Full opinion text
FREDERICK van PELT BRYAN, District Judge: The plaintiff in this derivative action is a shareholder of Chemical Fund Inc., a mutual fund (the Fund). She sued on behalf of the Fund against the Fund’s investment adviser, F. Eberstadt & Co., Managers and Distributors, Inc., its parent company, F. Eberstadt.& Co., Inc., and Robert G. Zeller, a principal of the Fund, its investment adviser, and the parent company, for alleged unlawful failure to recapture portfolio brokerage commissions for the benefit of the Fund and for alleged inadequate disclosure of the Fund’s brokerage practices to Fund shareholders. After trial without a jury before Judge Robert L. Carter in the Southern District of New York on the question of liability only, judgment was entered dismissing the complaint. Judge Carter’s opinion below is reported at 399 F.Supp. 945 (S.D.N.Y.1975). Plaintiff appeals from that judgment. The appeal presents troublesome questions concerning the duties of investment advisers and directors of mutual funds with respect to recapture of portfolio brokerage commissions for the benefit of the fund. The applicable legal principles were largely laid down by this court in Judge Friendly’s comprehensive opinion in Fogel v. Chestnutt, 533 F.2d 731 (2d Cir. 1975), cert denied, 429 U.S. 824, 97 S.Ct. 77, 50 L.Ed.2d 86, 45 U.S.L.W. 3250 (1976), which approved with some qualifications the holdings of the First Circuit in Moses v. Burgin, 445 F.2d 369 (1st Cir.), cert. denied, 404 U.S. 994, 92 S.Ct. 532, 30 L.Ed.2d 537 (1971), the only previous court of appeals decision dealing with the recapture problem. A basic question here is whether application of the Fogel and Moses principles to the facts in the case at bar requires reversal of the dismissal of the complaint by the court below. The essential questions which we find presented and our rulings thereon are as follows: (A) Did the manager and interested Fund directors have a duty to recapture excess commissions for the benefit of the Fund either under the Fund’s charter or under the various agreements between the Fund and the adviser? We hold they did not. (B) Did the manager and interested directors violate their duty of disclosure to the independent directors under Moses and Fogel ? We hold they did not. (C) Did failure to recapture violate section 36 of the Investment Company Act of 1940? We hold it did not. (D) Did the proxy statements for the years 1967-1971 violate the disclosure provisions of the federal securities laws? We hold they did and remand for determination of what damages, if any, were caused by such violations. I. At the outset, a review of the background of the recapture problem in the mutual fund industry is in order. Since Judge Friendly’s opinion in Fogel, and the authorities there cited, cover this subject in considerable detail, the discussion here will be limited to what is essential for an understanding of the problems presented in this case. The mutual fund industry is in many ways unique, which in part explains the specific federal regulatory legislation concerning it. See, e. g., Investment Company Act of 1940, 15 U.S.C. § 80a-l, et seq.; Investment Advisers Act of 1940, 15 U.S.C. § 80b-l, et seq. A mutual fund is a “mere shell,” a pool of assets consisting mostly of portfolio securities that belongs to the individual investors holding shares in the fund. The management of this asset pool is largely in the hands of an investment adviser, an independent entity which generally organizes the fund and provides it with investment advice, management services, and office space and staff. The adviser either selects or recommends the fund’s investments and rate of portfolio turnover, and operates or supervises most of the other phases of the fund’s business. The adviser’s compensation for these services is a fee which is usually calculated as a percentage of the fund’s net assets, and thus fluctuates with the value of the fund’s portfolio. Portfolio transactions are carried out by brokers selected by the adviser, who receive commissions at the regular rates therefor. The sale of fund shares to new investors is generally the responsibility of a “principal underwriter” who is usually the adviser itself or a close affiliate. Actual sales are made by brokers or dealers selected by the underwriter, and the sales charge or “load” is divided between the selling broker or dealer and the underwriter. This management structure contrasts sharply with that of a typical corporation. In the usual corporate situation, the interests of management and shareholders are identical on most matters. Since the officers who run the corporation are paid directly by the corporation and usually have a substantial equity investment in it, they devote themselves to profit maximization and thus act in the best interests of both the corporation and themselves. Control of a mutual fund, however, lies largely in the hands of the investment adviser, an external business entity whose primary interest is undeniably the maximization of its own profits. While the management and shareholders of a mutual fund have certain parallel interests (such as improving the quality of investment performance by increasing the value of the fund’s portfolio and thus raising both the value of fund shares and the investment adviser’s fee), there are important areas in which their interests may conflict. These include the level of management fees and sales charges, and various aspects of portfolio transactions. Mundheim, Some Thoughts on the Duties and Responsibilities of Unaffiliated Directors of Mutual Funds, 115 U.Pa.L.Rev. 1058, 1059-60 (1967). The situation caused by this unique mutual fund structure was serious enough to prompt the observation by the First Circuit that “self-dealing is not the exception but; so far as management is concerned, the order of the day.” Moses v. Burgin, supra, at 376. See Galfand v. Chestnutt Corp., 545 F.2d 807, 808 (2d Cir. 1976). Congress sought to minimize the possibilities of abuse of position by mutual fund managers by means of the Investment Company Act of 1940, 15 U.S.C. § 80a-l, et seq. This statute expanded the disclosure provisions already applicable to the industry under the Securities Act of 1933, 15 U.S.C. § 77a, et seq., and the Securities Exchange Act of 1934, 15 U.S.C. § 78a, et seq., and imposed specific requirements as to the structure and operation of mutual funds. See Comment, Mutual Funds and Independent Directors: Can Moses Lead to Better Business Judgment?, 1972 Duke L.J. 429, 433-35. Thus what was then section 10 of the Investment Company Act of 1940, 54 Stat. 806, required that at least 40 percent of a mutual fund’s board of directors not be officers or employees of the investment company or “affiliated” with its investment adviser. This key provision was designed to place the unaffiliated directors in the role of “independent watchdogs” who would assure that, in accordance with the preamble of the Investment Company Act, mutual funds would operate in the interest of all classes of their securities holders, rather than for the benefit of investment advisers, directors, or other special groups. The Act also placed specific restrictions on insider transactions, 15 U.S.C. § 80a-17, and required that the contracts governing the relationship between a fund and its investment adviser be approved by investors and reexamined periodically, 15 U.S.C. § 80a-15(a). While the 1940 Acts succeeded in correcting a number of obvious abuses which had been prevalent in the mutual fund industry prior to their enactment, it became apparent in the early 1960’s that problems still remained. Believing that the existing regulatory scheme then relying on “unaffiliated” directors to police the industry had proved inadequate, the SEC set in motion a series of developments which raised for the first time the question of the recapture of portfolio brokerage commissions for the benefit of the fund, and eventually culminated in the Securities Act Amendments of 1975. In Fogel, Judge Friendly summarized the origins of the recapture controversy: At the root of the recapture problem was the historic practice of the New York Stock Exchange (NYSE) and other exchanges of charging a fixed rate of commission on each share traded regardless of the size of the transaction (except for the odd-lot differential). Since the costs of executing an order do not vary in accordance with size, the large sales and purchases at the command of investment advisers of mutual funds were particularly attractive orders. At first fund managers allocated their brokerage business to reward brokers who had been helpful in selling the fund’s shares, in furnishing advice, or in doing both; orders allocated as rewards were known as “reciprocals.” However, as the business grew, the practice of reciprocals resulted, especially for the large funds, in using too many brokers, some of whom were not the best qualified to execute the particular order placed with them. Hence there developed the practice of relying on a few executing brokers who were then instructed to “give-up” a portion of their commissions, sometimes as much as 75%, to another broker whom the fund manager wished to reward. On NYSE this was permitted only in favor of another member, but six of the seven regional exchanges permitted “give-ups” in favor of non-members as well, provided they were members of the National Association of Securities Dealers, Inc. (NASD). 533 F.2d at 735 (footnote omitted). The proper use of the “excess” portion of brokerage commissions — that over and above what a broker would charge for his execution services were it not for the exchanges’ fixed rates of commission — soon became a central question. Judge Friendly notes SEC awareness of the issue as early as 1963 when it issued its Report of the Special Study of Securities Markets, H.R. Doc.No.95 Pt. 4, 88th Cong., 1st Sess. (1963). The SEC there concluded: 1. The pattern of reciprocal business in the mutual fund industry is unique. The economies of the volume of securities transactions generated by the mass purchasing power of the funds for the most part are of minor benefit to the funds themselves. The primary beneficiaries are their investment advisers and their frequently related principal underwriters who to a large extent use reciprocity to reward the sales efforts of fund retailers, thereby increasing their own rewards. The use by fund advisers of investment advice and research provided by brokerage firms in return for fund brokerage, without diminution of their investment advisory fees, is another indication of the manner in which they are the primary beneficiaries of reciprocal business. This unbalanced reciprocal structure té’a direct outgrowth of a minimum commission rate structure which prohibits volume discounts and rebates. In the broad study of the commission rate structure recommended to the Commission in chapter VI-I, appropriate consideration should be given to the desirability and appropriate form of a volume discount from the viewpoint of mutual funds. Id. at 234, quoted in Fogel, supra, at 735-36. The SEC’s first explicit pronouncement on the subject of recapturing excess brokerage commissions came in late 1966, in its Report on the Public Policy Implications of Investment Company Growth (PPI), H.R. Rep.No.2337, 89th Cong., 2d Sess. (1966). The commission detailed the give-up and reciprocal practices which were being used to reward brokers furnishing sales and research services to mutual funds. It then described the mechanisms that some mutual funds had developed for recapturing excess commissions for the funds’ direct cash benefit — which relied upon exchange rules permitting the reduction of the adviser’s fee by some portion of brokerage commissions it received as give-ups or for actual execution — and concluded that this course of action probably conferred greater benefits on the fund shareholders than alternative use of excess commissions. The SEC also observed, however, that until such time as these recapture procedures became widespread in the industry, any adviser-underwriter to a dealer-distributed fund who utilized them would find certain dealers disinclined to promote sales of its fund’s shares since they could more profitably promote those of its competitors which did not recapture commissions. At the same time that it viewed with approval the efforts of some mutual funds to turn reciprocal and give-up practices to the direct cash advantage of shareholders, the Commission stated a broader view that certain aspects of these practices, particularly the customer-directed give-up, impair the orderly and proper functioning of the securities markets themselves. PPI at 185. Accordingly, the SEC gave notice that “it believes that exchange rules must be changed so as to preclude customer-directed give-ups.” PPI at 186. The next development came when SEC Securities Exchange Act Release No. 8239 (Jan. 26, 1968) proposed a rule 10b-10 which, if it had been adopted, would have required a fund manager to recapture brokerage commissions whenever it was capable of so doing. The release reasoned that mutual fund managers were under a fiduciary duty to utilize available recapture techniques. It also called for comment on a NYSE proposal to introduce a volume discount in brokerage commissions and make several changes in NYSE rules to limit give-ups and eliminate other reciprocal practices because of the distortions they caused in the market. The SEC viewed the NYSE proposal as essentially an alternative to its own proposed rule 10b-10. Fogel v. Chestnutt, supra, at 739-40. Later in 1968 the SEC finally accepted NYSE proposals for a volume discount on orders exceeding 1,000 shares and other alterations in rates, and withdrew its proposed rule 10b-10. NYSE abolished customer-directed give-ups effective December 5,1968, as did the regional exchanges shortly thereafter. In 1969, the Commission continued to address the question of the duty of funds to recapture. In SEC Securities Exchange Act Release No. 8746 (Nov. 10, 1969), quoted in Fogel, supra, at 741, the General Counsel for the SEC, Philip A. Loomis, Jr., stated: You first ask whether mutual fund management has a fiduciary duty to acquire a stock-exchange seat directly or through an affiliate, in order to utilize this means to recapture brokerage which in turn will be offset against management charges. We do not believe that management has this duty if in the exercise of its best business judgment management determines that it is not in the best interests of the fund to create such an affiliate. Proposed Rule 10b-10, as published for comment on January 26, 1968, to which you refer, has been withdrawn. The release went on to note the Commission’s understanding that the exchange rules abolishing give-ups did not prohibit the existing arrangements which a few mutual funds had made for the recapture of a portion of their commissions. It also cautioned that if a mutual fund management did acquire a seat on a regional exchange whose rules permitted the recapture of commissions through the use of that seat, there might be circumstances under which recapture would be required and management would not be free to retain revenues derived from that source for itself. The next significant event occurred in 1972 when the SEC issued a Policy Statement on the Future Structure of the Securities Markets (Feb. 2, 1972). The Fogel opinion, supra, at 741-43, sets forth the pertinent passages in detail, and little would be gained by repeating them here. Suffice it to say that the Commission advocated the discontinuance of the use of portfolio brokerage to promote the sale of mutual fund shares, and the elimination of institutional memberships on the exchanges insofar as they were employed primarily as vehicles for obtaining recapture of commissions. In response to this policy statement, the National Association of Securities Dealers proposed a rule abolishing the use of reciprocals to reward sales promotion by making sale of fund shares neither a qualifying nor disqualifying factor in the allocation of portfolio transactions. This rule becajne effective on July 15, 1973. The reaction to the other thrust of the policy statement, however, was quite different: By contrast, the validity of the SEC’s conclusions on the evil of institutional memberships, which were quite at variance with the earlier pronouncements we have quoted, was vigorously challenged, notably by Elkins Wetherill, president of the PBW Stock Exchange, see Wetherill and Hendon, Institutional Membership and the Experience of the Philadelphia-Baltimore-Washington Stock Exchange, 13 Boston College Ind. & Com.Rev. 959 (1972). Senator Williams introduced a bill, S. 3169, 92d Cong. 2d Sess. (1972), which would remove the SEC’s power to restrict institutional membership until one year after the effectiveness of a rule requiring negotiated rates on all transactions exceeding $100,000. Nevertheless, the SEC promulgated Rule 19b-2, effective March 29, 1973, forcing every exchange to “require every member of such exchange to have as the principal purpose of its membership the conduct of public business.” Fogel v. Chestnutt, supra, at 743 (footnote omitted). The final development was the Securities Act Amendments of 1975, which generally forbade exchange transactions for one’s own account or that of an associate, as well as the imposition of fixed rates of commission by national securities exchanges — the cause of the whole problem. See Fogel v. Chestnutt, supra, at 734-44. Thus, the problem of recapture of mutual fund portfolio brokerage commissions became intertwined with and to a considerable extent absorbed by the broader problem of general policy with respect to the effect of brokerage commission allocations on the securities markets. In this connection, the stance of the SEC on the recapture question has considerable significance. The Commission’s position cannot be fairly characterized as consistent. The amicus brief filed by the SEC on this appeal at the request of the court frankly admits this and attributes the “possibly conflicting views” of the Commission on the recapture question to its dual responsibilities under the Investment Company Act and the Securities Exchange Act. A portion of that brief is instructive: Under the [Investment Company Act], the Commission focused primarily on the effect of the allocation of brokerage commissions on mutual funds, their advisers and their shareholders. At the same time, however, the Commission was more broadly concerned under the Securities Exchange Act with the effect of brokerage allocation on the securities markets. From the latter perspective, the Commission was concerned with such matters as the appropriateness of fixed commission rates, the effect of such commissions on the structure of the securities markets, and the role of the Commission as an economic regulator. As the Commission’s thinking developed on these broader policy issues, and market characteristics continued to change and evolve, the Commission revised its prior positions to accommodate its market concerns. Undoubtedly, some persons regarded the Commission’s later conduct as inconsistent with its prior positions on the narrower issues arising under the Investment Company Act. The Commission’s brief traces this “duality of approach” throughout all its discussion on recapture, and notes the agency’s final determination to treat the practice as a problem of commission rates and market structure, rather than as a mutual fund problem. It concedes that it is difficult to find guidance — in the context of this lawsuit, involving a specific fact situation raising questions of the fiduciary obligation of investment advisers — in many of the Commission’s general statements on the recapture problem. The SEC points out, however, that the history of its response to the recapture problem is not unimportant since “it illustrates the dynamic and constantly changing background in which the defendants’ actions in this case must be judged.” With the foregoing background in mind, we turn to the specifics of the case before us. II. Chemical Fund, Inc., a Delaware corporation, is an open-end, diversified investment company or mutual fund registered with the SEC under the Investment Company Act of 1940. Its investment objective is to attain growth of capital and income through investment in companies specializing in certain aspects of the sciences. As an “open-end” investment company, the Fund is required under sections 5(a)(1) and 2(a)(32) of the Investment Company Act, 15 U.S.C. §§ 80a-5(a)(l), -2(a)(32), to stand ready at all times to redeem its shares for their “net asset value”, computed in accordance with the rules and regulations of the SEC, 17 C.F.R. §§ 270.22c-l, ,2a-4. As of December 31, 1965, the Fund had total net assets of $433,849,751. At the time of trial, the Fund’s total net assets were more than $700,000,000. The Fund’s investment adviser or manager and the distributor of its shares is, and has been for many years, F. Eberstadt & Co., Managers & Distributors, Inc. (M&D), a Delaware corporation. Pursuant to a written advisory contract, M&D makes investment advisory recommendations to the Fund’s board of directors, and, subject to the approval of the board, manages the business and affairs of the Fund. It also furnishes the Fund with office space and ordinary clerical and bookkeeping services. As is customary in the industry, the compensation paid by the Fund to M&D for its services as the Fund’s manager is based upon a percentage of the Fund’s net assets, with an incentive adjustment for the Fund’s investment performance. At all relevant times M&D has been a member of the NASD. Pursuant to a written distribution contract with the Fund, M&D arranges for the sale of Fund shares to the public through independent securities dealers at a price equal to net asset value plus a sales charge or commission. Under the terms of the distribution agreement, M&D retains less than a quarter of the sales charge and allows the balance to dealers who sell Fund shares. The parties have stipulated that at all times since at least January 1, 1965, when plaintiff’s allegations commence, a majority of the Fund’s board of directors have been neither “affiliated” nor “interested” persons within the meaning of the Investment Company Act. These unaffiliated or disinterested Fund directors were characterized by Judge Carter as men of repute in business and the professions. The defendant F. Eberstadt & Co. Inc. (Eberstadt), M&D’s parent company, originally a partnership but later a Delaware corporation, is and has been since 1962 a member firm of the NYSE and a member of the NASD. Eberstadt later became a member of the American Stock Exchange as well. Robert G. Zeller, the only individual defendant served, is vice-chairman of the Fund’s board of directors, vice-chairman of M&D’s board, and chairman of the board and chief executive officer of Eberstadt. Except in unusual circumstances, whenever the Fund wishes to purchase or sell securities for its portfolio it is necessary for M&D to select a broker to execute the transaction or to deal directly with a dealer who owns or wishes to purchase the particular securities being purchased or sold. Total brokerage commissions paid in connection with such portfolio transactions on the NYSE (on which 80% of the transactions were executed), the American Stock Exchange, and regional exchanges ranged from $339,860 in 1965 to $1,291,735 in 1973. The parties have stipulated that, in selecting brokers for the execution of portfolio transactions, M&D’s primary concern has always been securing the best price and quality of execution available to the Fund, i. e., the best execution. Only when two or more executing brokers could provide equal price and quality of execution were other criteria considered in the selection of brokers. Until July 15, 1973, the criteria employed in selecting a broker were the broker’s sales of Fund shares to the public and the usefulness of research and statistical services which it provided to the Fund through M&D. After July 15, 1973, as previously indicated, an NASD rule, binding on both M&D and Eberstadt as members, eliminated sale of Fund shares as a qualifying or disqualifying factor in the selection of executing brokers. The brokerage commissions paid by the Fund when the sale of shares was a criterion for selecting an executing broker fluctuated from $271,910 in 1965 to $462,613 in 1970. The commissions paid by the Fund when research and statistical services provided were criteria for selecting an executing broker fluctuated from $40,977 in 1965 to $91,662 in 1970. During 1971 and 1972 over 98% of the Fund’s portfolio brokerage in each year was allocated as “reciprocals” to brokers who either sold Fund shares or supplied statistical and research information. As we have seen, prior to December 5, 1968, it was common practice for a mutual fund or its manager to direct executing brokers on the NYSE and other national securities exchanges to “give-up” part of their commissions to other exchange members who had sold shares to the public or who had provided useful research or statistical material, but who had not participated in any way in the execution of the transaction on the exchange. The give-ups on Fund portfolio transactions from 1965 to 1968 exceeded the following amounts: Year Amount 1965 ’$ 81,686 1966 136,200 1967 214,600 1968 246,600 The NYSE permitted member firms who served as investment advisers to credit against the investment advisory fee some portion of the commissions earned by the member firm for the execution of portfolio transactions on behalf of the investment advisory client. Accordingly, the NYSE would have permitted M&D to credit against the management fee payable to it by the Fund some portion of any brokerage commissions earned by its parent Eberstadt in the execution of the Fund’s portfolio transactions and, prior to the time when give-ups were abolished, a portion of any give-ups received by Eberstadt with respect to Fund brokerage business. Prior to December 5, 1968 such recapture would not have required participation by Eberstadt in the execution of portfolio transactions. After December 5, 1968, when give-ups were abolished, recapture was still available although then, appellant asserts, participation by either Eberstadt or M&D in portfolio transactions would have been necessary. Well aware of this possibility of recapture, the board of directors of the Fund, with the concurrence of the unaffiliated and non-interested directors, consistently directed that Eberstadt not act as broker in the execution of Fund portfolio transactions nor receive give-ups from other brokers in connection with Fund portfolio transactions. Plaintiff, a shareholder of record of the Fund continuously since at least 1965, seeks to hold M&D, Eberstadt, and Zeller liable to the Fund for their part in implementing this decision of the unaffiliated and non-interested directors to forego recapture. Jurisdiction was laid under section 44 of the Investment Company Act of 1940, as amended, 15 U.S.C. § 80a — 43; section 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa; and section 22 of the Securities Act of 1933, 15 U.S.C. § 77v. Plaintiff first contended that by causing the Fund to forego recapture and allocate commissions to reward brokers who sold Fund shares and supplied it with research and statistical information, the defendants violated the management and distribution agreements then in force between the Fund and M&D, provisions of the Fund’s certificate of incorporation, and fiduciary duties imposed upon them by both the Investment Company Act of 1940 and common law. Plaintiff also claimed that the defendants failed to disclose accurately and fully to the unaffiliated or non-interested directors and to the shareholders the uses to which brokerage commissions were being put and the alternatives to those uses. At the trial before Judge Carter, plaintiff rested her case in chief solely on the documentary evidence contained in 163 exhibits. The defendants called four witnesses: Zeller, Robert M. Maynard, a partner in Price Waterhouse & Company, auditors of the Fund; and Professors Roger F. Murray and Bertrand Fox, unaffiliated or non-interested Fund directors. In rebuttal, the plaintiff called Burt Dorsett, another independent Fund director. Judge Carter found “no basis1 for liability under either the federal securities law or the common law.” 399 F.Supp. at 956. Accordingly, he entered judgment for the defendants dismissing the complaint. This appeal followed. III. On this appeal appellant contends (1) that the failure to recapture violated the Fund’s advisory and distribution contracts with M&D; (2) that the failure to recapture violated the Fund’s certificate of incorporation; (3) that the defendants breached their fiduciary duties to the Fund in their dealings with the independent directors regarding recapture; and (4) that the defendants violated the disclosure provisions of the securities laws by failing to keep the shareholders of the Fund properly informed as to the recapture problem. We will address these contentions seriatim. A. A key contention of appellant is that by allocating brokerage commissions and give-ups to reward dealers for selling shares and providing the Fund with research and statistical information, albeit at the direction of the independent directors on the Fund’s board, the defendants violated the management and distribution contracts with the Fund. Appellant argues that, under these agreements, M&D was obligated to pay all the expenses relating to the promotion and sale of Fund shares and to provide research and statistical services to the Fund at its own expense. Through its allocation of the Fund asset of brokerage, appellant asserts, M&D profited at the expense of the Fund to the extent that it was able to avoid using its own funds to purchase sales promotion, research, and statistical services needed to discharge its contractual obligations. Appellant relies heavily on this allegation of self-dealing to support her other claims of breach of fiduciary duty and inadequate disclosure. Appellees contend that both parties to the management and distribution agreements at all times contemplated that brokerage would be allocated by the investment adviser to obtain sales promotion, research, and statistical services. They claim that this understanding was in accordance with the generally prevailing method of business in the industry, and that this usage added implicit terms to the management and distribution contracts. Judge Carter found that the allocation of brokerage for these purposes was done with the unaffiliated directors having all the facts and specifically approving the practice . 399 F.Supp. at 955. He concluded that the management and distribution agreements had not been violated. The management and distribution agreements are silent on the subject of allocation of excess portfolio commissions. Since the industry usage of brokerage is not inconsistent with the pertinent provisions of the agreements, evidence as to its existence and the parties’ awareness of it during negotiations was properly admitted to clarify the intentions of the parties, Lowell v. Twin Disc, Inc., 527 F.2d 767, 770 (2d Cir. 1975), and to annex provisions in accord with the usage to those expressed in the agreements, 3 A. Corbin, Contracts § 556 (1960); 5 S. Williston, Contracts §§ 648, 652 (3d ed. 1961). Contrast Kama Rippa Music, Inc. v. Schekeryk, 510 F.2d 837, 841-42 (2d Cir. 1975). The uncontradicted testimony oí defendant Zeller was that the amount of compensation awarded to M&D under the distribution contract was arrived at by a negotiation process in light of all of the circumstances, including the services which the adviser got from outside sources. One of the “circumstances” he specified was the “known industry facts.” He also testified that, while there was no explicit provision in the advisory contract which gave M&D the right to use a portion of brokerage commissions to reward firms that assisted it in providing research, such a provision “was implicit in the negotiation of the management fee.” Zeller characterized the Fund’s use of give-ups as “simply part of the brokerage practices of the times.” In response to a question concerning the compensation paid M&D under its management contract for research and statistical services, Dr. Roger F. Murray, an independent director of the Fund, testified as follows: The amount we were paying them was for what they could do, and they could not be an expert in all fields, and if they didn’t have the benefit of those give-ups or commission business to use for getting outside additional facilities we would have had to raise their fee and make . arrange for them to buy them, because we were convinced it was essential to the performance of the fund that that kind of exposure to other ideas get into the decision-making process of the fund. He stated that while no explicit contractual provision authorized such use of brokerage, it was “fully understood that that would be done,” and was made “explicit and clear in the prospectus and in the proxy statements. .” The record fully supports this assertion. Appellant adduced no evidence to rebut the testimony that the allocation of brokerage business and give-ups by M&D on the basis of shares sold and services rendered was customary in the industry and specifically contemplated by the Fund’s management and distribution agreements. Appellees’ evidence to this effect stands uncontradicted and, on this record, the conclusion that the agreements were not violated is sustained. Compare Moses v. Burgin, 316 F.Supp. 31, 59-60 (D.Mass.1970), rev’d on other grounds, 445 F.2d 369 (1st Cir.), cert. denied, 404 U.S. 994, 92 S.Ct. 532, 30 L.Ed.2d 547 (1971). B. Appellant’s next argument can be disposed of briefly. Relying on Moses v. Burgin, supra, at 374, she contends that defendants’ allocation of commissions to compensate dealers for sales promotion and research violated an express provision of the Fund’s certificate of incorporation that requires it to receive not less than “net asset value” for each share sold. The Moses court observed that [i]f Fund receives the asset value of new shares, but at the same time rewards the selling broker with give-ups that it has a right to recapture for itself, then the net income Fund receives from the process of selling a share is less than asset value. The existing shareholders have contributed — by paying more than otherwise necessary on Fund’s portfolio transactions— to the cost of the sale, which was supposed to have been borne by the new member alone. 445 F.2d at 374. In Fogel, Judge Friendly rejected this reasoning and held that [although the argument is not without force, we think it presses too far. The term “net asset value” is one of art in the mutual fund industry and is elaborately defined in the certificate of incorporation. The objective of the charter provision was to prevent dilution of per share net asset value by the issuance of new shares at a discount; defendants’ failure to recapture part of the commissions on portfolio transactions does not result in such dilution. Plaintiffs’ real complaint is not that new shareholders did not pay net asset value but that the Adviser, for selfish motives, refrained from handling portfolio transactions in a manner that would have diverted a portion of the commissions to itself, with an attendant decrease in the advisory fee — in substance a charge of breach of a fiduciary duty resulting in corporate waste. 533 F.2d at 744-45. His holding is equally applicable in the case at bar and disposes of this contention of the appellant. C.. Appellant next contends that the conduct of the defendants in implementing the Fund’s decision to forego recapture constituted a breach of fiduciary duty under both the Investment Company Act and common law. To resolve this issue, we must determine whether the Investment Company Act imposed on the Fund and the persons who controlled it an absolute duty to recapture excess brokerage commissions, and, if not, whether the decision to forego recapture here is justifiable as a proper exercise of the informed discretion reposed in the board of directors of a mutual fund under the Act. Section 36 of the Investment Company Act of 1940, which prohibited “gross misconduct or gross abuse of trust” as originally enacted, 54 Stat. 841, and “breach of fiduciary duty involving personal misconduct” as amended in 1970, 15 U.S.C. § 80a-35, established a federal standard of fiduciary duty in dealings between a mutual fund and its adviser. Fogel v. Chestnutt, supra, at 745, citing Brown v. Bullock, 294 F.2d 415, 421 (2d Cir. 1961), and Rosenfeld v. Black, 445 F.2d 1337, 1345 (2d Cir. 1971), petition for cert. dismissed, 409 U.S. 802, 93 S.Ct. 24, 34 L.Ed.2d 62 (1972). In its original form, this section authorized SEC injunctive actions and, by implication, private damage actions by investors against fiduciaries who failed to meet its standards. The remedial 1970 amendment of the section added a subsection (b) which explicitly granted a private right of action to recover unreasonable compensation paid by a fund to its investment adviser. Congress did not intend this modification to abrogate the private action already recognized under the Act for other types of breach of fiduciary duty. See Fogel v. Chestnutt, supra; Moses v. Burgin, supra, at 373, 373 n.7, 384; S.Rep.No.184, 91st Cong., 1st Sess. 16 (1969), U.S.Code Cong. & Admin.News 1970, p. 4897; H.R.Rep.No.1382, 91st Cong., 2d Sess. 38 (1970). But see Monheit v. Carter, 376 F.Supp. 334, 342 (S.D.N.Y.1974). Consequently, appellant’s claim of breach of duty under the Act is properly before the court. We have found nothing in the structure or legislative history of the Investment Company Act which indicates that Congress meant to remove the question of how best to use the brokerage generated by portfolio transactions from the informed discretion of the independent members of a mutual fund’s board of directors. Nor do the opinions in Fogel and Moses suggest that the Act compelled recapture of commissions for the Fund’s direct cash benefit as a matter of law. It is true that, in response to the management’s argument that even if recapture were practical the directors still had a right to choose between recapturing of give-ups for the fund’s direct benefit and awarding them to brokers for its indirect benefit, the Moses court stated that “if recovery was freely available to [the fund], the directors had no such choice.” 445 F.2d at 374. This conclusion, however, was based solely on the First Circuit’s interpretation of that fund’s charter as mandating recapture, see supra at 415-416, and not upon the fiduciary obligations imposed under the Investment Company Act. When the question of the fiduciary duty of the investment adviser under the Act was addressed in Moses and Fogel, the inquiry of both courts was into the adequacy of the disclosure of the possibilities of recapture by the managers to the independent directors of the mutual fund. Plainly, such full and effective disclosure was required so that the independent directors could exercise informed discretion on the question of recapture vel non, thus performing the watchdog function envisaged for them by Congress. See, e. g., Moses v. Burgin, supra, at 383; Fogel v. Chestnutt, supra, at 749-50. The violation of section 36 perceived in both cases resulted from management’s failure to disclose sufficiently to the independent directors the possibilities of recapture, and not from the breach of an absolute duty to recapture imposed by the Act. While we thus conclude that the Investment Company Act did not remove the recapture decision from the discretion of the Fund’s board of directors, such discretion is by no means unrestrained. As previously mentioned, independent directors can perform their function under the Act only when they exercise informed discretion, and the responsibility for keeping the independent directors informed lies with the management, i. e., the investment adviser and interested directors. See, e. g., 15 U.S.C. § 80a-15(c). This responsibility is particularly pressing when the matter in question is one on which the interests of the management and the mutual fund may be at odds. As stated by Judge Aldrich in Moses: Whatever may be the duty of disclosure owed to ordinary corporate directors, we think the conclusion unavoidable that Management defendants were under a duty of full disclosure of information to these unaffiliated directors in every area where there was even a possible conflict of interest between their interests and the interests of the fund. This duty could not be put more clearly than was stated by the SEC in 1965. “The Investment Company Act’s requirement as to unaffiliated directors, if its purposes are not to be subverted, carries with it the obligation on the part of the affiliated directors, and the investment adviser itself, to insure that unaffiliated directors are furnished with sufficient information so as to enable them to participate effectively in the management of the investment company.” Imperial Financial Services, Inc. CCH Fed.Sec.L.Rep. ¶ 77,287 at 82,464 (SEC 1965). Except where it may be fairly assumed that every unaffiliated director will have such knowledge, effective communication is called for. And, in testing that assumption, it must be borne in mind that they are not full time employees of the fund and it may be — as with Fund’s unaffiliated directors — that neither their activities nor their experience are primarily connected with the special and often technical problems of fund operation. If management does not keep these directors informed they will not be in a position to exercise the independent judgment that Congress clearly intended. The only question can be whether the matter is one that could be thought to be of possible significance. 445 F.2d at 376-77. Fogel recognized that PPI had raised such a question which “could be thought to be of possible significance” and on which the interests of a mutual fund and its adviser were in clear conflict. 533 F.2d at 749. Consequently, the investment adviser was obliged to disclose fully in order to assure that the independent directors supplied an independent check on management and adequately represented and protected the shareholder in fund decisions. Assuming such disclosure, Judge Friendly concluded that [the] minimum requirement to enable the Fund’s independent directors to discharge these duties with respect to recapture was a careful investigation of the possibilities performed with an eye eager to discern them rather than shut against them, and, if these possibilities were found to be real, a weighing of their legal difficulties and their economic pros and cons. . If this had been done .and the independent directors had concluded that, because of legal doubts, business considerations or both, the Fund should make no effort at recapture, we would have a different case. But when there has been inadequate communication to the independent directors, it is no defense to the Adviser and those exercising control over it that a decision not to recapture, taken after proper communication, would have been a “reasonable business judgment.” 533 F.2d at 749-50 (footnotes omitted). Thus the decision to forego recapture here did not violate the fiduciary obligations of either the Fund’s adviser or directors under section 36 of the Investment Company Act if the independent directors (1) were not dominated or unduly influenced by the investment adviser; (2) were fully informed by the adviser and interested directors of the possibility of recapture and the alternative uses of brokerage; and (3) fully aware of this information, reached a reasonable business decision to forego recapture after a thorough review of all relevant factors. We now turn to the record in this case to see if these conditions were met. 5jC S}5 * if: * The documentation of the disclosure to the independent directors on the subject of recapture begins with the issuance of PPI by the SEC on December 2,1966. Copies of the report were distributed to the directors of the Fund, as was a December 5, 1966 memorandum from M&D assessing PPI’s impact. This memorandum pointed specifically to the SEC proposal to preclude give-ups. It was followed almost immediately, on January 9, 1967, by a second memorandum from M&D to the directors. M&D there noted that “Chemical Fund’s turnover rate is substantially below not only the mutual fund average but the average rate for the entire Stock Exchange,” and made the following summary of the PPI proposal to prohibit give-ups: We believe, therefore, that the recommendations of the SEC would benefit both funds in that the volume discount would reduce the cost of operation and the elimination of give-ups would make the funds more competitive from a sales standpoint since they would be purchased on a performance basis rather than a reciprocal business basis, a practice in which Chemical Fund has not been competitive with the industry because of the low amount of brokerage commissions available. The SEC apparently looks with favor on the practice of using brokerage business on portfolio transactions to reduce the cost of management. It strongly endorses the method of operation of the Broad Street complex in which the partners of J. & W. Seligman receive substantial profits from the brokerage business carried out for the investment companies in that complex. It does not refer in this connection to the risks of excessive portfolio turnover nor to the pending derivative stockholder suits against this complex based on the theory that the funds could save money by using the third market or direct trades. The Report also points out that IDS is now a member of the Pacific Coast Exchange with the fund receiving the full profit on this brokerage business and the fact that the United Fund Group is also a member of the Pacific Coast Exchange with the fund receiving 50% of the profit. They refer to the fact that the brokerage subsidiaries do substantial amounts of Pacific Coast Exchange business for brokers who execute orders for the funds on other exchanges, (emphasis added). The memorandum ended with a recommendation that the fund “continue the practice of using give-ups until such time as the SEC or Congress shall rule against that practice.” By October 17, 1967, M&D determined that in order to help formalize the board’s annual consideration of the management and distribution contracts, it would prepare a memorandum outlining the comparative performance record of the Fund, comparative cost of operation, and the use of brokerage commissions to secure sales, research, and other services. M&D was by then fully aware, because of actions taken by both the SEC and competitor funds, that the board of directors itself should consciously make the decision whether or not to recapture. Consequently, at the November 29, 1967 board meeting of the Fund, the chairman, the late Ferdinand Eberstadt, suggested that the independent directors consider appointing a subcommittee to review the operations of the Fund and M&D with a view toward reporting to the board prior to its next consideration of renewal of the management and distribution agreements. The independent directors chose from their number a subcommittee consisting of Dr. Murray and Mr. Dorsett to conduct such a review of operations. On January 26, 1968, SEC Securities Exchange Act Release No. 8239, announcing proposed rule 10b-10 which would have mandated recapture when possible, see supra at p. 408, was issued. The subcommittee of the Fund’s board reviewing operations, Murray and Dorsett, then requested Sullivan & Cromwell, counsel to the fund, and also to Eberstadt and M&D, to review the Fund’s brokerage practices. Sullivan & Cromwell responded with an opinion letter to the board dated February 20, 1968, which follows in its entirety: You have asked us to review the method by which F. Eberstadt & Co., Managers & Distributors, Inc. (the “Manager”) places brokerage orders for Chemical Fund, Inc. (the “Fund”) and directs the allocation of a portion of the brokerage commissions arising therefrom to brokers other than the broker executing the order. As you know, F. Eberstadt & Co., the sole stockholder of the Manager, became a member of the New York Stock Exchange in 1962 and, since that time, as a matter of policy, has not executed brokerage orders for the Fund or requested or received “give-ups” on business done for the Fund by other brokers on the New York or other stock exchanges. We have reviewed Securities Exchange Act Release No. 8239, dated January 26, 1968, which discusses, among other things, the level and structure of commission rates on the New York Stock Exchange, the practice of reciprocity and “give-ups”, and the possibility of a manager receiving commissions or “give-ups” in connection with a fund’s portfolio transactions in reduction of the management fee by all or a portion of such brokerage commissions or “give-ups”. The Release also proposes the adoption of Rule 10b-10 under the Securities Exchange Act of 1934. We understand that you have received a copy of this Release. We have also examined the Investment Company Act of 1940 and such other matters of law as we have considered appropriate. On the basis of the above and assuming that the Board of Directors has considered all the relevant facts concerning this matter, including the possibility of adopting alternate methods of handling the Fund’s brokerage business whereby a portion of the commissions might be used to reduce the management fee, and assuming further that, as a result of such consideration, the Board of Directors has come to the conclusion as a matter of reasonable business judgment that it is in the best interest of the Fund and its shareholders that the continuation of the present method of placing brokerage orders and directing “give-ups” be approved, it is our opinion that such approval would be lawful. The board of directors of the Fund met on February 21,1968, and the subcommittee previously appointed to review the operations of the Fund and M&D prior to the board’s consideration of the management and distribution agreements submitted its report in writing. In this and subsequent years M&D furnished this subcommittee with copies of its financial statements for several preceding years, and various schedules comparing the expenses of M&D with other publicly owned companies in the field and the Fund’s performance and expense ratio with those of certain other common stock growth funds. M&D also reviewed with the subcommittee the amount of portfolio brokerage commissions and the method of allocating such commissions. In addition, the subcommittee considered the opinion letter of Sullivan & Cromwell regarding the various matters referred to in SEC Securities Exchange Act Release No. 8239 The Murray/Dorsett report went into a lengthy consideration of what use should be made of brokerage commissions: In Release No. 8239 dated January 26, 1968, the SEC discusses the level and structure of commission rates on the New York Stock Exchange, the practice of reciprocity and “give-ups” and the possibility of a manager receiving commissions or “give-ups” in connection with a fund’s portfolio transactions in reduction of the management fee by all or a portion of such brokerage commissions or “give-ups”. We have” studied this Release and the proposal to issue Rule 10b-10 on the subject of give-ups and we also read the opinion of Messrs. Sullivan & Cromwell addressed to the Board of Directors of Chemical Fund dated February 20, 1968 dealing with this subject. In 1967, as fully disclosed in the proxy statement, the Fund paid brokerage commissions of $618,000. Of this amount $510,000 was allocated to dealers based on the volume of Fund shares sold. The allocation of brokerage business and the use of directed give-ups can be regarded as additional compensation to dealers who sell Fund shares. This is a long established practice of the business, which has been followed by Chemical Fund with the full knowledge of the Board and the stockholders. In addition to the information regularly provided in proxy statements, prospectuses and Form N-1R, the manager has reported from time to time and the Board has approved these practices. The specific allocations to individual brokers are made by the fund’s officers without prior review by the directors but in accord with the general policy approved by the Board. We quote from the SEC release as follows: “Many mutual fund managers believe that so long as this type of sales incentive can be given to dealers, competition among mutual fund managers for the favor of dealers will make it difficult, if not impossible, for any individual fund manager to fail to provide such compensation to dealers, both members and nonmembers of exchanges, selling shares of his funds.” We agree completely with this statement. Regardless of the merits of this method of doing business, it is not practical to attempt a change for Chemical Fund at this time even though we recognize that it would be possible to request the manager to execute some portfolio transactions as a member of the New York Stock Exchange or request give-ups on portfolio transactions which would be credited against the amount of the management fee. We believe that the directors must look upon this question realistically and in proper perspective. Chemical Fund has a very low portfolio turnover rate. The Board retains close control over that rate of turnover. We are mindful of the fact that through the portfolio committee as presently constituted the unaffiliated directors have, in effect, power over portfolio transactions and this power has been frequently exercised. Therefore, management does not really exercise complete control over the generation of commission business for the purpose of stimulating sales. While we recognize fully that allocation of the purchase and sale orders is an additional resource to the distributor, we are not impressed with either its size or the possibility of abuse. We propose therefore, no change in this arrangement and recommend approval of a continuation of the past practice of leaving the allocation of brokerage commission business to the officers of the Fund. The report concluded by recommending renewal of the existing contracts for another year. The interested directors withdrew from the meeting during the discussion of the management and distribution agreements. After discussion, the board, with only independent directors voting, unanimously approved the continuance until March 81,1969 of the existing management and distribution agreements. At a board meeting on July 17, 1968, Dr. Murray made reference to hearings being conducted by the SEC with respect to the level of NYSE commission rates and the use of give-ups by mutual fund managers and distributors. He reminded the board that this subject had been dealt with in the February 21,1968 subcommittee report, and stated that he saw no reason to make any change in the practice of leaving the allocation of brokerage business to the officers of the Fund, as recommended in that report. After discussion, the unaffiliated directors again unanimously approved the continuation of this practice. On December 5, 1968, the constitution of the NYSE was amended to prohibit customer directed give-ups. In a cover letter dated January 10, 1969 which accompanied the material furnished for the annual review of operations, Francis S. Williams, then chairman of M&D, informed the Murray/Dorsett subcommittee that the use of give-ups was abandoned on December 5, 1968 to conform to the new NYSE stance. He also suggested to the unaffiliated directors that it was in the best interests of the Fund and its shareholders to have the Manager direct the brokerage business in such a way as to obtain the best price and execution. However, in selecting such brokers the extent to which such dealers have sold shares of the Fund or have provided statistical and research information will continue to be important factors. The subcommittee’s written report of February 19, 1969 accepted this recommendation. The cover letter from M&D of January 9, 1970 and the subcommittee’s report of January 22, 1970 were similar to their 1969 counterparts, and basically recommended continuation of existing policies. At a board meeting on February 18, 1970, the unaffiliated directors, relying on this subcommittee report, unanimously adopted a new management agreement and approved the continuance of the existing distribution agreement. The cover letter of January 15, 1971 accompanying the material furnished by M&D to the subcommittee to review operations stated that a summary of Judge Wyzanski’s district court opinion in Moses v. Burgin, supra, had been recently distributed to the board of directors. The district court there held that the decision to recapture or not was a matter of business judgment for the board of directors, and that the board members did not breach their fiduciary duties by permitting portfolio brokerage to be used to acquire statistical information and assist sales — provided that best execution was obtained. The.letter pointed out to the subcommittee the possibility of recapture, but recommended that the unaffiliated directors continue the current use of brokerage commissions. The subcommittee to review operations, which now consisted of Murray and Driscoll, prepared a written report to the board dated February 17,1971 which recommended no change in the method of directing brokerage business. It noted that, because of a relatively low rate of portfolio turnover, the volume of commissions paid was small for a mutual fund of Chemical Fund’s size, and reasoned that [w]ith so many proposals under discussion regarding negotiated commission rates, institutional membership, and the possibility of “unbundling,” we believe that it would be unwise to alter present arrangements. The report also suggested, however, that the subject of brokerage allocation “be reviewed promptly in light of any developments during the year.” At the board meeting of June 16, 1971, the chairman, Williams, referred to the First Circuit’s decision in Moses v. Burgin, copies of which had been previously mailed to the directors. Copies of the Sullivan & Cromwell opinion letter dated February 20, 1968 were again distributed to the board at the meeting. Williams suggested that in the light of Judge Aldrich’s decision it would be advisable to appoint a committee of unaffiliated directors to again review the Fund’s practices with respect to brokerage, to consult with Sullivan & Cromwell regarding brokerage practices, and to consider the various alternatives available. A committee of independent directors, consisting of Dr. Murray as chairman, Driscoll, and Fox, was then appointed. On July 21, 1971, Robert C. Porter, then president of the Fund, reported to the board that a meeting had been scheduled with the NYSE to explore the question of whether it would be permissible, if the Fund did some of its brokerage business with Eberstadt as a member of the Exchange, to credit a portion of the commissions against the management fee payable by the Fund. He also reviewed a proposed settlement, involving recapture by means of executing portfolio transactions on regional exchanges, in a case against two other funds. On July 30, 1971, Porter received from David D. Huntoon, assistant vice-president and associate d