## Facts

- A shareholder brought a derivative action on behalf of an open-end mutual fund against the fund, its investment adviser, a distribution affiliate, and directors (including purportedly unaffiliated directors).
- Brokerage commissions on the fund’s portfolio transactions generated “give-ups,” i.e., portions of commissions directed to other brokers.
- On the adviser’s recommendation, the fund used a give-up policy directing give-ups to brokers who sold the fund’s shares, aiming to stimulate share sales.
- The give-up policy tended to increase the adviser’s advisory fees and the distributor’s sales-related compensation.
- The plaintiff alleged the adviser and affiliated directors used fund-generated value to advance their own interests and failed to disclose material information about give-ups to the unaffiliated directors.
- The plaintiff further alleged that the nondisclosure impaired the statutory role of unaffiliated directors required by the Investment Company Act of 1940 to provide independent oversight of adviser-related conflicts.

## Issues

1. Whether unaffiliated mutual-fund directors breach their fiduciary and statutory duties by failing to take reasonable steps to inform themselves about and oversee give-up arrangements that may benefit the adviser and its affiliates.
2. Whether the investment adviser and affiliated directors breach fiduciary duties by using fund-generated give-ups to stimulate fund share sales and increase their own compensation without full disclosure to, and informed consideration by, unaffiliated directors.
3. Whether nondisclosure to unaffiliated directors undermines the independence contemplated by the Investment Company Act, warranting judicial intervention despite ordinary deference to board decisions.

## Decision

- The First Circuit reversed the district court’s adverse disposition for the plaintiff and remanded.
- The court held that unaffiliated directors were not permitted to act as passive figureheads and had an affirmative duty to take reasonable steps to learn about give-up practices and related conflicts.
- The court held that the adviser and affiliated directors owed a duty of full candor to unaffiliated directors regarding material facts about give-ups and the adviser’s use of fund-generated value.
- The court treated give-ups as value generated by fund transactions; directing that value to brokers to spur share sales could improperly divert value from existing shareholders to distribution interests benefitting the adviser and its affiliate absent informed independent approval.
- The court indicated that, given structural conflicts in the mutual-fund setting, judicial review of adviser-related arrangements is more searching when the independence of unaffiliated directors is compromised by lack of information.

## Legal Principles

- The Investment Company Act’s requirement of unaffiliated directors is a substantive governance safeguard; those directors must exercise informed, independent oversight of conflicts involving the adviser.
- Unaffiliated directors have an affirmative duty to make reasonable inquiry into practices (including trading and distribution arrangements) that may involve conflicts or the use of fund-generated value.
- Investment advisers and affiliated directors must make full and timely disclosure of material information to unaffiliated directors concerning conflicted arrangements and the use of fund assets or fund-generated value.
- Board action in the mutual-fund context receives limited deference when purported independence is undermined by informational imbalance or nondisclosure in adviser-related matters.

## Conclusion

The court required meaningful independent-director oversight in mutual-fund governance: unaffiliated directors must investigate conflicted practices like give-ups, and advisers and affiliated directors must provide full disclosure so that independent judgment can function as the statute intends.


Moses v. Burgin, 445 F.2d 369 (1st Cir. 1971)