Nettie M. LUTZ and Managed Funds, Inc., Plaintiffs,
Lloyd E. BOAS, J. John Brouk, Robert A. Hicks, James J. Mullen, Jr., Jefferson J. Rebstock, Dr. Earl Rice, W. Munro Roberts, Jr., Hilton H. Slayton and Hovey E. Slayton, Leo Model, Rolf R. Roland, Frits Markus, Robert R. Rosenberg, Walter H. Berton, Walter S. Morris, Erwin Wolff, Herman H. Stone, Stephen M. Jaquith, Elliot D. Fox, Jr., and Frank L. Thompson, individually and as partners doing business under the firm, name and style of Model, Roland & Stone, James S. Stubbs and Harold W. Smith, and Slayton Associates, Inc. Defendants.
[Copyrighted Material Omitted]
[39 Del.Ch. 587] Richard L. McMahon, of Berl, Potter & Anderson, Wilmington, and R. Walston Chubb, Robert S. Allen, Dominic Troiani, of Lewis, Rice, Tucker, Allen & Chubb, St. Louis, Mo., for plaintiff, Managed Funds, Inc.
William E. Taylor, Jr., Wilmington, and Abraham L. Pomerantz and Jerome T. Orans, of Pomerantz, Levy & Haudek, New York City, for plaintiff, Nettie M. Lutz.
Hilton Slayton, Hovey Slayton and Slayton Associates, St. Louis, Mo., pro se.
[39 Del.Ch. 588] Robert H. Richards, Jr., of Richards, Layton & Finger, Wilmington, and Arthur H. Dean and Marvin Schwartz, of Sullivan & Cromwell, New York City, for defendants, Model, Roland & Stone, Leo Model, Rolf R. Roland, Frits Markus, Robert Rosenberg, Walter H. Berton, Walter S. Morris, Erwin Wolff and Herman H. Stone.
John VanBrunt, Jr., and E. Dickinson Griffenberg, Jr., of Killoran & VanBrunt, Wilmington, for defendant, Dr. Earl Rice.
Defendant Jefferson J. Rebstock did not appear; jurisdiction limited to stock seized.
The other defendants were not subject to this court's jurisdiction.
Originally, this was a stockholder's derivative action for the benefit of Managed Funds, Inc. ('Funds'), a mutual fund. Subsequently, Funds was realigned as plaintiff and given primary control of the case. The defendants who are before the court fall into three groups:
1. Hilton Slayton ('Hilton') and his cousin Hovey Slayton ('Hovey'), who were the founders of Funds in 1946; their wholly-owned investment advisory company, Slayton Associates, Inc. ('Associates').
2. The partnership and eight of the individual partners of the New York brokerage firm of Model, Roland & Stone ('Model').
3. Dr. Rice, a former director of Funds. The defendant, Rebstock, also a former director of Funds, had his shares in Funds seized but did not appear. These were so-called non-affiliated directors. The other non-affiliated directors were not subject to this court's jurisdiction.
Neither of the Slaytons' sales companies, Slayton and Company, Inc. ('Slayton Inc.) and Mutual Fund Distributors, Inc., is a party defendant here. Each was at all times owned 51% by Hilton and 49% by Hovey and both were the principal officers and directors of Slayton, Inc.
Before launching into a narration of the actions of the various defendants of which plaintiffs complain, it is pertinent to describe [39 Del.Ch. 589] Funds. It was organized in 1946 as a Delaware corporation. It is an open-end investment company registered under the Investment Company Act of 1940 (15 U.S.C.A. § 80a-1 et seq.) ('Act'). It operated out of St. Louis, Missouri, around the idea that the new fund would realize capital gains and distribute them and the income quarterly to their shareholders in relatively level amounts. Funds offered several classes of shares which concentrated their investments in different industry groups. Its shares were widely distributed and its assets were valued at close to $80,000,000 when, in 1959, the S. E. C. held public hearings to determine whether a registration filed by Funds was false and misleading. This action followed and is based to a large extent on the disclosures there adduced.
Hilton, the president and dominant figure of both Funds and Associates, had a great deal of experience with mutual funds when he formed Funds. Hovey is involved, but his conduct was largely that of a Hilton follower. While not technically a securities analyst, Hilton was quite conversant with the important aspects of securities management. Throughout the period here involved, the Board of Directors of Funds consisted of nine persons. The non-affiliated directors were nominated by Hilton or his friends.
In 1945, Hovey, who was also experienced in selling mutual fund shares, joined Slayton Inc. After Hilton and Hovey organized Funds, Slayton Inc. became the exclusive sales organization or 'underwriter' and investment adviser for Funds. Associates succeeded Slayton Inc. as investment adviser on August 15, 1952, when a 'Funds Management Agreement' ('Agreement') was executed by Funds and Associates and was approved by the stockholders of Funds. Like the earlier management agreement between Funds and Slayton Inc., it was for a period of two years, and was also subject to annual renewal by the directors. While it contained a termination provision, it was in fact renewed from year to year. Under the Agreement, which remained in effect throughout the period here pertinent, Associates agreed to furnish Funds, '* * * advisory, research and statistical services as required in accordance with the provisions of the Certificate of Incorporation and the investment policies adopted and declared by [39 Del.Ch. 590] its Board of Directors'. Associates was to be paid for its services one-half of one per cent per annum on the average of the daily net asset value of Funds.
At the time Funds and Associates executed the Agreement, Associates had one employee, Boll, who was a full-time security analyst. It also had a contract with one Jacob Baker of the Econometric Institute. Both of these men plus Hilton and Hovey received salaries from Associates, although
Hovey's contribution was apparently minimal.
It is necessary next to turn from St. Louis to New York to pick up another important actor in this drama. In April 1952, one Stephen Jaquith ('Jaquith') was employed by Model, a New York brokerage partnership, to manage an investment advisory department just being created. At that time Model had several partners and associates but Jaquith was not made a partner. Model specialized in European securities and had a limited contact with so-called American securities. It did, however, advise several substantial American accounts.
Jaquith had a fine academic record and a reputation as a brilliant securities analyst. He had been in business for himself as an investment counselor and had rendered advice, inter alia, to an investment adviser to a mutual fund. Because of a change of management he lost that position. When he joined Model he registered with the New York Stock Exchange as a salesman and representative. He was to be paid a salary and bonus by Model, plus a commission of 40% of each brokerage fee he produced.
In the fall of 1953, Hilton approached Jaquith about rendering certain services to Associates. After some conferences, Hilton and Jaquith reached an understanding. One James Stubbs, a Dayton attorney, who was a director of Funds and who represented the Slayton companies, drew the contract. Associates entered into the contract with Jaquith, in his individual capacity. Hovey came to know of the agreement in 1954.
The contract, dated December 1, 1953, was to have considerable future significance. Under it Associates employed Jaquith 'as an Investment Counselor and Manager of the Securities Portfolios' of [39 Del.Ch. 591] Funds, for which Associates then acted as investment manager. Under its provisions, Jaquith, 'under the general direction and approval of the Company [Associates], [was to] use his best judgment in the selection, purchase, and sale of said securities, under the general policy of the Company [Associates], as it may be determined from time to time'. The agreement provided further that 'In payment of the services so rendered, Company [Associates] will direct brokerage commission business to Stephen M. Jaquith, or to such person, persons or firms, as he may designate in writing * * *' for a five year period in a total minimum amount of $250,000 at a $50,000 per year minimum. There was also a provision for an additional five year period. It was provided that should conditions not reasonably warrant the payments in the first five year period, they would be in effect added to the second five year commitment.
I find as a fact that Jaquith did not disclose the existence of the December 1, agreement to any of the Model partners. He did tell them that he was about to obtain, as a new customer, a St. Louis mutual fund with a $20 million dollar portfolio. He stated further that he hoped to receive substantial amounts of brokerage business.
Nor did Jaquith advise the Model partners of what I shall euphemistically call a 'loan' which, I find, he caused his wife, to make to Hilton about that time, at Hilton's instance. He also failed to advise them that in 1955, at Hilton's 'suggestion', he caused his wife to make a $42,500 investment in a company organized by Hilton to purchase a parcel of real estate to be used for the erection of a building to be leased to Funds and the Slayton companies. I further find that the Jaquith contract was not disclosed to the non-affiliated directors of Funds.
At first, Jaquith's function was largely confined to making general recommendations of securities he considered attractive. In February 1954, Hilton asked Jacquith to make some specific recommendations concerning stocks, the amounts thereof, purchase prices and the portfolios for which they should be purchased. The board of
Funds expressed its appreciation for Jaquith's services in April 1954.
On June 12, 1954, Mr. Boll terminated his connection with Associates. The contact with the Econometric Institute also was terminated. [39 Del.Ch. 592] Thus, Associates had no employees except the Slaytons. Up to that date I am satisfied that Jaquith was not buying or selling for Funds or rendering to Funds any substantial amount of the services for which Associates was being paid by Funds.
After June 12, 1954, there occurred a substantial change in the relationship between Associates and Jaquith. Hilton gave Jaquith specific instructions as to the allocation of Funds' brokerage business among several brokerage houses. Under Hilton's instructions, 30% to Spencer Trask, 30% to Model, 15% to Bacon Stevenson & Co., 10% to Seligman, Lubetkin, and 15% to miscellaneous firms. The business directed to Spencer Trask was, pursuant to Hilton's instructions to Jaquith, credited to Harold W. Smith, who maintained a small office for Spencer Trask in Manchester, N. H. Smith was a brother-in-law of Hovey Slayton. Pursuant to Hilton's request, Jaquith placed orders with the other brokers by phone but apparently the Model partners were not aware of this practice.
At about this same time Jaquith acquired a direct line from his room at Model to its order room. Model began rendering daily telegraph confirmations of purchases and sales of securities on orders placed by Jaquith with Model for Funds. Funds' custodian authorized its New York correspondent to accept delivery and pay Model direct in New York City.
After June 1954, Jaquith and Hilton had innumerable phone conversations with respect to all facets of the investment world, but particularly concerning stock in different businesses and those which might be bought or sold by Funds. The parties are in dispute as to whether, during the period from June 1954 to 1959, Jaquith only recommended purchases and sales or whether he actually bought and sold without prior approval to any substantial degree. Preliminarily, it seems clear tht Hilton as the president of Funds obviously had a continuing responsibility with respect to the purchase and sale of stock for it. He will not be permitted to deny that such discussions were in connection with the discharge of his responsibilities as president of Funds. Model also knew he was president of Funds.
The bulk of the investment transactions over these years (1954-1959) arose from selling programs designed to realize capital gains [39 Del.Ch. 593] and from reinvesting programs. Jaquith was told by Hilton how much money was needed to meet the required distribution of capital gains in each class of shares. Jaquith then, I find, selected a list of securities for possible sale and, sometimes at least, discussed them with Hilton. The same procedure was followed in connection with reinvestments. However, I find that Jaquith bought and sold for Funds generally without specific prior approval from Hilton as to particular securities. Jaquith testified that he could not recall that he had not discussed such securities at some previous time with Hilton. This may have been so but it does not alter the fact that the buying and selling was done without specific prior approval, and was done pursuant to a grant of such power in fact from Hilton after June 12, 1954, although Associates itself did not have such power under its management Agreement with Funds.
In July 1954, Slayton asked Jaquith whether Model would be interested in hiring Harold W. Smith, Hovey's brother-in-law, as a registered representative. Jaquith understood that Model would get the Funds' business then going to Spencer Trask if satisfactory arrangements could be made. Model employed Smith to get the additional business and not because of any particular concern about Smith's attainments or abilities. When Smith was hired it was also agreed between Jaquith and Model that Jaquith would receive a 10%
override on the commissions credited to Smith, provided Smith produced commissions of $50,000 a year. This was justified on the basis that Jaquith was servicing the work which created the Smith commissions.
Also, in the latter half of 1954, Jaquith reviewed with a Model partner his relationship with the firm. Even at this early date the Funds' work had become more than Jaquith could handle. Model agreed to hire and pay for a full-time research assistant, provided Jaquith obtained from Funds gross commissions of at least $100,000 a year. Jaquith's commissions were raised from 40% to 50% of the Funds' business provided it reached $100,000 a year.
In the spring of 1955, Hilton asked Jaquith whether Model would consider hiring auttorney Stubbs, heretofore mentioned, as a registered representative. Because of his physical condition Stubbs had [39 Del.Ch. 594] gone to Florida to live. It was made clear by Hilton that $50,000 to $60,000 of additional Funds' brokerage business would go to Model if it hired Stubbs. Stubbs was employed by Model on an agreed commission in order that Model could get the additional business. Jaquith also got a 10% override on this business.
As the business grew Model increased its staff assigned to Funds' work until in 1958 it had five other analyists and four secretaries working full time on Funds' portfolio. Some of the expense was shared by Jaquith. Brokerage commissions for the period 1953-1959 were over $2,300,000 of which Model received $1,940,806.72.
Most of the important facts here stated were developed in the S. E. C. investigation of 1959, which was concerned with the issue as to whether the effectiveness of a Funds' registration statement should be suspended  . Model was not a party to that proceeding.
Jurisdiction, which is unchallenged, is based on general equitable principles and the Investment Company Act.
Preliminarily, while Hilton, Hovey and Associates (collectively called 'Slayton defendants') appeared in this action and denied liability, they did not participate in the trial either personally or through counsel. It would appear that the Slayton defendants are largely if not wholly without assets. However, I must resolve the various issues involving their liability because they are urged by plaintiffs and also because they involve, in part, ...