## Facts

- The Brazil Fund, Inc. (the Fund) was a closed-end investment company incorporated in Maryland and advised by Scudder, Stevens & Clark, Inc. (Scudder).
- The Fund’s board approved a rights offering that allowed existing shareholders to buy newly issued shares, allegedly at a discount that could dilute shareholders who did not (or could not) fully exercise their rights.
- Plaintiff Robert Strougo, a Fund shareholder, brought (i) a shareholder derivative action on behalf of the Fund and (ii) a related putative class action on behalf of shareholders.
- The pleadings alleged that the rights offering primarily benefitted Scudder because Scudder’s advisory fee was based on the Fund’s net assets, and the offering increased the asset base and Scudder’s compensation.
- Strougo alleged that Scudder and Fund directors breached fiduciary duties in approving and implementing the offering, and that offering/proxy materials contained misstatements or omissions about the offering’s dilutive effects and related conflicts.
- Defendants moved to dismiss on several grounds, including failure to make a pre-suit demand under Maryland law for the derivative claims (Rule 23.1), failure to state a claim (Rule 12(b)(6)), and failure to plead fraud-based allegations with particularity (Rule 9(b)).
- Strougo argued that demand was excused as futile because a majority of the board lacked independence from Scudder, including because certain directors received compensation for serving on boards of other Scudder-managed funds; Scudder conceded that some directors were not independent but disputed that the remaining directors were disabled.

## Issues

1. Whether Maryland law required Strougo to make a pre-suit demand on the Fund’s board before filing derivative claims, or whether demand was excused as futile based on alleged director interest or lack of independence from Scudder.
2. Whether the complaint stated viable Maryland fiduciary-duty claims arising from the board’s approval of the rights offering, including claims premised on adviser self-interest and alleged shareholder dilution.
3. Whether the complaint adequately pleaded federal securities claims challenging the offering and proxy disclosures (including under § 10(b)/Rule 10b-5 and § 14(a)/Rule 14a-9), and whether any fraud-based theories satisfied Rule 9(b).

## Decision

- The court granted the motions to dismiss in part and denied them in part.
- The court held that Maryland law governed the demand requirement because the Fund was a Maryland corporation, and it evaluated demand futility under Maryland standards as applied through Rule 23.1.
- The court found demand excused as futile for certain derivative claims because the complaint pleaded particularized facts supporting a reasonable doubt that a majority of directors could independently consider a demand in light of their alleged financial and professional ties to Scudder.
- The court permitted certain derivative fiduciary-duty claims under Maryland law to proceed at the pleading stage, concluding that allegations of a conflicted transaction and director/adviser self-interest tied to advisory compensation were sufficient to state claims requiring factual development.
- The court dismissed some claims (including portions of state-law and federal theories) where the pleadings were conclusory, failed to connect specific defendants to actionable conduct, or otherwise did not meet the required elements.
- As to the federal disclosure-based claims, the court applied the pleading standards under Rules 12(b)(6) and 9(b), allowing some adequately pleaded allegations of material misstatements/omissions related to the rights offering and shareholder vote to proceed while dismissing deficient aspects that lacked required detail or an adequate causal link.

## Legal Principles

- A shareholder bringing derivative claims must satisfy Fed. R. Civ. P. 23.1 by either making a pre-suit demand or pleading demand futility with particularity; state law supplies the substantive demand standard.
- For a Maryland corporation, Maryland law governs whether demand is required or excused; demand may be excused where particularized facts support a reasonable doubt that directors can exercise independent business judgment because of interest or lack of independence.
- Director independence may be impaired where a director has material financial ties to, or ongoing compensation relationships with, an interested adviser or affiliate in connection with the challenged transaction.
- Maryland fiduciary-duty claims can be stated at the pleading stage where the complaint plausibly alleges that directors approved a transaction for reasons tied to conflicted benefits to an adviser (such as increased fee revenue) and that the transaction could harm shareholders through dilution or other economic effects.
- Federal securities claims based on disclosure require allegations of material misstatements or omissions; § 10(b)/Rule 10b-5 additionally requires scienter and an adequate theory of causation, and fraud-based allegations must satisfy Rule 9(b)’s particularity requirement.
- Section 14(a)/Rule 14a-9 claims challenging proxy solicitation focus on whether shareholders were asked to vote based on materially misleading proxy materials and whether the alleged defect was linked to the corporate action approved.

## Conclusion

Strougo held that, applying Maryland law, demand was adequately pleaded as futile for certain derivative challenges to a dilutive rights offering allegedly structured to increase the adviser’s asset-based fees, and it allowed key Maryland fiduciary-duty and some disclosure-based federal claims to proceed while dismissing other portions that did not satisfy the governing pleading and causation standards.


Strougo v. Scudder, Stevens & Clark, Inc., 964 F. Supp. 783 (1997)