The Supreme Court held yesterday that independent minority directors of a mutual fund have the power to block a shareholder lawsuit if state law permits.
The 8-0 decision, which overturned an appeals court ruling, marked a victory for those who have promoted the role of outside directors of mutual funds.
It is also likely to give added force to the so-called "business judgement rule" that, in broad terms, allows a board of directors to be free of liability in the operation of a corporation even when their judgments turn out to be wrong.
The case, Burks vs Lasker, involved a move by five independent directors of Fundamental Investors, Inc., a mutual fund, to stop a suit brought against another six of the fund's directors-and the fund's investment adviser, Anchor Corp.,-by two shareholders.
The shareholders were suing for breach of duty in connection with a purchase of $20 million in Penn Central commercial paper made by the fund just months before the railroad entered bankruptcy proceedings.
A mutual fund is a pool. primarily of securities, owned collectively by investors. But instead of owning the securities themselves, each investor holds one or more shares in the fund.The purpose of such an arrangement is to diversify the risk of stock ownership.
Fundamental Investors' five independent directors tried to have the shareholder suit dismissed on the grounds it was contrary to the best interests of the mutual fund. The District Court approved their action, but the Second Circuit Appeals Court ruled against them, claiming the directors did not have the power to stop the suit under the Investment Company Act.
The act was passed in 1940 to control conflicts of interest within mutual funds. Its cornerstone provision requires that 40 percent of a fund's board be composed of independent outside directors. In 1970, Congress amended the law to strengthen the board's independence.
The justices ruled that neither this act nor a companion one-the Investment Advisers Act of 1940-justified a flat ban against directors terminating suits such as the one against Fundamental Investors.
"In fact," wrote Justice William Brennan for the court, "the evidence is overwhelming that Congress did not intend to require any such absolute rule."
When Congress did intend to limit directors' powers, Brennan noted, it expressly did so-such as prohibiting directors from cutting off suits charging breach of duty with respect to adviser's fees.
The court said that Congress had intended the independent directors to have primary responsibility for looking after the interests of mutual fund shareholders. It would be counter to this purpose, the court suggested, to tie the directors' hands.
The court also stressed that state law pertaining to independent directors of mutual funds should be applied, to the extent such law is consistent with federal law. The justices remanded the case for further proceedings.
In other court actions yesterday as reported by news services:
The court cleared the way for Congress to get "competitively sensitive information" about uranium mines owned by Exxon and Kerr-Mc-Gee Corp. The justices refused to review a lower court's ruling that left the Federal Trade Commission free to give the information to a Senate subcommittee on antitrust and monopoly. At issue was what obligation, if any, a federal agency has to give the owner of information advance notice of its intention to give the information to Congress.
The court agreed to consider an appeal by the nation's largest television manufacturers to bar government release of data on accidents rsulting from the operation of television sets.