After a string of successes in the courtroom through most of last year, the mutual fund industry suffered a setback recently in a federal class action lawsuit which contends that directors lost their independence by earning high pay for serving on multiple mutual fund boards.

U.S. District Court Judge Daniel T. K. Hurley has rejected directors' arguments that a new Maryland law effectively prohibits lawsuits that allege fund directors lose their independence when they serve on several boards within the same mutual fund complex. Hurley made his initial ruling as a part of a 13-page decision Dec. 6. In that ruling, Hurley allowed to go forward a case that shareholders filed in West Palm Beach, Fla. federal court against Templeton Asset Management of San Mateo, Calif. and directors of the Templeton Vietnam Opportunities Fund.

Hurley provided little explanation for the ruling in the Dec. 6 decision. Nevertheless, he reaffirmed the initial decision in a second ruling Dec. 21 after lawyers for the Vietnam Opportunities Fund directors argued that the Dec. 6 ruling was unclear.

The December decisions prompted shareholders this month to expand the allegations in their lawsuit. Shareholders alleged in a revised complaint filed Jan. 5 that the Vietnam Opportunities Fund violated federal law because of the alleged lack of independence of its directors. Hurley's December rulings about directors turned on Hurley's interpretation of Maryland state law rather than federal law.

Hurley's decision appears to be the first that applies the Maryland fund directors' law, which the mutual fund industry helped pass in 1998, to allegations about directors' independence. Industry lawyers and executives had expected that the law would make it easier to dismiss lawsuits challenging directors' independence well before trial.

Those dismissals reduce legal expenses and tend to discourage similar lawsuits, according to lawyers. Hurley's decisions provide plaintiffs' lawyers, who have been unsuccessful thus far in challenging director independence, a toehold for winning potential cases against the industry.

"We're very heartened by this," said Karl Barth, a lawyer with the firm of Hagens Berman of Seattle, Wash., of Hurley's rulings. "I wouldn't hesitate to bring another case on the same grounds."

Mutual fund industry executives believe the Maryland law should make it easier to dismiss challenges to directors' independence based on multiple board membership long before trial, said Barry Barbash, a lawyer in the Washington office of Shearman & Sterling of New York. Indeed, the Vietnam Opportunities Fund directors argued that point in court papers, saying the Maryland law says that fund directors do not lose their independence by serving on multiple fund boards.

The Vietnam Opportunities Fund directors received between approximately $73,000 and $362,000 in compensation annually for serving on as many as 57 funds, according to the shareholders' allegations. The pay and multiple board memberships effectively made the independent directors employees of Templeton, according to the allegations.

The case now will move into pre-trial fact finding, said Barth. The Vietnam Opportunities Fund case is not scheduled for trial until April 2001, he said.

"I look at this as clear sailing until the trial," Barth said. "This will go to trial."

So far, the Vietnam Opportunities Fund case is an anomaly. Shareholders last year were unsuccessful in challenging director independence in cases against Credit Suisse Asset Management of New York, BlackRock Financial Management of New York, Prudential Investments of Newark, N.J. and T. Rowe Price Associates of Baltimore, Md. Each of those cases is bogged down now in either appeals or procedural wrangling. A Boston federal court judge has yet to rule on a similar case challenging the independence of directors at Fidelity Investments of Boston. In all instances, the fund companies and their directors deny that their directors have lost their independence.

The Vietnam Opportunities Fund case arises out of allegations that the fund, its directors and Templeton invested fund assets in violation of the fund's investment objectives. Shareholders allegedly suffered more than $40 million in losses as a result of those actions, according to the complaint.

Templeton and the directors contested the allegations in court papers. A spokesperson for Templeton and the lawyer for the independent directors did not return calls seeking comment.

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