The mutual fund industry is now mulling the implications of the recent courtroom encounter between money manager Louis Navellier, of Navellier Investment Management of Reno, Nev., and three independent fund trustees.

The trustees, who emerged victorious, were appointed watchdogs to oversee the Navellier Series Trust Aggressive Small-Cap Fund, which was launched in 1993. In March 1997, the three trustees decided to allow the investment management contract with Navellier to expire because, they contended, Navellier was unwilling to provide them with information necessary for them to carry out their trustee responsibilities. The board subsequently handed the fund's advisory contract to MFS of Boston, pending shareholder approval.

On July 21 in the U.S. district court in San Francisco, a 10-member jury found in favor of the fund trustees after only four hours of deliberation. The trial lasted six weeks. The firm is considering appealing the decision, said Arjen Kuyper, chief operating officer of Navellier Investment Management.

Industry participants, many of whom view the trustees' victory as a boost to the fund governance process, have closely watched this case, the first time a fund adviser has sued its independent trustees.

"It's a good thing," said C. Meyrick Payne of the verdict. Payne is a partner at Management Practice, a New York consulting firm that works with fund boards. The verdict in favor of the fund's trustees strengthens fund governance because there is a "stand on the part of the court that directors are entitled to act as they see fit. The directors did what they thought was right," he added.

The court's decision "sends the right message," said David Sturms, partner with Vedder Price, a law firm in Chicago. "At the end of the day, if you perform your duties in a way in which shareholders benefit, you will prevail."

The lawsuit, originally filed in San Francisco district court in April 1997 on behalf of Louis Navellier, owner of Navellier Investment Management and manager of the small-cap fund, charged the fund's three trustees with several misdeeds. By the time of the trial, the court had dismissed all but two of the allegations in an amended complaint.

The court also refused to allow Navellier's attorney, Samuel Kornhauser, to elevate the lawsuit to class-action status in February 1998. In addition, the court blocked Navellier's attempts to name MFS as a defendant in the case. Arnold Scott, an MFS trustee, and Roy Adams, who served as legal counsel to Navellier's independent trustees, also were not allowed to be named as defendants.

The third independent trustee, Ken Sletten, settled with Navellier before the trial began, according to Don Simon, one of the two trustees against whom the case proceeded. The other was Larry Bianchi.

Navellier alleged that the trustees had breached their fiduciary duty and caused economic hardship for shareholders when the trustees willfully allowed the management contract between Navellier and the fund to lapse in March 1997. Navellier argued that the trustees were trying to entrench themselves, protect their future trustee compensation and were seeking to retaliate against Navellier's firing of a marketing executive who had been a friend of the trustees. Navellier further alleged that the trustees had been upset by not being chosen to sit on the board of directors of a second and separate fund group Navellier had created, The Navellier Performance Funds.

But Navellier was not forthcoming with important information the trustees needed to make informed decisions about Navellier's continuing as the fund's investment manager, including verification of Navellier's financial wherewithal, according to Roy Adams, the fund trustees' then independent counsel. Also, information related to the Navellier-proposed merger between the Navellier Series Aggressive Small-Cap Fund and another Navallier fund -- the Navellier Aggressive Small-Cap Equity Fund -- was repeatedly requested by the trustees but never received.

According to Adams, the trustees had twice allowed for a temporary continuation of the advisory contract with Navellier, pending receipt of the requested information. But the fund's independent trustees subsequently voted to sever the fund's ties to Navellier when the information was not produced. The board then asked MFS of Boston to serve as interim adviser for the fund.

A subsequent shareholder vote seeking approval of MFS as the fund's manager was unsuccessful because MFS failed to obtain the two-thirds super-majority vote necessary. The fund was eventually returned to Navellier to manage for lack of another manager willing to assume the role, said Paul Finigan, a partner with Brobeck, Phleger & Harrison of San Francisco and Simon's lawyer. According to court documents, Navellier then requested the resignation of the independent trustees. In its lawsuit Navellier also charged the trustees with "wasting" approximate $212,000 spent on the MFS proxy vote process.

Despite having prevailed, the trustees still may be saddled with hefty legal costs incurred in defending themselves because their directors and officers insurance was allowed to lapse. While Navellier claimed the responsibility of continuing proper insurance fell to the trustees' lawyer, the trustees charged that Navellier was responsible for continuing the insurance coverage.

The district court made it clear that the responsibility of maintaining proper insurance rests with the investment management firm, according to Finigan. But, the court did not order Navellier to pay the costs.

Because the fund was merged out of existence, the trustees can not look to the original fund to recover their out-of-pocket costs. But, the trustees can seek reimbursement from the newer $40 million Navellier Performance Fund Aggressive Small-Cap Equity Fund, which absorbed the original fund, Finigan said.

One source close to the situation estimates the trustees' final expenses could run as high as $5 million. If they did, Navellier small-cap shareholders could expect as much as a 10 percent decline in their share price. It is also possible that the insurance companies involved in indemnifying the fund and its trustees or even the trustees themselves could seek to recover their costs directly from Navellier, one attorney said.

While the win is considered by many industry watchers to vindicate the actions of the fund trustees in carrying out their fiduciary responsibilities and protecting the interests of fund shareholders, some industry lawyers are concerned that the whole case gives the fund industry and its processes a black eye.

"It's scary what happened," said David Butowsky, a fund attorney with Mayer Brown & Platt in New York. "Here's Navellier suing these people for exactly what they were supposed to be doing." According to another fund attorney, in the future trustees may be more interested in ensuring their own directors and officersinsurance policies are adequate than worrying about the protection of shareholders.

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