Commercial Litigation and Arbitration

Derivative Actions — Massachusetts Business Trusts — Applicable Law (Substantive (Mass.) vs.Procedural (Forum) — Dismissal Based on Special Litigation Committee Investigation

Rotz v. Van Kampen Asset Mgmt., 2014 N.Y. Misc. LEXIS 4663 (Sup. Ct. N.Y. Cnty. Oct. 22, 2014):

In these shareholder derivative suits, plaintiffs allege that certain officers of the nominal defendant trusts and the trusts' former investment advisers breached their fiduciary duties and wasted corporate assets by causing the trusts to redeem auction rate preferred securities ("ARPS") at their liquidation value, at a time when the market valued the shares at a lower rate. Plaintiffs further allege that Morgan Stanley, the parent company of the former investment advisers, aided and abetted the breaches. Plaintiffs seek a declaration against defendants as to liability, a permanent injunction preventing the trusts from redeeming ARPS at liquidation value, and unspecified monetary damages. The nominal defendants in Rotz move to dismiss the amended complaint in its entirety [*2]  based on documentary evidence and for failure to state a claim, pursuant to CPLR 3211 (a) (1) and (7). The nominal defendants in Curbow move to dismiss the amended complaint in its entirety based on documentary evidence, pursuant to CPLR 3211 (a) (1).1

1   The two captioned actions were previously joined for purposes of resolving discovery motions, but were never consolidated. (Curbow Family LLC v Morgan Stanley Investment Advisors, 36 Misc 3d 889, 891 [Sup Ct, New York County 2012]. On the court's own motion, these actions are consolidated solely for the purpose of resolving the two pending motions to dismiss.

The Rotz Action

Plaintiffs are shareholders in five investment funds organized as business trusts under Massachusetts law: Invesco Van Kampen Advantage Municipal Income Trust II ("Advantage Municipal Income Trust II"), Invesco Van Kampen Municipal Opportunity Trust ("Municipal Opportunity Trust"), Invesco Van Kampen Municipal Trust ("Municipal Trust"), Invesco Van Kampen High Income Trust II ("High Income Trust II"), and Invesco Van Kampen Senior Income Trust ("Senior Income Trust") (collectively, "Trusts").2 Defendant Van Kampen Asset Management ("Adviser") is the former investment adviser to the Trusts, and Morgan Stanley was the parent of the Adviser. (Rotz FAC, ¶¶ 29, 54.) The individual defendants were officers of the [*3]  Trusts and/or portfolio managers associated with the Adviser. (Id., ¶¶ 30-52.) The officers, together with the Adviser, "controlled the business affairs of the Trusts." (Id., ¶ 2.)

2   Specifically, plaintiff Clifford T. Rotz is a shareholder of nominal defendant Advantage Municipal Income Trust II; Robert Fast of Municipal Opportunity Trust; Gene Turban of Municipal Trust; Leon McDermott of High Income Trust II; and Marilyn Morrison, Harry Suleski and John Johnson of Senior Income Trust. (Rotz First Amended Complaint [Rotz FAC], ¶¶ 17-23.)

The Trusts are closed-end funds, and as of late 2007 or early 2008, had issued approximately 1.8 billion dollars' worth of auction rate preferred shares with a liquidation value of $25,000 per share. (Rotz FAC, ¶¶ 61-66.) The ARPS were auction rate securities and paid variable interest  [**2]  rates that were reset periodically through auctions conducted by broker-dealers.3 Such "Dutch" auctions were also the platform through which the ARPS were bought and sold. (Rotz FAC, ¶¶ 66-67.) The liquidity of the ARPS was dependent on the outcome of the Dutch auctions:

3   The parties use the term auction rate preferred securities (ARPS) and auction preferred securities (APS) [*4]  interchangeably.

"In a successful Dutch action, bidders offer to buy a specific number of APS at the lowest dividend rate they would accept for purchasing those APS at their liquidation value. . . . Holders of APS have three options: (1) the holder may issue a Hold order, which means the holder would remove the APS from the auction regardless of the new dividend rate; (2) the holder may issue a Bid or Hold at Rate order, which means the holder would sell his APS if an acceptable rate was met; or (3) the holder may issue a Sell order, which means the APS would be sold to a bidder regardless of the new dividend rate, assuming the auction does not fail. The broker/dealer running the auction matches the bids and offers, and the periodic dividend rate on the APS is then reset to the lowest bid rate at which all of the shares offered for sale can be sold at liquidation value.

In a failed auction there are insufficient bids to purchase all the shares offered by sellers. In the event of a failed auction, the prospectuses and terms of the APS provide for the dividend rate to be reset to a preset maximum rate in order to compensate APS holders who were not able to sell."

(Id., ¶¶ 67-68.)

In or about [*5]  February 2008, "the auction market for APS dried up . . . causing APS to become unsellable." (Rotz FAC, ¶ 77.) Plaintiffs allege that, due to the restricted liquidity, "certain broker-dealers and other companies" valued "certain" auction rate securities at below their stated liquidation value. (Id., ¶ 78.) The Trusts, however, did not value their ARPS at less than liquidation value and began redeeming the ARPS at liquidation value in April 2008. (Id., ¶¶ 83-84.) The Trusts, with the approval of their boards, used tender option bonds (TOBs)4 or debt financing to redeem the ARPS. (Id., ¶ 92.) Plaintiffs allege that TOBs and debt financing increased the costs and the risks to the Trusts without concomitant benefit. (Id., ¶ 94.) Specifically, TOBs forced the Trusts to sell lower grade bonds into a distressed market and to hold municipal bonds, which paid a lower interest rate and prevented the Trusts from making other investments which would have been more profitable. (Id., ¶ 94.) TOBs also required the Trusts to post more assets to satisfy the debt coverage ratio than the ARPS did and cost additional fees. (Id., ¶¶ 97, 99.) Plaintiffs allege that the Trusts could have marked the ARPS down [*6]  below their liquidation value and redeemed them at market value at much lower cost to investors. (Id., ¶ 5.)

4   The Trusts created TOBs by depositing municipal bonds owned by the Trusts with broker-dealers, who would issue a new security collateralized by the deposited bonds. Once deposited, the Trusts retained a security interest and received cash flows from the investment, less payment of interest on the floaters and TOB-related fees. (Rotz FAC, ¶ 93.)

In the first cause of action, plaintiffs contend that the Adviser and the individual defendants gave priority to their own interests in determining to redeem the ARPS at liquidation value and, thus, breached their fiduciary duties to the common shareholders. Plaintiffs allege that the redemption of the ARPS at liquidation value benefited ARPS holders -- largely institutional investors and high net worth individuals, and broker-dealers -- and that the Adviser and the individual defendants sought to preserve their business relationships with those investors to the detriment of the shareholders of the Trusts. (Id., ¶¶ 103-104, 107.) Further, the redemptions at liquidation value benefited the Adviser and its affiliates directly as it acted to [*7]  limit liability of any "Morgan Stanley-affiliated broker-dealers for potential claims of APS holders arising out of the broker-dealers' misrepresentations," and enabled the Adviser and its affiliates to avoid recognizing large losses on their own holdings of ARPS. (Id., ¶¶ 109-111.) In the second cause of action, plaintiffs allege that the Adviser and the individual defendants wasted corporate assets by redeeming the ARPS at liquidation value as opposed to the then-market value. (Id., ¶ 137.) In the third cause of action, plaintiffs allege that defendant Morgan Stanley, as the parent of the Adviser, aided and abetted the breaches of fiduciary duty of the Adviser and the individual defendants. (Id., ¶¶ 143-144.)

In April 2010, plaintiffs sent letters to the Trusts demanding that the boards "take action" against the Adviser and the officers of the Trusts for alleged breaches of fiduciary duty, aiding and abetting of those breaches, and corporate waste described in the complaint. (Letters from Ps.' counsel to each of the Trusts, dated April 8, 2010 [Ex. A to Rotz FAC].) The Trusts responded that they were investigating the allegations and "intend[ed] to conclude their investigation before considering [*8]  whether additional action [was] necessary." (Letter from Ds.' Counsel to Ps.' counsel, dated May 12, 2010 [Ex. B to Rotz FAC].) Plaintiffs commenced this action on July 22, 2010.

It is undisputed that on August 10, 2010, the boards of the Trusts established a special litigation committee ("Rotz SLC") comprised of independent trustees. (Curbow Family LLC, 36 Misc 3d at 892-893. See also Invesco Van Kampen Press Release, dated June 24, 2011 at 1 [Ex. C to Kennedy Aff. in Supp.].) The SLC and its independent outside counsel issued a 162-page report with two volumes of exhibits, recommending that the demands be rejected and that the Trusts move to dismiss the pending lawsuit.5 (Curbow Family, LLC, 36 Misc 3d at 892-893; Press Release at 1.) The independent trustees for each of the Trusts unanimously adopted the SLC's recommendation. (Press Release at 1.)

5   Although this Court denied plaintiffs' request for additional discovery, the Rotz plaintiffs were provided with the SLC report and the exhibits, and the Curbow plaintiffs were provided with the SLC report, five volumes of exhibits, and " all the documents'" collected and received by the Curbow SLC. (Curbow Family LLC, 36 Misc 3d at 892-893, 897.)

The Curbow Action

Plaintiffs are shareholders of two investment funds organized as business trusts under Massachusetts law: Invesco Insured Municipal Income Trust and Invesco [*9]  Municipal Premium  [**3]  Income Trust (collectively "Curbow Trusts").6 Defendant Morgan Stanley Investment Advisors Inc. ("Curbow Adviser") is the former investment adviser to the Curbow Trusts, and Morgan Stanley was the parent of the Adviser. (Curbow FAC, ¶¶ 19, 33.) The individual defendants were officers of the Trusts and/or portfolio managers associated with the Adviser. (Id., ¶¶ 20-31.) As in Rotz, the officers, together with the Adviser, "controlled the business affairs of the Trusts." (Id., ¶ 2.)

6   Specifically, plaintiff Curbow Family LLC is a shareholder in Invesco Insured Municipal Income Trust, and plaintiff Elsie Mae Melms Revocable Living Trust is a shareholder in Invesco Municipal Premium Income Trust. (Curbow First Amended Complaint [Curbow FAC], ¶¶ 15-16.)

As in the Rotz action, the Curbow Trusts are closed-end funds, and as of late 2007 or early 2008, each had issued over one hundred million dollars' worth of ARPS with a liquidation value of $50,000 or $100,000 per share. (Curbow FAC, ¶¶ 40-42.) As in Rotz, the ARPS were auction rate securities and paid variable interest rates that were reset periodically through Dutch auctions conducted by broker-dealers. (Id., ¶ 42.) The  [*10] Curbow FAC contains a description of the Dutch auction process, including the effect of a failed auction on liquidity, which is virtually identical to that set forth above. (Id., ¶¶ 43-44.)

Like the Rotz plaintiffs, the Curbow plaintiffs allege that in or about February 2008, the auction market for ARPS "dried up," and the ARPS became unsellable. (Curbow FAC, ¶ 50.) The Curbow plaintiffs also allege that a secondary market formed for auction rate securities trading for less than liquidation value. (Id., ¶ 51.) The Curbow Trusts did not reduce the value of their ARPS and began redeeming the ARPS at liquidation value in July 2008. (Id., ¶¶ 56-57.) As in Rotz, the Curbow Trusts, with the approval of their boards, used TOBs to redeem the ARPS. (Id., ¶ 62.) The Curbow plaintiffs make the same allegations as in Rotz with respect to the costs and risks of TOBs. (Id., ¶¶ 63-64, 66-67.) Finally, the Curbow plaintiffs make the same allegations as in Rotz with respect to breaches of fiduciary duty and waste by the Adviser and the individual defendants, and aiding and abetting of the breaches by Morgan Stanley. (Id., ¶¶ 84-87, 99-100, 103, 106, 110-113.) The Curbow plaintiffs assert the same three [*11]  causes of action for breach of fiduciary duty (first cause of action), waste (second cause of action), and aiding and abetting (third cause of action) as the Rotz plaintiffs.7 (Id., ¶¶ 105-114.)

7   Unlike the Rotz plaintiffs, however, the Curbow plaintiffs do not seek to permanently enjoin the Curbow Trusts from redeeming ARPS at liquidation value. (Curbow FAC at 37.)

In April 2010, plaintiffs sent demand letters to the Curbow Trusts virtually identical to those sent to the Rotz Trusts. (Letters from Curbow Ps.' counsel to each of the Curbow Trusts, dated April 8, 2010 [Ex. A to Curbow FAC].) The Curbow Trusts responded that they had already begun an investigation of the allegations and requested that plaintiffs "refrain" from bringing suit until the investigation was complete. (Letter from Curbow Ds.' Counsel to Curbow Ps.' counsel, dated June 30, 2010 [Ex. B to Curbow FAC].) Plaintiff Elsie Mae Melms Revocable Living Trust commenced a derivative action on August 3, 2010, and the current amended complaint was filed on January 17, 2011. (Curbow Ds.' Memo. In Supp. at 8 n 7.)

It is undisputed that on June 24, 2010, the boards of the Curbow Trusts established a special litigation committee ("Curbow SLC") comprised of independent [*12]  trustees. (Curbow Family LLC[**4]  36 Misc 3d at 892. See also Invesco Press Release, dated July 12, 2011 at 1 [Ex. C to Dutill Aff. in Supp.].) The SLC and its independent outside counsel issued a 377-page report with five volumes of exhibits, recommending that the demands be rejected and that the Trusts move to dismiss the pending lawsuit. (Curbow Family, LLC, 36 Misc 3d at 892; Invesco Press Release at 1.) The independent trustees for each of the Trusts unanimously adopted the SLC's recommendation. (Invesco Press Release at 1.)

Applicable Law

This Court (Fried, J.) previously held, and the parties agree, that the Massachusetts Business Corporations Act ("MBCA") governs the substantive legal issues, as the Trusts are organized under Massachusetts law. (Curbow Family, LLC, 36 Misc 3d at 893; Rotz Ds.' Memo. In Supp. at 8; Rotz Ps.' Memo. In Opp. at 6; Curbow Ds.' Memo. In Supp. at 13; Curbow Ps.' Memo. In Opp. at 6. See also Greenspun v Lindley, 36 NY2d 473, 477 [1975] [holding that Massachusetts law applied where investment trust at issue was "organized and existing under the laws of Massachusetts" and the trust declaration provided that Massachusetts law applied "as to the rights of all parties," including shareholders].)

Massachusetts Dismissal Standard: The Business Judgment Rule

Under Massachusetts law, shareholder derivative actions are governed by the MBCA. (Halebian v Berv, 457 Mass 620, 623 [Mass 2010].) Section 7.44 of this statute, which codifies the business [*13]  judgment rule, "protects a corporation's decision that prosecution of the claim demanded by the shareholder is not in the best interests of the corporation where the decision is made in good faith by independent decision makers after reasonable inquiry." (Id. at 627 n 11; see also Introductory Cmt. to "Derivative Proceedings," MBCA § 7.40, et seq. [stating that MBCA "[s]ection 7.44 expressly requires the dismissal of a derivative suit if independent directors or shareholders have determined that the maintenance of the suit is not in the best interests of the corporation. This section confirms the basic principle that a derivative suit is an action on behalf of the corporation and therefore should be controlled by those directors who can exercise independent business judgment with respect to its continuance"]; Pinchuk v State Street Corp., 2011 WL 477315, *14 [Mass Super Ct, Jan. 19, 2011, No. 09-2930] [holding that majority independent board's determination to reject a demand is entitled to presumption of validity under business judgment rule] [internal quotation marks and citation omitted].)

Section 7.44 (a) (1) provides, in relevant part, that a "derivative proceeding commenced after rejection of a demand shall be dismissed by the court on motion by the corporation if the court finds" [*14]  that a majority vote of independent directors "has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation."8 Defendants seeking to  [**5]  dismiss must submit a written filing stating "whether a majority of the board of directors was independent at the time of the determination by the independent directors," and that "the independent directors made the determination in good faith after conducting a reasonable inquiry upon which their conclusions are based."9 (§ 7.44 [d].) "[T]he court shall dismiss the suit unless the plaintiff has alleged with particularity facts rebutting the corporation's filing in its complaint or an amended complaint or in a written filing with the court." (§ 7.44 [d]. See also § 7.44 Cmt. 3 ["The court is to accept this information [provided in the corporation's filing] unless it is rebutted with particularity by the plaintiff"].) If a majority of the board was independent at the time the determination was made, the plaintiff bears the burden of proving that the directors did not reach their determination in good faith after conducting a reasonable inquiry. [*15]  (§ 7.44 [e].)

8   Although the term "corporation" is used in the statute, it applies with equal force to business trusts under Massachusetts law. (See Halebian v Berv, 457 Mass at 623 n 4 [Mass 2010].) The relevant provisions of section 7.44 state in full:

"(a) A derivative proceeding commenced after rejection of a demand shall be dismissed by the court on motion by the corporation if the court finds that either: (1) 1 of the groups specified in subsections (b)(1) or (f) has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation; or (2) shareholders specified in subsection (b)(3) have determined that the maintenance of the derivative proceeding is not in the best interests of the corporation.

(b) Unless a panel is appointed pursuant to subsection (f), the determination in subsection (a) shall be made by:

(1) a majority vote of independent directors present at a meeting of the board of directors if the independent directors constitute a quorum . . . .

* * *

(d) If the corporation moves to dismiss the derivative suit, it shall make a written filing with the court setting forth facts to show (1) whether a majority of the board of directors was independent at the time of the determination [*16]  by the independent directors and (2) that the independent directors made the determination in good faith after conducting a reasonable inquiry upon which their conclusions are based. Unless otherwise required by subsection (a), the court shall dismiss the suit unless the plaintiff has alleged with particularity facts rebutting the corporation's filing in its complaint or an amended complaint or in a written filing with the court. All discovery proceedings shall be stayed upon the filing by the corporation of the motion to dismiss and the filing required by this subsection until the notice of entry of the order ruling on the motion; but the court, on motion and after a hearing and for good cause shown, may order that specified discovery be conducted. . . ."

9   The purpose of the distinction between interested and disinterested directors is to ensure that the directors voting on a plaintiff's demand can exercise their business judgment in the best interests of the corporation, free from significant contrary personal interests and apart from the domination and control of those who are alleged to have participated in wrongdoing." (Harhen v Brown, 431 Mass 838, 843 [Mass 2000].)

Plaintiffs acknowledge that section 7.44 of the Massachusetts statute governs the issue [*17]  of whether the boards' determinations that these derivative actions are not in the best interests of the trusts were made in good faith after conducting a reasonable inquiry. At the oral argument, plaintiffs contended that the procedural law of New York governs the parties' burdens on these motions to dismiss, and plaintiffs further appeared to assert that the burden shifting provisions of section 7.44 do not apply. (See OA Tr. at 44-45.)

The court agrees that New York procedural law applies. (See Lerner v Prince, 119 AD3d 122, 127-128 [1st Dept 2014].) Thus, defendants have the ultimate burden of demonstrating on these motions that they are entitled to dismissal. However, the Massachusetts statute, which the court must apply, mandates substantive standards for evaluating whether the boards' determinations were properly made, and the parties' burdens on this issue are defined by Massachusetts law: Once the proponent of dismissal makes a prima facie showing of the trustees' independence, the burden shifts to the plaintiffs to make a particularized showing that the determination not to proceed with a derivative action was not made in good faith after conducting a reasonable inquiry.

Courts applying Massachusetts law have effectively treated this burden [*18]  shifting as a substantive aspect of the statute. (See Operative Plasterers' and Cement Masons' Local Union Officers' and Empls.' Pension Fund, 2013 WL 5442366, *5 [D Mass, Sept. 30, 2013, No. 12-10767-GAO] [holding that as "defendants have sufficiently shown, prima facie, that the voting directors who rejected the plaintiff's demand were independent within the meaning of § 7.44 . . . [,] it falls to the plaintiff to rebut that showing. . . ."]; Wiener v Eaton Vance Distrib., Inc., 2011 WL 1233131, *4-5 [D Mass, March 30, 2011, No. 10-10515-DPW] [holding that "[s]tate substantive law applies to the question whether a complaint alleges facts with sufficient particularity to comply with [Federal] Rule 23.1 and provides the level of deference given to a decision by the nominal defendant to terminate a derivative action," and finding that section 7.44, in particular, is a substantive provision]; see also Halebian v Berv, 644 F3d 122, 131-133 [2d Cir 2011] [holding that the section 7.44 burden-shifting provision governed the court's determination as to whether the derivative action should be dismissed, but ordering conversion  [**6]  of a motion to dismiss to a motion for summary judgment].)

Section 7.47, the choice of law provision of the MCBA, is further indication that Massachusetts treats section 7.44 as substantive law. Section 7.47 provides that, in any derivative proceeding involving a foreign corporation, "the matters covered by this subdivision shall be governed by the laws of the [*19]  jurisdiction of incorporation of the foreign corporation except for section 7.43, 7.45 and 7.46." As the comment to this section notes, under "prevailing practice" the place of incorporation governs substantive issues. By providing that only sections 7.43, 7.45, and 7.46 apply to foreign corporations, the statute is implicitly treating those sections as procedural. In contrast, the burden-shifting provision of section 7.44 is substantive. The court accordingly holds that it must apply this provision in determining the motions to dismiss.

The Massachusetts statute also expressly requires the court to consider evidence in determining whether a derivative action should be dismissed and specifies the evidence to be considered -- namely, the Trusts' written filing in support of the motion and plaintiffs' pleading or written filing in rebuttal. (§ 7.44 [d].) The court holds that this aspect of section 7.44 is also substantive. The court will therefore consider the evidence specified in the statute, notwithstanding that it may not qualify as the type of documentary evidence that would ordinarily be considered on a 3211 (a) (1) motion to dismiss. (See Leon v Martinez, 84 NY2d 83, 88 [1994].)10

10   In a decision and order dated July 18, 2012, this Court (Fried, J.) denied motions by plaintiffs for discovery prior [*20]  to hearing of these motions to dismiss which had been held in abeyance pending determination of the motions for discovery. (Curbow Family LLC, 36 Misc 3d at 897.) The Court reasoned that section 7.44 is a substantive statute, that the discovery component should be applied in this forum, and that section 7.44 " establish[es] a norm that the motion to dismiss is to be decided without discovery, with a narrow exception for unusual cases.'" (Id. at 894-895 [quoting Pinchuck v Logue, slip op at 1-2 [Mass Sup Ct, Dec. 9, 2009, No. 09-2930-BLS2].) The Court concluded that plaintiffs failed to show good cause for discovery. In addition, the Court declined to convert the motions to dismiss to motions for summary judgment. (Id. at 891 n 1.)

Discussion

All defendants contend that, because the trustees were independent and conducted an investigation through the SLCs, the decision not to prosecute this action is protected by the business judgment rule, and the mandatory language of Section 7.44 compels dismissal of this action. (Rotz Ds.' Memo. In Supp. at 10-12; Curbow Ds.' Memo. In Supp. at 18-22.) Plaintiffs do not dispute that the trustees were independent. (OA Tr. 42-43.) As this Court previously noted in the Rotz action, no trustee is even named as a defendant. (Curbow Family, LLC, 36 Misc 3d at 895.) Instead, plaintiffs contend that the SLCs' investigations and reports, upon which the determination [*21]  not to proceed with litigation was indisputably based, were not undertaken in good faith after a reasonable inquiry "because the evidence overwhelmingly disproves the SLC's conclusions." (Rotz Ps.' Memo. In Opp. at 7. See also Curbow Ps.' Memo. In Opp. at 8 ["The SLC's conclusion is contrary to the weight of the evidence and cannot be the product of a reasonable, good-faith investigation"].)

Plaintiffs allege that the Advisers and the individual defendants -- officers of the Trusts and portfolio managers -- suffered from impermissible conflicts of interest. Specifically, plaintiffs contend that the sale of ARPS at liquidation value (1) financially benefited other clients, who were larger and of greater value to the Adviser and the individual defendants, (2) relieved  [**7]  broker-dealers affiliated with Morgan Stanley from potential liability for misrepresenting the liquidity of the ARPS to purchasers, (3) insured that broker-dealers affiliated with Morgan Stanley would not have to write down the value of their own ARPS holdings, (4) prevented the Advisers from having to refund any fees received, and (5) shielded the ARPS from inclusion in settlements between Morgan Stanley and regulatory agencies that would [*22]  have required Morgan Stanley to purchase the ARPS. (Rotz Ps.' Memo. In Opp. at 8-10, 12-14; Curbow Ps.' Memo. In Opp. at 7-12.)

As noted above, it is undisputed that a majority of the trustees of the boards, which appointed the SLCs and voted to approve their reports, were independent, and that the members of the SLCs were also independent. Under MBCA section 7.44 plaintiffs can therefore prevail only if they can show with particularity that the trustees did not reject plaintiffs' demands to pursue this litigation in good faith after conducting a reasonable inquiry.

Good Faith

As to good faith, plaintiffs do not allege that any of the independent trustees, who approved the redemptions, had a conflict of interest, benefitted personally from the transactions, or otherwise acted in bad faith. Nothing in either of the complaints or the opposition papers submitted by plaintiffs supports a reasonable inference that the independent trustees had any motivation or reason to make decisions contrary to the shareholders' best interests. The allegations of conflicts of interest are limited to those on the part of the Advisers to the Trusts. (Rotz Aff. in Opp. of Jai K. Chandrasekhar, ¶ 16; Curbow Aff. in Opp. of Jai K. Chandrasekhar, ¶ 15.) The [*23]  court accordingly turns to the reasonableness of the inquiries.

 

The Rotz Inquiry

In response to plaintiffs' complaint, defendants submitted the SLC report and the affidavit of Craig Kennedy, who is an independent trustee for the Trusts and who chaired the SLC. Each of the Trusts has an eleven-member board of trustees. All of the trustees were independent at the time the decision to redeem the ARPS at liquidation value was made. (Kennedy Aff., ¶¶ 14-15.) The trustees formed the SLC on August 10, 2010, after the demand letters were received, and the SLC hired outside, independent counsel, Stroock & Stroock & Lavan LLP ("Stroock"), to assist in conducting the investigation. (Id., ¶ 16.) During the investigation, Stroock interviewed eight current and former employees of the Adviser, including portfolio managers as well as the treasurer and chief financial officer and the president and principal executive officer of the Van Kampen fund family. (Id., ¶ 17.) For the interviews Stroock selected employees of the Adviser "who regularly presented to the Board, portfolio managers with responsibility for the management of the [Trusts], and personnel with responsibility for certain key functions in [*24]  addition to portfolio management." (Rotz SLC Report [Ex. A to Kennedy Aff.] at 16.) In addition, Stroock interviewed the trustees, who were not members of the SLC, and conducted an "informal discussion" with the counsel to the board. (Id.; Kennedy Aff., ¶ 17.) The SLC demanded production of and received relevant documents from the Adviser and the Funds and reviewed approximately 200,000 pages of relevant documents, including "e-mails, presentations regarding developments in the [auction rate preferred securities] market, research into options for redeeming ARPS and alternate forms of leverage, and board minutes." (Rotz SLC Report at 15; Kennedy Aff., ¶ 18.) The SLC also received an expert report from Morgan Stanley's expert, Christopher L. Culp, analyzing plaintiffs' claims. (Kennedy Aff., ¶ 20.) As counsel to the SLC, Stroock expended more than 3000 hours "reviewing documents and materials, preparing for and participating in the interviews . . . and in drafting this Report." (Rotz SLC Report at 19.)

At the conclusion of the investigation, the SLC with the assistance of Stroock wrote a 162-page report concluding that it was not in the best interest of the Trusts to pursue litigation [*25]  and recommending that the Trusts seek dismissal of the current suit. (Kennedy Aff., ¶¶ 25, 28.) After the SLC report was circulated and Stroock gave the SLC "a detailed presentation about [p]laintiffs' allegations and the findings as to each allegation," the SLC met and "unanimously concluded that maintaining this suit would be expensive, burdensome, distracting, unlikely to succeed, and not in the best interests of the [Trusts]." (Id., ¶ 24.) The SLC presented its findings and recommendations to the boards of the Trusts, who also received a copy of the SLC report. (Id., ¶ 26-27.) The independent trustees, who constituted a quorum of the boards, unanimously affirmed the SLC's recommendation and determined to seek to dismiss this suit. (Id., ¶ 28.)

The Curbow Inquiry

In response to plaintiffs' complaint, defendants submitted the affidavit of Bruce L. Crockett, who is an independent trustee and chairman of the board for the Curbow Trusts, as well as the SLC report and exhibits. On June 24, 2010 and after the demand letters were received, the trustees unanimously voted to form the SLC, composed of four independent trustees who joined the boards after the decision to redeem the ARPS was made. (Curbow [*26]  SLC Report at 2, 35-39 [Ex. B to Dutill Aff.].) The SLC hired outside, independent counsel, Gregory P. Joseph Law Offices LLC, to assist in conducting the investigation. (Id. at 62-63.) During the investigation, the SLC interviewed each of the individual defendants, all Trust officers and portfolio managers of the Curbow Trusts. (Id. at 21-30.) In addition, the SLC interviewed other officers and portfolio managers named in the demand letters, but not in the suit, and all but one of the current trustees. (Id., at 33-34.)

The SLC demanded production of and received relevant documents from defendants and, with outside counsel, reviewed approximately 187,760 pages of relevant documents, including the Trusts' annual reports, common share prospectuses, meeting minutes, "emails, analyses, [ARPS] redemption and TOBs transaction details, regulatory investigations and settlements," and public documents. (Curbow SLC Report at 64, 68-69.) In addition, the SLC retained additional independent financial experts. (Id. at 71-73.) The SLC also received Morgan Stanley's expert report and rebuttal report from Christopher L. Culp, analyzing plaintiffs' claims. (Id. at 77-78.) The SLC met 21 times during the investigation and reviewed materials on a rolling basis. [*27]  (Id. at 78.)

At the conclusion of the investigation, the SLC and its counsel wrote a 378-page report concluding that it was not in the best interest of the Trusts to pursue litigation and recommending that the Trusts seek dismissal of the current suit. (Curbow SLC Report at 377.) After the SLC issued its report and exhibits to the boards, the independent trustees, who constituted a quorum of the board, unanimously affirmed the SLC's recommendation and determined to seek to dismiss this suit. (Crockett Aff., ¶¶ 6, 11.)

The Massachusetts statute does not prescribe the scope or form of the inquiry that must be taken by a board in determining whether to refuse a demand to pursue litigation. Where independent boards have conducted comprehensive inquiries through special litigation committees with the assistance of outside counsel, such inquiries have been found reasonable within the meaning of  [**8]  section 7.44.11 In Averbach v Arch (2013 WL 5531396 [Mass Super Ct, Aug. 27, 2013, No. SUCV 201102502]), a shareholder derivative action involving claims substantially similar to those here, the plaintiff alleged that the trustees and Van Kampen Asset Management, the Adviser to the trust, breached their fiduciary duties to the common shareholders by redeeming [*28]  ARPS at liquidation value. In particular, the plaintiff claimed that the decisions to redeem the ARPS were made to preserve the business relationships that the Adviser and its Morgan Stanley affiliates had with ARPS holders and broker-dealers, and that the trustees were under pressure from Morgan Stanley, which would have had to acquire the ARPS pursuant to a settlement with the government, if the trustees had not redeemed them. (Id. at * 2-3.) The Court dismissed the action under the business judgment rule, holding that the trustees were independent and that a special litigation committee had undertaken a "fairly comprehensive inquiry." (Id. at * 4.) In making the latter finding, the Court noted that the committee "interviewed numerous witnesses, reviewed thousands of pages of documents, obtained expert reports, and met several times to discuss its investigation and findings. It provided a detailed account of the circumstances surrounding the redemptions and thoroughly explained why it believed litigation was not in the fund's best interest." (Id.; see also Operative Plasterers', 2013 WL 5442366 at * 6 [applying section 7.44 and holding that plaintiff failed to show inquiry was not in good faith and not reasonable where "the committee conducted interviews, reviewed [*29]  contracts, considered thousands of pages of documents, analyzed the investment portfolio, and investigated public disclosures" as well as "evaluated the legal theories that could possibly be pursued and the prospects of eventual recovery"]; Safier v Nuveen Asset Mgt., 2011 WL 7069082 at 2-3 [Ill Cir Ct, Dec. 16, 2011, Nos. 10CH32166, 10CH34793, 10CH40929, 11CH3078] [applying section 7.44 to Massachusetts Business Trusts and holding that plaintiffs did not demonstrate board acted unreasonably where board formed demand committee of independent directors, hired outside counsel, interviewed witnesses and reviewed documents over several months, drafted a 44-page report, and "directly addressed all issues raised by the [shareholder] Demands and stated why litigation would not be appropriate"].)

11   As a further indication of the deference to be afforded to investigations conducted by the corporations, Massachusetts law allows a court to "stay any derivative proceeding for a period as the court considers appropriate" once a corporation "commences an inquiry into the allegations made in the demand or complaint." (§ 7.43. See also § 7.46 [2] ["the court may . . . order the plaintiff to pay any defendant's reasonable expenses, including counsel fees, incurred in defending [*30]  the proceeding if it finds that the proceeding was commenced or maintained without reasonable cause or for an improper purpose."].)

Further, where a majority of independent trustees reject a plaintiff's demand to pursue derivative litigation based on the report of an independent SLC, the business judgment rule applies to the decisions of both the trustees and the SLCs. (See Harhen, 431 Mass at 847 [holding, under the Massachusetts common law business judgment rule which was codified in MBCA § 7.44, that "[w]hen a disinterested board refers a demand to a disinterested standing committee, both receive the protection of the business judgment rule"].) As the business judgment rule applies, the standard of review by this court is not whether the recommendations of the SLC and approvals by the boards were "reasonable and principled," but whether plaintiffs have presented particularized facts rebutting the trustees' showing that the determinations were not made in  [**9]  good faith after a reasonable inquiry. (MBCA § 7.44, Cmt. 2 [stating that the Act "reflects the rule established in Harhen," and that under section 7.44 the business judgment rule applies when a majority of the board is independent, with the burden of proof then upon the plaintiff; in contrast, [*31]  when a majority of the board is not independent, the "reasonable and principled review standard" applies] [internal quotation marks and citation omitted].) As recently explained by a Connecticut Court construing its statute governing dismissal of shareholder derivative actions which, like Massachusetts section 7.44, is based on ABA Model Business Corporation Act section 7.44, this provision "authorizes courts to conduct a limited inquiry into the process of the board's decision, but not to review the reasonableness of the board's determination to reject a demand or seek dismissal of a derivative action." (Sojitz Am. Capital Corp. v Kaufman, 141 Conn App 486, 492 n 4 [Conn App 2013] [emphasis in original].) In determining whether dismissal is mandated where a disinterested board determines not to pursue the litigation, the standard of review is whether " the [corporation's] inquiry and the conclusions follow logically,'" not the "propriety of the board's considerations." (Id. at 508-509 [quoting Official Comment to § 7.44 of the ABA Model Business Corporation Act] [emphasis in original].)

As the above review of the investigations undertaken by the SLCs for both the Rotz and Curbow Trusts indicates, the SLCs undertook thorough investigations of plaintiffs' claims. In the course of these investigations, both SLCs extensively considered plaintiffs' allegations.

The SLCs' [*32]  reports reveal both that the conflicts of interest of which the plaintiffs complain were known and considered at the time the decisions to redeem were made and were evaluated again and rejected at the time of the SLCs' inquiries. For example, the Rotz SLC report noted that in the interviews, Rotz Trustees stated that at the time of the redemption decisions "they were aware that the [Trusts'] obligations to [ARPS] holders were contractual and that, although the [Adviser] was under pressure from broker-dealers and the [Trusts'] ARPS holders, that was secondary to the fiduciary duty owed to the [Trusts'] common shareholders." (Rotz SLC Report at 41.) The report further stated: "The Trustees were resolute that the business ramifications of the frozen ARPS market were solely the [Adviser's] concern, and that any solution for the [Trusts'] ARPS holders would have to be in the interest of, or at least be neutral to the interests of, the [Trusts'] common shareholders." (Id. at 45, 153.) Similarly, the Curbow report stated that the Curbow trustees were informed, prior to making the determinations to redeem the ARPS, that many ARPS investors were "distressed over the loss of liquidity" and had complained [*33]  to their broker-dealers, and that Morgan Stanley had been sued by ARPS investors. (Curbow SLC Report at 283.) The report noted that "[n]ot only were these specific complaint and concerns [of the ARPS holders] communicated to the Boards, but the general benefits to Morgan Stanley entities as a result of the Challenged Redemptions also were disclosed." (Id. at 284.) After considering the impact of the ARPS' lack of liquidity on the Trusts, the SLC concluded that any "advantage [to the ARPS holders or Morgan Stanley entities] was disclosed to the Boards and was not unreasonably perceived as inuring directly to the benefit of the [Trusts] and their common shareholders. (Id. at 286.)

With respect to TOB financing, the SLC reports made extensive findings that the Rotz and Curbow trustees approved the periodic redemptions of the ARPS and the use of such financing only after thorough review of the costs and benefits to the common shareholders and the lack of viable alternatives. (Rotz SLC Report at 51-97; Curbow SLC Report at 119-152, 327-332.) Further, the SLCs concluded that the trustees stated legitimate business reasons to redeem the ARPS and to utilize TOB or debt financing, including an illiquid secondary market [*34]  for ARPS,  [**10]  cost savings, maintaining leverage, diversification of the Trusts' leverage sources, and avoiding other potential consequences from ARPS illiquidity. (Rotz SLC Report at 55-58; Curbow SLC Report at 107-109, 118.)

Both SLCs found that the redemption of ARPS and replacement with TOBs and debt financing did not harm common shareholders and were not undertaken to improperly benefit the Advisers and Morgan Stanley. (Rotz SLC Report at 97-109, 113-121, 148-153; Curbow SLC Report at 264-267, 273-282.) Both SLCs found that there was no developed secondary market on which to trade the ARPS and that the ARPS could not have been traded at below liquidation value. (Rotz SLC Report at 129-140; Curbow SLC Report at 287, 305-313.) The SLCs also found no support for the claim that the boards were influenced to adopt the alternate funding structure in order to yield additional fees for the Advisers or to protect the Advisers and/or Morgan Stanley from having to writing down the value of any ARPS they held. (Rotz SLC Report at 149-151, 154-157; Curbow SLC Report at 286-287.)

According to the SLC reports, both the Rotz and Curbow Advisers informed the trustees of Morgan Stanley's settlement [*35]  with regulatory authorities in August 2008 when it was announced, prior to the September 30, 2008 date on which Morgan Stanley would have the obligation to repurchase ARPS at par (liquidation) value. The impact of the settlement was again discussed with the trustees in 2009, at least in the case of the Rotz Trusts. (Rotz SLC Report at 64-66; Curbow SLC Report at 134-138, 294-304.) The Rotz report expressly discussed the trustees' awareness of the increased pressure to redeem the ARPS that would occur as a result of the settlement, while the Curbow report discussed at length whether the redemptions would benefit the Advisers and/or Morgan Stanley to the detriment of common shareholders. Both reports concluded that the trustees were aware of their fiduciary obligations to the common shareholders, and that any determination must not harm the common shareholders. (Rotz SLC Report at 64-66, 153; Curbow SLC Report at 105-109, 134-138, 294-304, 361-365.)

After spending thousands of hours interviewing defendants and key witnesses, reviewing hundreds of thousands of pages of documents, analyzing plaintiffs' allegations, working with experts and memorializing their findings in extensive reports, [*36]  all with the assistance of independent outside counsel, the SLCs determined that the trustees did not breach their fiduciary duties. (Rotz SLC Report at 145-153; Curbow SLC Report at 362-365.) In addition, as noted above (supra at16), the Rotz SLC determined at the conclusion of the investigation, taking into account the expense and lack of likelihood of success, that maintenance of this suit would not be in the best interest of the Trusts. The Curbow SLC concluded that, even if a claim could be stated, the costs and risks of any litigation, including delay, disruption of business, indemnification and possible advancement of legal fees, far outweighed the slim chance of any recovery. (Curbow SLC Report at 361-377.)

Applying the burden shifting standards of MBCA section 7.44 and the business judgment rule in reviewing the SLCs' investigations and the independent trustees' determinations to reject plaintiffs' demands based the recommendations, this court holds that plaintiffs have failed to rebut the Trusts' showing and to demonstrate that the independent trustees' determinations were not made in good faith after reasonable inquiry. The investigation process was reasonably comprehensive, and the SLCs' findings, [*37]  which the trustees' adopted, were not illogical and can be attributed to a rational business judgment.

In so holding, the court finds that plaintiffs misconstrue the standard under the Massachusetts statute for judicial review of the trustees' determinations. Plaintiffs contend repeatedly that the  [**11]  findings and recommendations of the SLCs were against the weight of the evidence. (See supra at 13-14.) At oral argument, plaintiffs argued that the evidence showed gross negligence on the boards' part. (OA Tr. at 45.) As the authority discussed above holds, however (see supra at 19-20), it is not the courts' role to weigh the evidence or assess the correctness of the SLCs' or trustees' reasoning, where, as here, the decision of disinterested trustees, based on a comprehensive report of12 a disinterested special litigation committee, is protected by the business judgment rule.

12   Plaintiffs reliance on Blake v Friendly Ice Cream Corporation (2006 WL 1579596 [Mass Super Ct, May 24, 2006, No. 030003], reconsideration denied 21 Mass L Rptr 610, * 22 [Mass Super Ct 2006]), which held that an SLC report was missing adequate supporting documentation, does not compel a different result. (Rotz Ps.' Memo. In Opp. at 7, 15; Curbow Ps.' Memo. In Opp. at 10, 16.) In that action, the Court found that one of the two members of the special litigation committee was [*38]  not independent. As a result, the special litigation committee "was improperly constituted, not independent and lacked authority to render a valid determination as to whether or not to maintain the derivative proceeding," and the Court denied the special litigation committee's motion to dismiss. (Id. at *17.) As noted above, plaintiffs do not dispute that the trustees, including the members of the SLC, were independent.

Pursuant to the mandatory language of the Massachusetts' statute, plaintiffs' claims against defendant officers and Adviser of the nominal defendant Trusts for breach of fiduciary duty must accordingly be dismissed. As these claims fail, plaintiffs' claims against defendant Morgan Stanley for aiding and abetting such breach must also fail.

It is hereby ORDERED that in the Rotz action (No. 651060/2010), the nominal defendants' motion to dismiss is granted and the amended complaint is dismissed with prejudice; and it is further

ORDERED that in the Curbow action (No. 651059/2010), the nominal defendants' motion to dismiss is granted and the amended complaint is dismissed with prejudice.

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