Kamen v. Kemper Financial Services, Inc.
Headline: Court refuses to impose a nationwide rule forcing shareholders to demand board action first, preserves state-law 'futility' exception, affecting who can sue on behalf of investment companies.
Holding: The Court held that federal courts must apply state-law demand futility rules in derivative suits brought under the Investment Company Act and may not impose a federal rule abolishing the futility exception.
- State law decides when shareholders must first ask boards to act in fund lawsuits.
- Mutual fund boards retain state-defined control over starting or stopping derivative litigation.
- Reverses the nationwide demand rule and returns cases to state-law analysis on remand.
Summary
Background
A shareholder sued on behalf of an investment company against its investment adviser, saying the fund’s proxy statement misrepresented adviser fees. She alleged she did not first ask the board to act because demand would have been futile, claiming the board was controlled by the adviser. The district court and the Court of Appeals dismissed her derivative claim; the Court of Appeals adopted a national rule requiring demand in all cases and rejected the futility exception.
Reasoning
The Court considered whether federal courts should create a uniform federal rule that would bar the futility exception in derivative suits under the Investment Company Act. It held that the demand requirement governs who controls corporate litigation and thus implicates state law on corporate governance. The Court reaffirmed Burks v. Lasker, saying federal courts should incorporate state corporate law unless the federal statute’s objectives would be frustrated. Because the futility exception does not impede the Act’s goals, federal courts must apply the law of the state of incorporation when deciding whether demand is excused.
Real world impact
The decision means whether a shareholder must first ask a fund’s board to act depends on the state law where the fund is incorporated. Boards and shareholders of mutual funds and other investment companies will continue to follow their state’s rules about when demand can be excused. The Court reversed the Court of Appeals and sent the case back for further proceedings, leaving some questions — like whether Section 20(a) itself supports a derivative action and whether the complaint adequately pleaded futility — for later resolution.
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