US SUPREME COURT DECISIONS

Respondents, shareholders of an investment company registered under the Investment Company Act of 1940 (ICA), brought this derivative suit in Federal District Court against several of the company's directors and its registered investment adviser, alleging that the defendants had violated their duties under the ICA, the Investment Advisers Act of 1940 (IAA), and the common law in connection with a purchase by the company of the commercial paper of another company. The investment company's five directors who were neither affiliated with the investment adviser nor defendants in the action, acting as a quorum pursuant to the company's bylaws, concluded that continuation of the litigation was contrary to the best interests of the company, and its shareholders and moved the District Court to dismiss the action. Finding no evidence that the directors who voted to terminate the suit had acted other than independently and in good faith, the District Court entered summary judgment against respondents. The Court of Appeals reversed, holding that, because of the ICA, disinterested directors of an investment company have no power to foreclose the continuation of nonfrivolous litigation brought by shareholders against majority directors for breach of their fiduciary duties.

Held: In suits alleging violations of the ICA and IAA, federal courts should, as a matter of federal law, apply state law governing the authority of independent directors to discontinue derivative suits to the extent such law is consistent with the policies of the ICA and the IAA. Congress did not require that States, or federal courts, absolutely forbid director termination of all nonfrivolous actions. Pp. 441 U. S. 475-486.

(a) Assuming, without deciding, that respondents have implied derivative causes of action under the federal Acts, state law cannot operate of its own force. Instead,

"the overriding federal law applicable here would, where the facts required, control the appropriateness of redress despite the provisions of state corporation law. . . ."

J. I Case Co. v. Borak, 377 U. S. 426, 377 U. S. 434 (emphasis added). Pp. 475-477.

(b) The fact that the scope of respondents' federal right is a federal question does not, however, make state law irrelevant. Since the ICA does not purport to be the source of authority for managerial power, chanrobles.com-red

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but instead functions primarily to impose controls and restrictions on the internal management of investment companies, the ICA and the IAA do not require that federal law displace state laws governing the powers of directors unless the state laws permit action prohibited by the Acts, or unless "their application would be inconsistent with the federal policy underlying the cause of action. . . ." Johnson v. Railway Express Agency, 421 U. S. 454, 421 U. S. 465. Pp. 441 U. S. 477-480.

(c) Thus, the threshold inquiry in this case (not determined by either of the courts below) should have been to determine whether state law permitted the disinterested directors to terminate respondents' suit; if so, the next inquiry should have been whether such a state rule was consistent with the policy of the federal Acts. The Court of Appeals incorrectly implied that the only state law that would be consistent with the ICA would be one which absolutely prohibited the termination of nonfrivolous derivative suits. Although the Acts may justify some restaints upon the unfettered discretion of even disinterested mutual fund directors, they do not justify a flat rule that directors may never terminate nonfrivolous actions involving codirectors. The structure and purpose of the ICA indicate that Congress entrusted to the independent directors of investment companies, exercising the authority granted to them by state law, the primary responsibility for looking after the interests of the funds' shareholders. There may be situations in which the independent directors could reasonably believe that the best interests of the shareholders call for a decision not to sue -- as, for example, where the costs of litigation to the corporation outweigh any potential recovery. In such cases, it would be consistent with the Act to allow the independent directors to terminate a suit, even though not frivolous. Pp. 441 U. S. 480-485.

567 F.2d 1208, reversed and remanded.

BRENNAN, J., delivered the opinion of the Court, in which BURGER, C.J.,and WHITE, MARSHALL, BLACKMUN, and STEVENS, JJ., joined. BLACKMUN, J., filed a concurring opinion, post, p. 441 U. S. 486. STEWART, J., filed an opinion concurring in the judgment, in which POWELL, J., joined, post, p. 441 U. S. 487. REHNQUIST, J., took no part in the consideration or decision of the case. chanrobles.com-red

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