Weiss v. Temporary Investment Fund, Inc.

OPINION OF THE COURT EDWARD R. BECKER, Circuit Judge. The principal question presented in this appeal is whether a shareholder of an investment company must make a demand on directors pursuant to Fed.R.Civ.P. 23.1 prior to commencing suit under section 36(b) of the Investment Company Act of 1940 (ICA), 15 U.S.C. §§ 80a-35(b) (1976), to challenge the company’s contracts with its investment advisers. The district judge dismissed the action for failure to satisfy the demand requirement, Weiss v. Temporary Investment Fund, Inc., 516 F.Supp. 665 (D.Del. 1981), and denied the appellant leave to replead after making a demand, Weiss v. Temporary Investment Fund, Inc., 520 F.Supp. 1098 (D.Del.1981). Appellant Weiss contends that the ICA was a product of Congress’ recognition of potential conflicts of interest in the management of investment companies and that the ICA’s legislative history and statutory scheme, which reflect that concern, are inconsistent with the requirement of shareholder demand. After reviewing that legislative history and statutory scheme and the purposes of the demand requirement, we perceive no such inconsistency. We conclude that the contributions of the demand requirement to corporate governance mandate application of Rule 23.1 to section 36(b) suits. We also conclude that the circumstances alleged in the complaint do not warrant excusing such a demand as futile, and the district judge did not err in denying leave to replead. We therefore affirm. [931] I. INTRODUCTION A. Factual and Procedural Background Plaintiff-appellant Melvyn I. Weiss, as custodian for his son Gary Michael Weiss, is a shareholder of the Temporary Investment Fund, Inc. (the Fund). The Fund is a no-load open-end investment company, commonly referred to as a “money market fund,” whose objective is to increase the current income of its shareholders through investments in a variety of prime money market obligations. The Fund is managed by a seven-member board of directors elected by its shareholders.1 Under an Advisory Agreement, the management of the Fund’s portfolio is entrusted to its investment adviser, Provident Institutional Management Corporation (the Adviser), a wholly-owned subsidiary of Provident National Bank (Provident). Under a sub-advisory agreement, Provident receives seventy-five percent of the Adviser’s fees, in return for which it supplies, inter alia, investment research services, computer facilities, and operating personnel. Shearson Loeb Rhoades, Inc. (Shearson) serves as underwriter for the Fund and performs other administrative functions under its Administration and Distribution Agreement with the Fund. The terms of the Advisory and Administration Agreements (collectively referred to as “advisory contracts”) provide that the fees received by the Adviser and Shearson are computed as a percentage of the Fund’s assets. The percentage rate is scaled downward: Shearson and the Adviser each received .175 percent of the first $300 million in assets, .15 percent of the next $300 million, and .125 percent of the third $300 million. For average net assets in excess of $900 million, the rate is fixed at .1 percent. The recent popularity of money market funds has dramatically increased the Fund’s assets, to more than $2 billion when suit was commenced in 1980. This phenomenon has produced a commensurate increase in the fees received by the Adviser and Shear-son. On May 7, 1980, Weiss brought a shareholder suit on behalf of the Fund against the Adviser, Shearson, and seven directors of the Fund. One count of the complaint charges that Shearson and the Adviser breached their fiduciary duties to the Fund under section 36(b) of the ICA by receiving “excessive and unreasonable” compensation. The basis of this count is the advisory contracts, which Weiss contends permit the Adviser to receive twenty-five percent of the fees without performing any services and fail to provide for any reduction in fees after the Fund’s assets exceed $900 million. Additional counts allege that all defendants breached their fiduciary duties by participating or acquiescing in the advisory contracts; that shareholder approval of the fee arrangements was secured through misleading proxy statements in violation of section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a) (1976); and that the management and fee arrangements violate the Banking Act of 1933, 12 U.S.C. §§ 24, 378(a) (1976), the ICA, and common law fiduciary duties. As relief, the plaintiff sought a judgment declaring the Advisory Agreement and the Distribution Agreement void, an order requiring that the Adviser and Shearson repay all excessive fees to the Fund, and an order requiring the individual defendants to reimburse the Fund for damages caused by their violations of the ICA and the Securities Exchange Act. The complaint acknowledges that no demand was made on the directors of the Fund. It asserts, however, that demand is not a prerequisite for the section 36(b) count and that demand would have been futile as to all counts because the directors are controlled by the Fund’s advisers and because they participated in the alleged violations. Amended Complaint at ¶ 37. The defendants moved to dismiss the complaint on a number of grounds, including the plaintiff’s failure to satisfy the Rule [932] 23.1 demand requirement. The district court, concluding that demand is required for a section 36(b) suit and was not excused as futile, dismissed the complaint.2 Having determined that intra-corporate remedies should be exhausted first, the court found it unnecessary to address the other challenges to the complaint. The court subsequently denied Weiss’ motion seeking leave to make a demand on the directors and to file an amended complaint if demand was refused. Weiss appeals from all three rulings. As we indicated at the outset, section 36(b) is the principal focus of our attention. Its relevant portions are set forth in the margin.3 Although section 36(b) does not explicitly excuse shareholders from the demand requirement of Rule 23.1, Weiss advances two theories to support his position that demand is not required. First, he argues that because the statute does not authorize a cause of action by the corporation, a section 36(b) suit is not derivative and is thus not governed by Rule 23.1 at all. Alternatively, he asserts that the legislative history and the statutory scheme supersede the policies underlying the requirement of shareholder demand. Although he presents a number of discrete arguments to support this latter thesis, their common predicate is that Congress, perceiving directors of investment companies to be ineffective checks on advisory fee levels, structured section 36(b) to permit shareholders to bypass the directors. Before considering Weiss’ specific contentions, we must describe the contours of section 36(b) and other relevant provisions of the ICA. B. The Statutory Scheme The management of an investment company is distinguished by its reliance on external management and investment advisers. See, e.g., Burks v. Lasker, 441 U.S. 471, 480-85, 99 S.Ct. 1831, 1838-41, 60 L.Ed.2d 404 (1979); Tannenbaum v. Zeller, 552 F.2d 402 (2d Cir.), cert. denied, 434 U.S. 934, 98 S.Ct. 421, 54 L.Ed.2d 293 (1977); Note, Mutual Fund Independent Directors: Putting a Leash on the Watchdogs, 47 Fordham L.Rev. 568 (1979) [hereinafter cit [933] ed as Fordham Note]. Typically, an external organization such as Shearson creates the investment fund and appoints the initial board of directors. The board then enters into a contract with one or more external companies who manage the fund and provide investment services. In addition to receiving fees for these two functions (which may be performed by the same outside adviser), the independent advisers may receive underwriting fees or brokerage commissions if they also serve in those capacities. This web of financial ties among the fund and its advisers invites several conflicts of interest. In negotiating advisory fees, for example, directors affiliated with the adviser face the competing interests of the adviser, who seeks high fees, and the investors, who want low fees in order to maximize their return on investment. Similarly, an adviser who also serves as broker has an incentive to increase its fees through frequent portfolio transactions that may dissipate the earnings of the investors. See Fordham Note, supra p. 932, at 570-71. The ICA was intended to minimize the potential conflicts arising from the creation, sale, and management of an investment company such as a mutual'fund by external investment advisers. S.Rep. No. 184, 91st Cong., 1st Sess., reprinted in 1970 U.S.Code Cong. & Ad.News 4897, 4901. As originally enacted in 1940, the ICA’s principal device to prevent self-dealing by the directors was the requirement that at least forty percent of the board members be independent — that is, that they have neither a direct nor an indirect financial interest in the company or its adviser. 15 U.S.C. § 80a-10(a) (1976). Over time, however, it became apparent that this safeguard was insufficient to stem the burgeoning advisory fees. Recognizing that a company’s dependency on its adviser limited the influence of arms-length bargaining in keeping, advisory fees competitive, Congress enacted section 36(b) as part of the 1970 amendments to the ICA. That section imposes on the adviser a fiduciary duty with respect to compensation for its services and explicitly authorizes suits by the Securities and Exchange Commission and the fund’s shareholders to enforce that duty. By increasing the standard of care owed by the advisers, Congress sought to ease the difficult burden faced by shareholders trying to prove that advisory contracts violated common law prohibitions against “corporate waste.” See infra note 9. The remedy under 36(b) is an action against the recipient of the allegedly excessive payments for actual damages resulting from the breach of fiduciary duty, not to exceed actual payments received from the investment company. A showing of personal misconduct by the defendant is not required. The recovery of excessive fees is limited to those paid by the investment company during the one-year period prior to initiation of the suit. Additional responsibility for monitoring management fees were also imposed on directors. The 1970 amendments require directors to investigate and evaluate advisory fee contracts, demand that a majority of disinterested directors approve the contracts, and permit the directors to terminate contracts without financial penalty upon sixty days’ notice. 15 U.S.C. § 80a-15(c) (1976). The amendments also tightened the qualifications of the independent directors serving on the board. Id. §§ 80a-2(19), 80a-10(a).4 The essence of the amendments, as the Supreme Court has noted, is to place these unaffiliated directors in. the role of “independent watchdogs” charged with supervising the management of the company. Burks v. Lasker, supra, 441 U.S. at 484, 99 S.Ct. at 1840. With this background in mind, we turn to Weiss’ arguments that suits under section 36(b) are not subject to Rule 23.1. II. IS A SECTION 36(b) ACTION DERIVATIVE? Before addressing the arguments set forth in the briefs, we must consider a [934] threshold contention — advanced by Weiss for the first, time at oral argument — that a shareholder suit under section 86(b) is not a derivative action and thus is not subject to Rule 23.1.5 Weiss apparently relies on the rule’s requirement that the right enforced by a shareholder be one which “may properly be asserted” by the corporation.6 The ICA, however, explicitly authorizes suits only by the SEC and by the shareholders and does not state that the Fund itself may sue its advisers for breach of fiduciary duties. If the Fund cannot sue, Weiss’ theory proceeds, then a section 36(b) cause of action does not derive from a right that “may properly be asserted” by the Fund. We disagree. We can approach this issue in several ways. One approach, adopted by the First Circuit in Grossman v. Johnson, 674 F.2d 115 (1st Cir.1982), cert. denied, - U.S. -, 103 S.Ct. 85, 74 L.Ed.2d 80 (1982), views an investment company’s right to sue its advisers as a necessary, if not explicit, corollary of the right of action conferred on shareholders by section 36(b). In holding that an investment company has a direct cause of action under section 36(b), the Grossman court stated: We cannot believe ... that, for example, a new and independent board of directors, intent on recovering excessive fees from the investment adviser, would be precluded from suing under section 36(b). That section is explicit that recovery by a shareholder is to be on behalf of the investment company and that his suit must be brought on the same behalf. With those clear requirements, Congress could well have believed that, though it was appropriate to specify that the Commission and shareholders had the new statutory cause of action under section 36(b), see Moses v. Burgin, 445 F.2d 369, 373 n. 7 (1st Cir.1971), it was unnecessary to say with particularity that the company also did. A suit ‘on behalf of such company’ (a phrase which is more than merely one ‘for the benefit of the company’) is normally a derivative action that the company could itself bring. Id. at 120 (footnotes omitted).7 Along similar lines, the Supreme Court noted in Burks v. Lasker, supra, 441 U.S. at 477, 99 S.Ct. at 1836, that “[a] derivative suit is brought by shareholders to enforce a claim on behalf of the corporation” (emphasis áupplied), and the Court thereafter referred without comment to a section 36(b) suit as derivative, id. at 484, 99 S.Ct. at 1840. We agree with the First Circuit’s reasoning as far as it goes, but we expand our analysis to consider the test enunciated in Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975). Cort provides the generally accepted framework for determining whether a statute creates an implied right of action.8 Our application of the Cort test [935] leads us to the same conclusion as the First Circuit. Cort counsels consideration of four factors: First, is the plaintiff ‘one of the class for whose especial benefit the statute was enacted,’ — that is, does the statute create a federal right in favor of the plaintiff? Second, is there any indication of legislative intent,'explicit or implicit, either to create such a remedy or to deny one? Third, is it consistent with the underlying purposes of the legislative scheme to imply such a remedy for the plaintiff? And finally, is the cause of action one traditionally relegated to state law, in an area basically the concern of the States, so that it would be inappropriate to infer a cause of action based solely on federal law. Cort v. Ash, supra, 422 U.S. at 78, 95 S.Ct. at 2088 (citations omitted). With respect to the first factor, we have no difficulty in concluding that an investment company is the intended beneficiary of section 36(b). The legislative history states that the fiduciary duty imposed on advisers, one of the major innovations of the statute, is owed to the company itself. S.Rep.No. 184, 91st Cong., 1st Sess., reprinted in 1970' U.S.Code Cong. & Ad.News 4897, 4902. Moreover, as Weiss concedes, any recovery obtained in a shareholder suit reverts to the investment company and not to the plaintiff. The second factor, ascertainment of Congress’ intent, is the principal focus of the Cort inquiry. Merrill Lynch, Pierce, Fenner & Smith v. Curran, - U.S. -, 102 S.Ct. 1825, 1839, 72 L.Ed.2d 182 (1982); see Walck v. American Stock Exchange, Inc., 687 F.2d 778, at 781, 783 (3d Cir.1982). We find nothing in the legislative history of the ICA that suggests an intent to deprive the company of a direct remedy. Neither, we must concede, do we find an explicit expression by Congress that the investment company is authorized to sue its adviser. But our conclusion is unaffected by this absence of express authorization for, as the Supreme Court noted in canvassing the same legislative history, silence regarding the powers of the board of directors is 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.’ ” Burks v. Lasker, supra, 441 U.S. at 478, 99 S.Ct. at 1837 (citation omitted) (emphasis in original). Thus we may properly infer from this legislative silence that Congress did not intend to restrict the company’s right to sue. The state of the law at the time of the 1970 amendments supports this construction of the legislative history. We are required to look at this “contemporary legal context” to determine whether the company had a right to sue when the statute was enacted. If such a right existed, we need only determine whether Congress intended to preserve the preexisting remedy. See Merrill Lynch, Pierce, Fenner & Smith v. Curran, supra, 102 S.Ct. at 1839. In this regard, we agree with the district court’s observation, see 516 F.Supp. at 670 n. 11, that the company possessed (and still possesses) a cause of action against the adviser at common law.9 We also note that a shareholder’s right to sue derivatively was implied by former section 36 (now section 36(a)), which [936] authorizes SEC enforcement of the ICA’s regulatory scheme. See, e.g., Moses v. Burgin, 445 F.2d 369 (1st Cir.1971) (finding implied right of action under former section 36 for shareholder to sue derivatively to recapture excessive brokerage fees paid by the mutual fund). “Where Congress adopts a new law incorporating sections of a prior law, Congress can be presumed to have had knowledge of the interpretation given to the incorporated law, at least insofar as it affects the new statute.” Merrill Lynch, Pierce, Fenner & Smith v. Curran, supra, 102 S.Ct. at 1841 n. 66. Against this legal backdrop at the time of the amendments, Congress’ assumption that the shareholder suit was derivative from the company’s right of action becomes clear, as does the correctness of the First Circuit’s conclusion that Congress assumed the company enjoyed a direct cause of action and there was no need to so specify. In sum, the second Cort criterion is met for the reasons set forth by the First Circuit in Grossman and because we find no evidence of a Congressional intent to deprive the company of its right to sue the company’s adviser. The third and fourth factors of the Cort test follow ineluctably from the preceding discussion. Providing the investment company with a cause of aetion fully accords with the purposes of section 36(b) by providing another means to recover excessive advisory fees. From a practical standpoint, in fact, the company’s financial resources and knowledge of the challenged transactions may render it an even more effective litigant than the shareholder. Finally, the express cause of action conferred by Congress upon shareholders ipso facto federalizes this type of litigation; hence implication of a companion remedy for the investment company does not intrude upon an area “traditionally relegated to state law.” Thus application of the four-pronged test of Cort v. Ash compels us to conclude that the investment company has a cause of action against the advisers for breach of the fiduciary duties imposed by section 36(b). We are aware that the Court of Appeals for the Second Circuit recently reached the opposite conclusion. Fox v. Reich & Tang, Inc., 692 F.2d 250 (2d Cir.1982). After careful consideration of the court’s reasoning, however, we remain convinced that the investment company has a cause of aetion and that a § 36(b) action is derivative. III. IS SECTION 36(b) CONSISTENT WITH THE DEMAND REQUIREMENT? Even if a section 36(b) suit is derivative, Weiss insists that the ICA excuses such suits from the Rule 23.1 demand requirement. As we have noted, he concedes that the statute does not do so expressly, but contends that the legislative history and statutory scheme of section 36(b) manifest Congress’ intent to eliminate this prerequisite to suit. At the outset we note that Weiss must overcome the presumption that Rule 23.1, like all Federal Rules of Civil Procedure, applies to any civil suit brought in federal district court unless inconsistent with an Act of Congress. Fed.R.Civ.P. 1; see 28 U.S.C. § 2072 (1976). Abrogation of a rule of procedure generally is inappropriate “[i]n the absence of a direct expression by Congress of its intent to depart from the usual course of trying ‘all suits of a civil nature’ under the Rules established for that purpose.” Califano v. Yamasaki, 442 U.S. 682, 683, 700, 99 S.Ct. 2545, 2548, 2557, 61 L.Ed.2d 176 (1979). Repugnancy of a statute to a civil rule is not to be lightly implied. Rather, “a subsequently enacted statute should be so construed as to harmonize with the Federal Rules if that is at all feasible.” Grossman v. Johnson, supra, 674 F.2d at 122-23 (quoting 7 Moore’s Federal Practice ¶ 86.04[4] at 86-22 (2d ed. 1980)); accord Fox v. Reich & Tang, Inc., 94 F.R.D. 94 (S.D.N.Y.1982), rev’d on other grounds, 692 F.2d 250 (2d Cir.1982). A. Does the Legislative History Reflect Congress’ Intent to Require Demand? Weiss relies first on the legislative history accompanying the 1970 amendments, passages of which reflect Congress’ [937] perception that even unaffiliated directors had not been able to secure changes in the advisory fee levels. For example, he quotes from the Securities and Exchange Commission Report on Investment Companies, H.R. Rep. No. 2337, 89th Cong., 2d Sess. (1966): It has been the Commission’s experience in the administration of the Act that in general the unaffiliated directors have not been in a position to secure changes in the level of advisory fee rates in the mutual fund industry. The analysis of the shareholder fee litigation not only underscores the need for changes in existing statutory provisions relating to management compensation in the investment company industry, but points to the direction which these changes should take. It makes clear the need to incorporate into the Act a clearly expressed and readily enforceable standard that would measure the fairness of compensation paid by investment companies for services furnished by those who occupy a fiduciary relationship to such companies. The right of the Commission as well as investment company shareholders to take action against violations of the statutory standard of reasonableness is essential to effective enforcement. Id. at 131, 143, 146 (emphasis supplied by appellant). Second, he invokes the Congressional intention to establish a mechanism by which the shareholders and courts could enforce the investment adviser’s fiduciary duty. The report accompanying the 1970 amendments states: In the case of management fees, the committee believes that the unique structure of mutual funds has made it difficult for the courts to apply traditional fiduciary standards in considering questions concerning management fees. Therefore your committee has adopted the basic principle that, in view of the potential conflicts of interest involved in the setting of these fees, there should be effective means for the court to act where mutual fund shareholders or the SEC believe there has been a breach of fiduciary duty. S.Rep. No. 184, 91st Cong., 1st Sess., reprinted in 1970 U.S.Code Cong. & Ad.News 4897, 4898 (emphasis supplied by appellant). These passages do not reflect a “direct expression by Congress” of its intent to eliminate the demand requirement. Expressions that shareholders and the SEC need increased judicial access in order to insure the reasonableness of advisory fees do not denote an intent to bypass the directors completely. On the contrary, the legislative history is replete with references to Congress’ intent to preserve, not preempt, the role of management in negotiating advisory fees. The Senate Report emphasizes this point: [Section 36(b) ] is not intended to authorize a court to substitute its business judgment for that of the mutual fund’s board of directors in the area of management fees.... Indeed, this section is designed to strengthen the ability of the unaffiliated directors to deal with these matters and to provide a means by which the Federal courts can effectively enforce the federally-created fiduciary duty with respect to management compensation. The section is not intended to shift the responsibility for managing an investment company in the best interest of its shareholders from the directors of such company to the judiciary. S.Rep.No. 184, 91st Cong., 1st Sess., reprinted in 1970 U.S.Code Cong. & Ad.News 4897, 4902-03. The clear intent of Congress was to install management as “the first line of defense for the individual investor” against any self-dealing by the adviser. Fox v. Reich & Tang, Inc., supra, 94 F.R.D. at 96. As the Supreme Court noted in Burks v. Lasker, supra, 441 U.S. at 484-85, 99 S.Ct. at 1840, the 1970 amendments were designed to place the unaffiliated directors in a “watchdog” role. Requiring that shareholders make a demand upon the directors is fully consonant with this purpose. [938] Requiring demand also accords with the legislative history, which itself alludes to the continued operation of the demand requirement. During Congressional hearings on the proposed amendments to the ICA, then SEC Chairman Hamer Budge assured the committee that providing shareholders with a cause of action would not encourage nuisance suits: “As we have pointed out previously, there are adequate safeguards under the Federal Rules of Civil Procedures [sic] and under this bill to prevent unjustified shareholder litigation.” Hearings on H.R. 11995, S. 2224, H.R. 13754 and HR. 14737 Before the Subcomm. of Commerce and Finance of the House Comm, on Interstate and Foreign Commerce, 91st Cong., 1st Sess. 201 (1969); accord id. at 860. It is clear to us that this statement refers to Rule 23.1 and its demand requirement. Contrary to Weiss’ suggestion, the legislative history reflects an implicit understanding that Rule 23.1 would apply — an understanding which comports with the purposes of section 36(b). B. Is the Statutory Scheme Consistent with the Requirement of Shareholder Demand? Weiss’ final arguments regarding the alleged inapplicability of Rule 23.1 spring from his contention that the structure of section 36(b) is inconsistent with the requirement of shareholder demand, and that Congress therefore did not contemplate demand as a prerequisite to suit. Weiss makes three arguments. The first two require only brief discussion; the third merits more extensive treatment. 1. The Effect of the One-Year Limitation on Recovery Weiss asserts that demand cannot be required because: (1) section 36(b) limits the recovery of unreasonable fees to those that were paid during the one-year period prior to commencement of suit; (2) once a shareholder plaintiff makes a demand, the directors can delay a response while the excessive fees continue to be paid; and (3) Congress could not have intended to interpose the demand requirement because the time consumed by the directors in responding to demand would time-bar claims to recover fees paid out by the investment fund. At least one court has identified this statutory provision as a basis for suggesting, in dictum, that demand should not be a prerequisite to a section 36(b) suit. See Blatt v. Dean Witter Reynolds Intercapital, Inc., 528 F.Supp. 1152, 1155 (S.D.N.Y.1982). We recognize that in some cases, demand will postpone the filing of suit and thereby move forward the one-year period allowed for the recovery of fees. In most instances, however, this will not reduce the allowable recovery. In any event, we do not see why demand cannot be promptly made and expeditiously considered.10 Notwithstanding Weiss’ intimations to the contrary, demand is a simple procedure that is not burdensome to the shareholders. We therefore do not believe that the one-year limitation period compels the conclusion that Congress intended to eliminate the demand requirement.11 2. The Analogy to Section 16(b) of the Securities Exchange Act of 1934 Weiss advances a somewhat tortured analogy between section 36(b) of the ICA and section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b) (1976), which allows shareholders to recover illegal insider “short swing” profits. Suits brought under section 16(b) are exempt from the contemporaneous ownership requirement of Rule 23.1. Blau v. Mission [939] Corp., 212 F.2d 77, 79 (2d Cir.), cert. denied, 347 U.S. 1016, 74 S.Ct. 872, 98 L.Ed. 1138 (1954). Weiss perceives similarities between insider trading and “insider” advisory fees. He suggests that section 36(b), like section 16(b), is an instrument of public policy which should not be hampered by procedural restrictions such as the demand requirement of Rule 23.1. Without reaching the merits of the statutory analogy, we simply note that it is irrelevant: suits to recover short swing profits under section 16(b) are subject to the demand requirement by the very terms of that statute, which states that a shareholder may institute an action “if the issuer shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter.” 15 U.S.C. § 78p(b) (1976). We therefore join the First Circuit in rejecting this argument as specious. See Grossman v. Johnson, supra, 674 F.2d at 120. 3. The Relationship Between Shareholder Demand and the Exercise of the Directors’ Business Judgment The heart of Weiss’ challenge based on the statutory scheme is his assertion that shareholder demand is superfluous because that scheme effectively precludes the Fund’s directors from taking action in response to any such demand. The premise of his argument is the Supreme Court’s suggestion that the ICA deprives the directors of their authority to exercise their business judgment to terminate a section 36(b) suit. In Burks v. Lasker, supra, the Court stated: when Congress ... intended to prevent board action from cutting off derivative suits, it said so expressly. Section 36(b) ... performs precisely this function for derivative suits charging breach of fiduciary duty with respect to adviser’s fees. 441 U.S. at 484, 99 S.Ct. at 1840. Although section 36(b) was not directly at issue in Burks, the Court’s interpretation of that section influenced its holding that other sections of the ICA do not deprive directors of their authority to terminate derivative suits under the shield of the business judgment rule. Prudence dictates that we accede to this strong signal from the Court that directors may not terminate suits under section 36(b), notwithstanding our perception that the statement’s import is unclear. See supra pp. 938-939. Weiss then argues that if a suit’s termination is precluded, it would be inconsistent to require demand as a prerequisite to initiation: if directors are too self-interested to be allowed to cut off shareholder suits in the exercise of their business judgment, they must be presumed to be too self-interested to respond objectively to a shareholder demand. Relying in part upon our observation in Cramer v. General Telephone and Electronics Corp., 582 F.2d 259, 274 (3d Cir. 1978), cert. denied, 439 U.S. 1129, 99 S.Ct. 1048, 59 L.Ed.2d 90 (1979), that the business judgment rule is “inextricably linked” to the demand requirement, Weiss essentially concludes that the Court’s inclination to disregard business judgment in this context makes the demand requirement superfluous and inefficient. Our opinion in Lewis v. Curtis, 671 F.2d 779 (1982), lends some credence to Weiss’ position.12 Lewis involved a shareholder complaint alleging that demand would have been futile because the directors had participated in an allegedly self-interested transaction.13 In evaluating this claim, we stated that the futility of demand turns on the disinterestedness of the directors, not on the nature of the alleged wrongdoing. We also noted that the relevant standard of disinterestedness is the same as that used to [940] determine whether a court should defer to the board’s business judgment not to pursue a lawsuit on behalf of the corporation. There is no reason why a court, in deciding whether a board is sufficiently interested to excuse demand, should not be informed by the same factors used to determine whether a court should defer to the board’s decision not to pursue the action. The board will lack such disinterestedness if plaintiff’s allegations, taken as true, would show that, under state law, a court should not defer to the board’s decision not to pursue the lawsuit.. .. Some courts have suggested that directors may not be sufficiently interested in a transaction to excuse demand, yet are interested enough to be unable to assert the protection of the business judgment rule.... On the other hand, formulating different standards for the two issues is ... difficult.... [W]e do not think that we should apply different standards of “interestedness” to cases in which plaintiff has made no demand and to those in which a demand has been made and rejected. Id. at 785-86 (citations omitted). Since (according to Weiss’ argument) directors are too self-interested to terminate shareholder suits, the logical extension of Lewis would be to say that they are so interested that demand should be excused in this case as a matter of law. Although Weiss’ argument is superficially alluring, we find it ultimately unpersuasive. First, to the extent that it is based on Burks, see supra pp. 937-938, the argument rests on rather uncertain footing. Weiss would read Burks as standing for the proposition that directors may not terminate shareholder suits because directors are too interested in advisory fee transactions. While this is not an implausible reading of Burks, we do not find the Supreme Court’s rationale so easy to discern. Section 36(b)(2) accords the advisory fee actions of directors only “such consideration by the Court.as is deemed appropriate under the circumstances.” Burks understandably concluded that Congress intended less judicial deference to directors’ actions regarding advisory fees than is ordinarily associated with the business judgment rule. But we are unable to divine from that opinion a per se rule that investment company directors are presumed to be self-interested, and we decline to adopt Weiss’ suggested rule on such a speculative basis. Weiss also reads too much into our statement in Cramer, supra, that the demand requirement and the business judgment rule are “inextricably linked.” 582 F.2d at 274. Rather, as the district court noted below, see 516 F.Supp. at 670 n. 13, the policies underlying each doctrine are distinct. The demand requirement originated as a judicially-created device that forced shareholders to exhaust intracorporate remedies before beginning suit. As explained in one of the earliest expositions of the principle: [I]t is ... important that before the shareholder is permitted in his own name to institute and conduct a litigation which usually belongs to the corporation, he should show to the satisfaction of the court that he has exhausted all the means within his reach to obtain, within the corporation itself, the redress of his grievances, or action in conformity to his wishes. He must make an earnest, not a simulated effort, with the managing body of the corporation, to induce remedial action on their part. Hawes v. Oakland, 104 U.S. 450, 460-61, 26 L.Ed. 827 (1882).14 The requirement reflects judicial cognizance of the prerogatives and expertise of the directors as stewards of the corporate welfare. One commentator summarized this purpose as follows: Forcing shareholders to exhaust intracorporate remedies by first making demand on directors allows the directors a chance to occupy their usual status as managers [941] of the corporation’s affairs, giving the corporation an opportunity to take control of a suit that will be brought on its behalf. The demand requirement thus furthers a principle basic to corporate organization, that the management of the corporation be entrusted to its board of directors. Note, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U.Chi.L.Rev. 168, 171 (1976). When faced with a demand by a shareholder, the directors have a number of options. They can exercise their discretion to accept the demand and prosecute the action, to resolve the grievance internally without resort to litigation, or to refuse the demand. It is at this point that the business judgment rule comes into play. The business judgment rule eludes precise categorization, as it assumes different shapes in different settings. See Duesenberg, The Business Judgment Rule and Shareholder Derivative Suits: A View from the Inside, 60 Wash.U.L.Q. 311 (1982). In its traditional form, the rule protects directors from personal liability for business decisions by presuming that they acted in good faith and with reasonable care. See Johnson v. Trueblood, 629 F.2d 287, 292 (3d Cir.1980) (even in a facially self-dealing transaction, the rule assumes directors were “exercising their sound business judgment rather than responding to any personal motivations”), cert. denied, 450 U.S. 999, 101 S.Ct. 1704, 68 L.Ed.2d 200 (1981). In shielding directors from the hazards of hindsight challenges to the wisdom of particular decisions, the rule serves two important functions. Were courts, with perfect retrospective vision, to second-guess the judgment of officers and directors in their decision-making function, they would be injecting themselves into a management role for which they were neither trained nor competent. Such judicial action would also be taking a step to discourage others from performing these desired and essential societal activities. One pragmatic objective of the business judgment rule, then, is to keep courts out of a role they are ill-equipped to perform. Another is to encourage others to assume entrepreneurial and risk-taking activities by protecting them against personal liability when they have performed in good faith and with due care, however unfortunate the consequence. Both are of monumental social utility. Duesenberg, supra, 60 Wash.U.L.Q. at 314 (footnotes omitted). Because the considerations involved in imposing the demand requirement and invoking the business judgment rule are distinct, their applicability is not necessarily coincidental. In fact, this Court so noted in Cramer: “[Wjhile the demand requirement of Rule 23.1 should be rigorously enforced, we do not think that the business judgment of the directors should be totally insulated from judicial review.”15 The American Law Institute recently expressed a similar view in its proposed Restatement on Principles of Corporate Governance and Structure § 7.02, at 270-71 (Tent. Draft No. 1, 1982): It is not inconsistent for a court to employ a strict standard with respect to the excusal of demand, but then to refuse to accept a decision by the same board of directors to seek termination of the same action.... As some decisions have emphasized, the focus at the demand stage should be on the issue of whether the corporation may take over the suit and either prosecute it or adopt other internal corrective measures, and not on the later question of whether a decision not to sue should be respected by the court. At the demand stage, the possibility should not be foreclosed that a demand will induce the board to consider issues and crystallize policies which otherwise might not be given attention (e.g., new accounting controls, revised corporate policy statements [942] or even a change in personnel or remu-. neration). The demand rule can have efficacy even where the board ultimately rejects the action and the court ultimately permits the plaintiff to sue. In particular, as we noted in Cramer, the demand requirement gives management the opportunity to pursue alternative remedies and to avoid unnecessary litigation. 582 F.2d at 275. We find the distinction particularly important here in light of Congress’ clear intent to enhance the independence of directors and their responsibility for advisory fees. The ICA and its amendments were designed to erase potential conflicts of interest inherent in the structure of investment companies by placing the unaffiliated directors in a substantial management role and providing them with authority to act as checks on advisory fees. Congress explicitly empowered the directors to redress challenges to advisory fees by imposing on directors a duty to evaluate the advisory fees and by authorizing them to terminate investment adviser contracts without penalty upon the giving of sixty days notice. 15 U.S.C. § 80a-15(a)(3) (1976).16 To allow shareholders to bypass the directors would undermine the role shaped for directors by the ICA. The opportunity to resolve the shareholder grievance without resort to litigation may, in fact, be especially important if the directors are not able to terminate the suit. In that event the Rule 23.1 demand provides the only opportunity for the Fund to avert a lawsuit through internal corrective measures.17 Finally, the different purposes served by the business judgment rule and the demand requirement show that the wooden transposition of Lewis to this statutory context is inappropriate. Lewis was concerned with the futility of demand. It involved an inquiry which is “intensely factual” and requires particularized pleading by the plaintiff. See Vernars v. Young, 539 F.2d 966, 968 (3d Cir.1976). In a conventional shareholder suit, the evaluation of the directors’ decision to refuse demand or terminate suit is equally factual, and it makes sense, as we stated in Lewis, to employ the same standard of interestedness. However, a statutory presumption of interestedness cannot substitute for the factual inquiry needed to determine whether a demand on directors “would be likely to prod them to correct a wrong.” Lewis, supra, 671 F.2d at 785.18 In sum, to read the ICA’s statutory scheme as depriving directors of the opportunity to respond to a shareholder grievance would undermine the very purpose of the ICA — to strengthen management of the Fund by its independent directors. We attribute no such inconsistent intent to the Congress and conclude that the demand requirement of Rule 23.1 applies to section 36(b) actions.19 IV. THE ALLEGED FUTILITY OF DEMAND Weiss contends that even if his section 36(b) claim is subject to the Rule 23.1 de [943] mand requirement, such demand would have been futile for all counts of his complaint. The complaint alleges that demand is unnecessary because (1) Shearson and the Adviser control and dominate the Fund and its directors; (2) all of the Fund’s directors have participated or acquiesced in the Adviser’s breach of fiduciary duty; and (3) the hostility of the directors to the claim was evidenced by the filing of an answer to the initial complaint. Amended Complaint at ¶ 37. The district court found that the allegations of the Adviser’s and Shearson’s control over the directors were inadequate to excuse demand: Weiss failed to provide proof sufficient to overcome the fact that four of the six directors who approved the transaction were not “interested” under the terms of the ICA, 15 U.S.C. § 80a-2(a)(19) (1976). The district court also rejected Weiss’ effort to use the company’s answer to the complaint as evidence of the directors’ hostility to suit. Applying the edict of this Court that futility “must be gauged at the time the derivative action is commenced, not afterward with the benefit of hindsight,” see Cramer v. General Telephone & Electronics Corp., supra, 582 F.2d at 276, the district court concluded that opposition expressed after suit was filed could not excuse demand. Finally, the court turned to the allegation that the directors’ participation in the transaction made demand unnecessary. The court first noted that simply naming the directors as defendants cannot automatically excuse demand on the theory that they would have to decide whether to sue themselves.20 The court then applied the test enunciated in In re Kauffman Mutual Fund Actions, 479 F.2d 257 (1st Cir.), cert. denied, 414 U.S. 857, 94 S.Ct. 161, 38 L.Ed.2d 107 (1973), which states that mere approval of the challenged transaction is insufficient to demonstrate futility of demand unless the complaint alleges facts showing that the transaction was motivated by self-interest or bias. The Court found that Weiss’ complaint failed to allege that the directors stood to gain any personal advantage from approval of the advisory contracts; rather, it challenged the directors’ action only as a breach of their statutory and common law fiduciary duties. The court accordingly ruled that the pleadings failed to assert a basis for excusing demand.21 We agree with the analysis of the district court that these allegations are insufficient to excuse demand and affirm on that basis. V. DENIAL OF WEISS’ MOTION TO REPLEAD AFTER MAKING DEMAND Finally, Weiss contends that the district court abused its discretion in refusing him leave to replead after a demand on the Fund’s directors. He relies principally on Markowitz v. Brody, 90 F.R.D. 542 (S.D.N. Y.1981), in which the court stayed dismissal for ninety days in order to allow plaintiff the opportunity to make a demand. We reject this contention as well. The law of this circuit makes clear that demand after a complaint has been filed is impermissible since it would “reduce the demand requirement of the rule to a meaningless formality.” Schlensky v. Dorsey, 574 F.2d 131 (3d Cir.1978). We recognize that application of this rule in this context may seem costly given the Act’s limitation on recovery to the excessive fees received during the year immediately prior to the filing of suit. Nevertheless, requiring demand before the filing of suit affords directors “the opportunity to decide in the first instance whether and in what manner action should be taken.” Id. A demand after suit is filed would usurp this prerogative. [944] The district court’s judgment dismissing the complaint will be affirmed. Footnotes [1] In January 1980, when the advisory contracts at issue were approved, the board consisted of six members. [2] The court also dismissed the action against defendant James L. Robinson for insufficient service of process. That portion of the district court’s order has not been appealed. [3] Section 36(b) provides, in relevant part: For the purposes of this subsection, the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser. An action may be brought under this subsection by the Commission, or by a security holder of such registered investment company on behalf of such company, against such investment adviser, or any affiliated person of such investment adviser, or any other person enumerated in subsection (a) of this section who has a fiduciary duty concerning such compensation or payments, for breach of fiduciary duty in respect of such compensation or payments paid by such registered investment company or by the security holders thereof to such investment adviser or person. With respect to any such action the following provisions shall apply: (1) It shall not be necessary to allege or prove that any defendant engaged in personal misconduct, and the plaintiff shall have the burden of proving a breach of fiduciary duty. (2) In any such action approval by the board of directors of such investment company of such compensation or payments, or of contracts or other arrangements providing for such compensation or payments, and ratification or approval of such compensation or payments, or of contracts or other arrangements providing for such compensation or payments, by the shareholders of such investment company, shall be given such consideration by the court as is deemed appropriate under all the circumstances. (3) No such action shall be brought or maintained against any person other than the recipient of such compensation or payments, and no damages or other relief shall be granted against any person other than the recipient of such compensation or payments. No award of damages shall be recoverable for any period prior to one year before the action was instituted. Any award of damages against such recipient shall be limited to the actual damages resulting from the breach of' fiduciary duty and shall in no event exceed the amount of compensation or payments received from such investment company, or the security holders thereof, by such recipient. 15 U.S.C. § 80a-35(b) (1976). [4] Independent directors are those who are not “interested” in the company or its advisers. The amendments define “interested person” to include persons who have close family ties or substantial financial or professional relationships with the investment company or its advisers, or who have beneficial or legal interests in securities issued by the adviser or underwriter. [5] The belated nature of this argument is evidenced by Weiss’ pleadings, which characterize the action as one brought “derivatively on behalf of the Fund.” Amended Complaint at 12(b). [6] Rule 23.1 states in pertinent part: In a derivative action brought by one or more shareholders or members to enforce a right of a corporation, ... the corporation ... having failed to enforce a right which may properly be asserted by it, the complaint shall allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors ... and the reasons for his failure to obtain the action or for not making the effort. The Rule establishes other derivative suit requirements such as contemporaneous ownership of stock by the plaintiff when the alleged wrong occurred. These additional requirements are not at issue in this appeal and referenees here to “Rule 23.1” are limited to the demand requirement unless otherwise noted. [7] The Second Circuit has rejected this argument. Fox v. Reich & Tang, Inc., 692 F.2d 250 (2d Cir.1982); see infra pp. 934-935. [8] We recognize that implication of the corporation’s right of action by a statute expressly authorizing suit by shareholders is somewhat atypical of the cases employing the Cort test. Three recent Supreme Court opinions illustrate the usual application of the Cort test in situations where the statute fails to specify either a private remedy or a cause of action for the particular relief' sought. See Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, - U.S. -, 102 S.Ct. 1825, 72 L.Ed.2d 182 (1982) (finding private rights of action for violations of the Commodity Exchange Act); Middlesex County Sewerage Authority v. National [935] Sea Clammers Ass’n, 453 U.S. 1, 101 S.Ct. 2615, 69 L.Ed.2d 435 (1981) (finding no implied private right of action for damages under the Federal Water Pollution Control Act or the Marine Protection, Research, and Sanctuaries Act of 1972); Texas Industries, Inc. v. Radcliff Materials, Inc., 451 U.S. 630, 101 S.Ct. 2061, 68 L.Ed.2d 500 (1981) (antitrust laws do not give rise to implied right of contribution). [9] The common law predecessor to a section 36(b) action was a suit against the adviser for “corporate waste,” an action traditionally deemed to be derivative. 13 W. Fletcher, Cyclopedia of the Law of Private Corporations ¶¶ 5924, 5926, 5927 (rev. perm. ed. 1980). Congress found the burden of proving corporate waste “unduly restrictive” and created the fiduciary duties in section 36(b) to reduce the burden of invalidating advisory contracts. S.Rep. No. 184, 91st Cong., 1st Sess. 5 (1969), reprinted in 1970 U.S.Code Cong. & Ad.News 4897, 4901. Because the common law action was derivative, we assume Congress expected the federal action to be derivative as well. [10] The First Circuit, in rejecting the identical argument, suggested that the district court could allow suit to go forward without waiting for a response if the directors unduly postpone a response to demand. Grossman v. Johnson, supra, 674 F.2d at 122. We intimate no view here concerning the propriety of that suggestion. [11] Additionally we note that the short statute of limitations may reflect a Congressional view of the ICA as designed to ameliorate the situation prospectively rather than to establish a long damage period. [12] Lewis was published after the briefs in this appeal were filed. [13] The directors were accused of entering into a wasteful settlement agreement with a shareholder. Pursuant to the agreement the shareholder abandoned his proxy contest in which he was seeking a seat on the corporation’s board. The complaint also alleged details of a larger scheme by the directors to retain control of the corporation by, among other things, obtaining long-term employment contracts for several directors and reducing the number of directors on the board. [14] The Court’s holding in Hawes was adopted in 1882 as Equity Rule 94, and was modified in 1912 by Equity Rule 27 to allow allegations of the futility of demand. Equity Rule 27 became Federal Rule of Civil Procedure 23(b) which, in turn, was promulgated as Rule 23.1 in 1966. [15] At issue in Cramer was whether a determination by a disinterested committee of directors that a litigation was not in the best interests of the corporation barred a shareholder suit alleging violations in connection with GTE’s foreign payments. The plaintiff had not made a Rule 23.1 demand, however, and we affirmed dismissal of the suit on that ground. [16] As appellees note, the directors can respond to a timely shareholder demand by (1) negotiating a rebate of fees, (2) satisfying the shareholder that the fees are reasonable in terms of the investment services provided, (3) persuading the shareholder that litigation would adversely affect shareholders’ interests, (4) accepting the demand and instituting suit, or (5) refusing the demand. [17] Weiss’ argument is also undermined by reference to § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b) (1976) which he invoked in another context. See supra pp. 937-938. In a § 16(b) action, where there is no power by the corporation to terminate, see Burks v. Lasker, supra, 441 U.S. at 484, n. 13, 99 S.Ct. at 1840, n. 13; Cramer, 582 F.2d at 276 n. 22, there is an express demand requirement. [18] Relying in part on Lewis, the Second Circuit suggested in Fox v. Reich & Tang, supra, that the demand requirement would serve no function in the § 36(b) context. “[I]t is possible to infer that Congress ... believed directors would always be so ‘interested’ that demand would inevitably be ‘excused.’ ” Id., slip op. at n. 13. Having already explained our conclusion to the contrary, we simply note the tentative nature of the Second Circuit’s language. [19] As noted above, see supra p. 935, we must presume that the federal rules apply to this action unless expressly displaced by Congress. [20] This conclusion was cited with approval in our decision in Lewis v. Curtis, supra, 671 F.2d at 785. [21] Lewis v. Curtis, supra, which was decided after the district court’s decision below, does not mandate a different conclusion. As did Kauffman, Lewis held that the futility of demand turns on the interestedness of the directors rather than the nature of the wrongdoing. See supra pp. 938-939. Unlike this case, however, Lewis involved specific allegations of a self-interested transaction by all the directors. See 671 F.2d at 787.