MR. JUSTICE BRENNAN delivered the opinion of the Court.
The question presented in this case is whether the disinterested directors of an investment company may terminate a stockholders' derivative suit brought against other directors under the Investment Company and Investment Advisers Acts of 1940, 15 U. S. C. § 80a-1 et seq.; 15 U. S. C. § 80b-1 et seq. To decide that question, we must determine the appropriate roles of federal and state law in such a controversy.
Respondents, shareholders of Fundamental Investors, Inc., an investment company registered under the Investment Company Act, brought this derivative suit in February 1973 in the District Court for the Southern District of New York. The action was brought against several members of the company's board of directors and its registered investment adviser, Anchor Corp. The complaint alleged that the defendants had violated their duties under the Investment Company Act (ICA),
The District Court held that under the so-called "business judgment rule," a quorum of truly disinterested and independent directors has authority to terminate a derivative suit which they in good faith conclude is contrary to the company's
A fundamental issue in this case is which law—state or federal—governs the power of the corporation's disinterested directors to terminate this derivative suit. The first step in making that determination is to ascertain which law creates the cause of action alleged by the plaintiffs. Neither the ICA nor the IAA—the plaintiff's two federal claims—expressly creates a private cause of action for violation of the sections relevant here. However, on the basis of District and Circuit precedent, the courts below assumed that an implied private right of action existed under each Act. Brown v. Bullock, 194 F.Supp. 207, 222-228 (SDNY), aff'd, 294 F.2d 415 (CA2 1961) (en banc) (ICA); Abrahamson v. Fleschner, 568 F.2d 862 (CA2 1977) (IAA); Bolger v. Laventhol, Krekstein, Horwath & Horwath, 381 F.Supp. 260 (SDNY 1974) (IAA). The two courts also sanctioned the bringing of the suit in derivative form, apparently assuming that, as we held in J. I. Case Co. v. Borak, 377 U.S. 426, 432 (1964), "[t]o hold that derivative actions are not within the sweep of the [right] would . . . be tantamount to a denial of private relief." As petitioners never disputed the existence of private, derivative causes of action under the Acts, and as in this Court all agree
Since we proceed on the premise of the existence of a federal cause of action, it is clear that "our decision is not controlled by Erie R. Co. v. Tompkins, 304 U.S. 64," and state law does not operate of its own force. Sola Electric Co. v. Jefferson Co., 317 U.S. 173, 176 (1942). See Board of Comm'rs v. United States, 308 U.S. 343, 349-350 (1939); Deitrick v. Greaney, 309 U.S. 190, 200 (1940); C. Wright, Federal Courts 284 (3d ed. 1976); Mishkin, The Variousness of "Federal Law": Competence and Discretion in the Choice of National and State Rules for Decision, 105 U. Pa. L. Rev. 797, 799-800 (1957); Hart, The Relations Between State and Federal Law, 54 Colum. L. Rev. 489, 529 (1954); 2 L. Loss, Securities Regulation 971 (2d ed. 1961). Rather, "[w]hen a federal statute condemns an act as unlawful, the extent and nature of the legal consequences of the condemnation, though left by the statute to judicial determination, are nevertheless federal questions, the answers to which are to be derived from the statute and the federal policy which it has adopted." Sola
The fact that "the scope of [respondents'] federal right is, of course, a federal question" does not, however, make state law irrelevant. De Sylva v. Ballentine, 351 U.S. 570, 580 (1956). Cf. United States v. Kimbell Foods, Inc., supra, at 727-728. It is true that in certain areas we have held that federal statutes authorize the federal courts to fashion a complete body of federal law. See Textile Workers v. Lincoln Mills, 353 U.S. 448, 451, 456-457 (1957). Corporation law, however, is not such an area.
A derivative suit is brought by shareholders to enforce a claim on behalf of the corporation. See Note, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U. Chi. L. Rev. 168 (1976). This case involves the question
Federal regulation of investment companies and advisers is not fundamentally different in this respect. Mutual funds, like other corporations, are incorporated pursuant to state, not federal, law. Although the Court of Appeals found it significant that "nothing in . . . the legislation regulating investment companies and their advisers . . . suggests that . . . disinterested directors . . . have the power to terminate litigation brought by mutual fund stockholders . . . ." 567 F. 2d, at 1210, such silence was to be expected. The ICA does not purport to be the source of authority for managerial power; rather, the Act functions primarily to "impos[e] controls and restrictions on the internal management of investment companies." United
The ICA and IAA, therefore, 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, 465 (1975).
The foregoing indicates that the threshold inquiry for a federal court in this case should have been to determine whether state law permitted Fundamental's 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 ICA and IAA. Neither the District Court nor the Court of Appeals decided the first question, apparently because neither considered state law particularly significant in determining the authority of the independent directors to terminate the action.
The Court of Appeals correctly noted, 567 F. 2d, at 1210-1211, that Congress was concerned about the potential for abuse inherent in the structure of investment companies. A mutual fund is a pool of assets, consisting primarily of portfolio securities, and belonging to the individual investors holding shares in the fund. Tannenbaum v. Zeller, 552 F.2d 402, 405 (CA2 1977). Congress was concerned because
As a consequence, "[t]he relationship between investment advisers and mutual funds is fraught with potential conflicts of interest," Galfand v. Chestnutt Corp., 545 F.2d 807, 808 (CA2 1976). See generally S. Rep. No. 91-184, supra, at 5; H. R. Rep. No. 2337, 89th Cong., 2d Sess., 9, 45-46, 64 (1966); H. R. Doc. No. 136, 77th Cong., 1st Sess., 2485-2490, 2569, 2579-2580, 2775 (1942); Hearings before a Subcommittee of the House Committee on Interstate and Foreign Commerce on H. R. 10065, 76th Cong., 3d Sess., 58-59 (1940); Securities and Exchange Commission, Report on Investment Trusts and Investment Companies, pt. 3, pp. 1-49 (1940); 15 U. S. C. § 80a-1 (b) (findings and declaration of policy).
The cornerstone of the ICA's effort to control conflicts of interest within mutual funds is the requirement that at least 40% of a fund's board be composed of independent outside directors.
Attention must be paid as well to what Congress did not do. Congress consciously chose to address the conflict-of-interest problem through the Act's independent-directors section, rather than through more drastic remedies such as complete disaffiliation of the companies from their advisers or compulsory internalization of the management function. See Report of the SEC on the Public Policy Implications of Investment Company Growth, H. R. Rep. No. 2337, 89th Cong., 2d Sess., 147-148 (1966). Congress also decided not to incorporate into the 1940 Act a provision, proposed by the
Congress' purpose in structuring the Act as it did is clear. It "was designed to place the unaffiliated directors in the role of `independent watchdogs,' " Tannenbaum v. Zeller, 552 F. 2d, at 406, who would "furnish an independent check upon the management" of investment companies, Hearings on H. R. 10065 before a Subcommittee of the House Committee on Interstate and Foreign Commerce, 76th Cong., 3d Sess., 109 (1940). This "watchdog" control was chosen in preference to the more direct controls on behavior exemplified by the options not adopted. Indeed, when by 1970 it appeared that the "affiliated person" provision of the 1940 Act might not be adequately restraining conflicts of interest, Congress turned not to direct controls, but rather to stiffening the requirement of independence as the way to "remedy the act's deficiencies." S. Rep. No. 91-184, pp. 32-33 (1969).
In short, the structure and purpose of the ICA indicate that
We hold today that federal courts should 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 IAA. Moreover, we hold that Congress did not require that States, or federal courts, absolutely forbid director termination of all nonfrivolous actions. However, since "[w]e did not grant certiorari to decide [a question of state law]," Butner v. United States, 440 U.S. 48, 51 (1979), and since neither the District Court nor the Court of Appeals decided the point,
Reversed and remanded.
MR. JUSTICE REHNQUIST took no part in the consideration or decision of this case.
MR. JUSTICE BLACKMUN, concurring.
I join the Court's opinion and its judgment. In so doing, I read that opinion to hold that on remand the Court of Appeals is free to determine and, indeed, should determine what the state law in this area requires, and then whether that state law is consistent with the policies of the Investment Company
MR. JUSTICE STEWART, with whom MR. JUSTICE POWELL joins, concurring in the judgment.
The Investment Company Act of 1940 and the Investment Advisers Act of 1940 are silent on the question whether the disinterested directors of an investment company may terminate a stockholders' derivative suit. The inquiry thus must turn to the relevant state law. I cannot agree with the implications in the Court's opinion, ante, at 480, 481-482, 486, that there is any danger that state law will conflict with federal policy.
The business decisions of a corporation are normally entrusted to its board of directors. A decision whether or not a corporation will sue an alleged wrongdoer is no different from any other corporate decision to be made in the collective discretion of the disinterested directors. E. g., Swanson v. Traer, 354 U.S. 114, 116; United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263; McKee v. Rogers, 18 Del. Ch. 81, 156 A. 191 (1931); Rice v. Wheeling Dollar Savings & Trust Co., 130 N.E.2d 442 (Ohio Ct. Com. Pleas 1954); Goodwin v. Castleton, 19 Wn.2d 748, 144 P.2d 725 (1944).
On remand, the issue will be whether the state law here applicable recognizes this generally accepted principle and thereby empowers the directors to terminate this stockholder suit. Since Congress intended disinterested directors of mutual funds to be "independent watchdogs," ante, at 484, I can see no possible conflict between this generally accepted principle of state law and the federal statutes in issue.
"No registered investment company shall have a board of directors more than 60 per centum of the members of which are persons who are interested persons of such registered company." 15 U. S. C. § 80a-10 (a).
The definition of "interested person" is found at 15 U. S. C. § 80a-2 (a) (19). See n. 12, infra.
Of the remaining six directors, five were defendants in the Lasker suit, and one was a director of the investment adviser. 404 F.Supp. 1172, 1175 (1975).
"(i) any affiliated person of such company,
"(ii) any member of the immediate family of any natural person who is an affiliated person of such company,
"(iii) any interested person of any investment adviser of or principal underwriter for such company,
"(iv) any person or partner or employee of any person who at any time since the beginning of the last two fiscal years of such company has acted as legal counsel for such company,
"(v) any broker or dealer registered under the Securities Exchange Act of 1934 or any affiliated person of such a broker or dealer, and
"(vi) any natural person whom the Commission by order shall have determined to be an interested person by reason of having had, at any time since the beginning of the last two fiscal years of such company, a material business or professional relationship with such company or with the principal executive officer of such company or with any other investment company having the same investment adviser or principal underwriter or with the principal executive officer of such other investment company."
Title 15 U. S. C. § 80a-2 (a) (2) states that " `[a]ffiliated company' means a company which is an affiliated person," and 15 U. S. C. § 80a-2 (a) (3) defines " `affiliated person' of another person" as
"(A) any person directly or indirectly owning, controlling, or holding with power to vote, 5 per centum or more of the outstanding voting securities of such other person; (B) any person 5 per centum or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote, by such other person; (C) any person directly or indirectly controlling, controlled by, or under common control with, such other person; (D) any officer, director, partner, copartner, or employee of such other person; (E) if such other person is an investment company, any investment adviser thereof or any member of an advisory board thereof; and (F) if such other person is an unincorporated investment company not having a board of directors, the depositor thereof."