archer v. SEC, 133 F.2d 795 (8th Cir.), cert. denied, 319 U.S. 767 (1943);H. C. Keister & Co., CCH FED. SEC. L. REP. 77,414 (SEC Exchange Act Release No.7988, Nov. 1, 1966).1 O'Neill v. Maytag, 339 F.2d 764 (2d Cir. 1964); Schoenbaum v. Firstbrook, 268 F.Supp. 385 (S.D.N.Y. 1967). See generally 51 VA. L. Rav. 508 (1965).17 See Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949); Thomas Brown III, CCH FED.SEc. L. REP. 77,430 (SEC Exchange Act Release No. 8032, Feb. 8, 1967); H. C.Keister 8: Co., CCH FED. SEc. L. RFP. 77,414 (SEC Exchange Act Release No. 7988,Nov. 1, 1966).1-375 U.S. 180 (1963).'Id. at 194.20339 F.2d 764 (2d Cir. 1964).21 Id. at 768.Vol. 1967: 1059] 1061their shareholders"22 in violation of the antifraud provisions of thesecurities acts. The use of a broker-dealer to execute transactions onbehalf of the funds in securities in which that broker-dealer did notmake a market was found to constitute a course of conduct prohibitedunder the acts. The Commission further determined that the in-curring of unnecessary brokerage fees and the transaction of pur-chases at a sum exceeding the most favorable price were fraudulent,since both were incompatible with the letter and spirit of the funds'policies stated in their prospectuses. Consequently, the prospectuseswere held to be materially false and misleading. Pursuant to itsacceptance of an offer of settlement in which Management agreed toreimburse the funds and Management and Associates consented toabide by the Commission's findings, the SEC temporarily suspendedthe registrations of the two firms, and suspended the officers fromassociation with any broker-dealer for periods of up to 60 days.Because the Commission did not clearly indicate in which of theirtwo capacities the officers were found to be perpetrating the fraud,the holding in the Delaware case lends itself to more than one inter-pretation. The Commission may have found the fraud to exist onlyin the breach of the duty owed the funds by Management and itsofficers in their capacity as investment brokers and advisers. Thisinterpretation is in keeping with the "equitable" fraud theory ad-vanced by the Supreme Court in Capital Gains, and does not conflictwith the recent cases requiring more than a general breach of corpo-rate responsibility to sustain a fraud allegation under the securitiesacts. If this were its rationale, the Commission has curtailed anabusive fund practice while remaining within the established limitsof the provisions designed to prevent fraud. The Commission,however, may also have found fraud in the breach of fiduciary re-sponsibility owed the fund corporations by their officers. The Com-mission placed some emphasis on the dual capacity in which theofficers were serving,23 but the parties' service as corporate officersof the funds assumes relevance only if viewed as the source offiduciary duties in addition to those owed as brokers or advisers.Reliance upon a breach of the officers' duty to their corporationwould represent a marked departure from the recent cases holding22 CCH FED. SEc. L. REP. at 82,886.23 Id. at 82,884.1062 DUKE LA4W JOURNAL [Vol. 1967:1059SECURITIES REGULATIONthat a general breach of fiduciary responsibility does not constitutefraud under the acts. Such a departure would serve to extend theCommission's power, without congressional authorization, into thearea of corporate regulation traditionally left to the states. Com-mentators have suggested that the regulation of fiduciary duties, aswell as procedural questions such as an appropriate statute of limita-tions, could better be handled through new federal legislation,rather than an expansive interpretation of the existing securitieslaws.24 Finally, it is possible that the Commission found that actualdeceit was present, reasoning that the funds, as corporate entities,were the victims of deception, and were not to be charged with theknowledge of their officers.25 Such a finding would indicate a tacitrejection of the doctrine of imputed knowledge,26 since the inter-locked fund officers had full knowledge of the improper practices.In addition to its potential impact on securities law, the Delawaredecision may significantly alter mutual fund practices. The Commis-sion's holding that three antifraud provisions were violated suggestsa desire to provide multiple remedies against interpositioning and"give ups." The need for Commission action to restrict sales rewardabuses cannot be questioned. However, the elimination of thesepractices from the over-the-counter market, while permitting themto continue on the exchange because of its minimum commissionrate, appears to place over-the-counter dealers at an unfair dis-advantage in competition for mutual fund portfolio business. Abetter approach would be to eliminate the abusive practices at theirsource; i.e., force reduction of the exchange's minimum commissionrate for large volume purchases and thus eliminate excess fees avail-able for distribution as sales rewards. This fee adjustment wouldgo far to remove the temptation confronting the mutual fund man-agement companies to divert fund assets to their own advantage,and would preclude the development of still more intricate pro-cedures to circumvent the Commission's ruling in the instant case.2 724 See Ruder, Pitfalls in the Development of Federal Law of Corporations by Im-plication Through Rule 10b-5, 59 Nw. U.L. REv. 185 (1964); 50 CORNELL L.Q. 545(1965); 51 VA. L. REv. 508 (1965).25 See Ruckle v. Roto Am. Corp., 339 F.2d 24 (2d Cir. 1964); Heilbrunn v. HanoverEquities Corp., 259 F. Supp. 936 (S.D.N.Y. 1966).25See generally 3 W. FLET r~, CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS§ 824 (1965).27 See H.R. REP. No. 2337, supra note 2, at 187.Vol. 1967:1059] 1063