This action concerns the administration of the investment of assets, valued at approximately $100 million, of two charitable foundations. It was brought by Barbara P. Johnson, a former trustee, against J. Seward Johnson, Jr., a trustee, chairman of the finance committee and investment manager, and against the foundations. The Attorney General has intervened as an additional plaintiff.
Plaintiff seeks the ouster of defendant Johnson as investment manager, as chairman of the finance committee, and from any role in directing the investments of the foundations. The basis asserted for this relief is that he was negligent in the design and implementation of the foundations' equity investment program. Plaintiff also seeks to have him surcharged for $48,772,931 which, she claims, the foundations lost because of his gross departure from accepted standards of care. The Attorney General agrees to the ouster but not the surcharge, and he takes no position as to any liability issues. Rather, the Attorney General argues that professional management advice is required for a charitable investment portfolio of the size found here, and that while defendant Johnson may not have been negligent, his lack of professional training alone requires his removal from a position in which investment decisions are controlled.
Defendants claim that plaintiff cannot maintain this action, in equity, because she brought it in bad faith, and she breached her duty, as a trustee of the foundations, to advise her fellow trustees of her agreement with her husband assuring him that the foundations would receive a significant benefit from his estate. Additionally, defendant Johnson argues that his conduct was not negligent and that there is no valid basis for either his removal or the imposition of a surcharge.
The Court's Factual Findings.
From all the testimony, the court finds the following are the relevant and believable facts. In 1963, J. Seward Johnson, Sr. directed the incorporation of The Atlantic Foundation, in New Jersey, for charitable, educational and scientific purposes. In 1973 The Harbor Branch Foundation was similarly incorporated in Florida. Each foundation has headquarters in New Jersey. Atlantic uses its assets to make grants to other charitable organizations, but its principal beneficiary is Harbor Branch, which has operated as an oceanographic research facility since its inception. Oceanographic research activities at Harbor Branch were directed, to a great extent, by Edwin A. Link, a long-time associate of Johnson, until Link died in 1981.
Each foundation was formed with trustees, directors and officers as the executives in charge. The "members," as defined in N.J.S.A. 15A:1-2(h), were called trustees and the "trustees" envisioned by N.J.S.A. 15A:1-2(i), were called directors.
Johnson,*fn1 was a principal stockholder of Johnson & Johnson, and he funded these foundations with stock from that corporation. He headed and dominated the foundations,*fn2 but he
groomed his son J. Seward Johnson, Jr.,*fn3 to take his place. When Harbor Branch was created, Senior was made President and Seward and plaintiff (Senior's wife) were made Vice-Presidents. Plaintiff was an incorporator of Harbor Branch, but she never had a significant role in its operational or financial activities.
Shortly thereafter, being displeased with an action taken in his absence by certain non-family trustees, Senior insisted that a majority of the board of trustees be members of the Johnson or Link families. In 1980 he reorganized each foundation, creating two classes of trustees: one class A trustee with eight votes and five class B trustees with one vote each. Senior was the original class A member; the original class B members included plaintiff, Seward, and his half-brother James L. Johnson. This reorganization illustrates Senior's absolute control over the foundations' organization at that time. Financial matters, including supervision and investment of assets, were always delegated to the finance committee, consisting of Senior, Seward and James. Other policy matters were delegated to the executive committee, chaired and controlled by Senior.
James never had a role of any consequence on the finance committee. The finances, including the investments of the corporate assets, were controlled by Senior and then by Seward. Until his death in May 1983, Senior remained a significant force in the foundations' operations, although his son Seward was denominated as the person responsible for investment decisions.
Seward became involved with the investments when he became a member/trustee in 1973. He became the chairman of the finance committee at that time and has so remained except for a short period in 1978- 79 when he lived in Paris, and Senior was the chairman of the committee. In 1977 the finance committee met frequently to consider various strategies for
investing the foundations' assets, which Senior had agreed to diversify. However, he rejected all types of outside help such as professional money managers, bank trust departments and mutual funds, having had an unsatisfactory experience with T. Rowe Price Company, a well-known investment management firm. When Senior expressed his intention to have Seward alone manage the investments, he (Seward) was apprehensive, having no significant experience in these matters. But he accepted the role.
The foundations began to sell off the Johnson & Johnson stock and invest in common stocks of publicly traded companies. Senior believed that he, Seward and the staff could develop expertise in the management of the foundation finances, so they continued on their own. At no time did plaintiff have substantive involvement in these activities at either the operational level or on the board of trustees.
Sometime in 1977-1978, the two Johnsons consulted with personnel of Merrill Lynch concerning the use of a computerized system of asset management. Neither Senior nor Seward nor their employees had been trained in the theories of investment analysis, but they thought that they had been successfully diversifying and reinvesting the equity portfolios of the foundations, and with guidance from Merrill Lynch, it was thought that the computerized system would yield good results. The Merrill Lynch personnel directly involved in this project were the account executive who had been retained by Senior to handle the foundations' accounts since 1974, and the manager of the institutional computer services department; other Merrill Lynch departments had input as well. In 1979, Seward returned from nine months in France and he was renamed chairman of the finance committee of each foundation. By then the computer system was ready for implementation, and Seward became the investment manager of the foundations' assets.
Senior believed that some types of industries were stronger than others, so he directed the exclusion of those which he
believed to be weaker from the universe of 6,000 to 7,000 companies whose stock was offered for sale to the public on the stock market. These qualifications*fn4 were then programmed, by a consultant working with Merrill Lynch personnel, into a computer selection system and called "fundamental screens." The screens acted to reduce to fewer than 1500 the number of companies targeted for investment.
Those companies were then ranked by their "relative strength," that is, by comparison to other companies based on variations in market prices.*fn5 The relative strength theory holds that stocks which have been strong in relation to other stocks would continue to be relatively stronger in the future. Such a measure of relative price strength could most objectively and precisely be calculated by a computer. The relative strength theory is one of many accepted methods of investment strategy. Its distinguishing characteristic was that it is based on price trends rather than on a measure of intrinsic value.
After the fundamental screens had eliminated approximately 80% of the companies on the stock exchange, and either before or after the relative strength ranking list of the remaining companies was prepared by Merrill Lynch and forwarded to the foundations, certain rules were implemented before buy/sell instructions were given to the Merrill Lynch account executive. Seward and Senior had rules about which industries to invest in and which to ignore, as well as rules as to how much to invest in any particular industry. These rules changed as their perception of the market conditions changed.
As experience dictated, and guided by daily advice from a Merrill Lynch expert (Robert Farrell), the investment manager would determine if the foundations should expose or withdraw assets from the investment market. The timing of the purchases and sales was independent of the computer programs, which only provided candidates for purchase or sale. The investment manager had to make the ultimate decision after considering the needs of the foundations and the conditions of the market. In doing so, he relied on advice from Merrill Lynch and other sources as to market timing, as well as on advice from Senior.*fn6 When he had settled on a "buy list" he would advise the account manager of its contents and the amount of money available for investment. The account manager would then execute the orders.
Tests were developed to be sure the computerized screening process worked. A reporting system was created which produced a daily portfolio summary report called an equity progress report.*fn7 This comprehensive document reported the adjusted market value of equities and options owned by the foundations, as well as cash and equivalents. It also reported performance as measured against the Dow Jones and the Standard & Poor's 500 indexes in terms of percentage and actual value for the day, week and year. Of course, it also gave a comprehensive inventory of the common stocks and options along with individual stock performances and every market indicator one could ever digest, except for the beta factor, a popular statistic showing relative volatility.
That computer stock selection system remained the same from 1979 to 1984 with Seward as investment manager, relying on the Merrill Lynch computers to screen the total market for
qualifying companies and for ranking those companies as to relative price strength.
In addition to his involvement with the financial aspects of the foundations, Seward carried on Senior's interest in oceanography when he (Seward) became heavily involved with the daily operations of Harbor Branch. Under his leadership, that foundation has become a respected leader in the oceanographic scientific and educational community. The physical facilities and scientific staff at the Florida location have grown tremendously in recent years, enabling that foundation to obtain significant grants to fund its research projects. At a cost of seven million dollars, it has built the most sophisticated oceanographic research ship in the world, the R/V Seward Johnson, and has developed many submersible vessels and tools. Harbor Branch interacts with such respected institutions as the Smithsonian Institution, the Woods Hole Oceanographic Institute, the National Oceanic and Atmospheric Administration and several university and government departments. Also under Seward's leadership, its most significant new development is in the field of recovering materials from the oceans to use in manufacturing pharmaceuticals; in this venture Harbor Branch has joined with a company known as SeaPharm. More and more, the trustees have relied on Seward's vision which has fostered the great progress made by Harbor Branch.
Beginning in 1981, the foundations paid Seward $95,000 annually for his services as president and investment manager. This "compensation package" was reviewed by the foundations' auditors and a written report dated March 14, 1983 was sent to the controller for presentation to and consideration by the board of trustees. That report indicates that the compensation was reasonable for the work done. The trustees continued this compensation from year to year.
In assessing the fiscal activities of the foundations, the court reviewed documentation presented by both parties. The foundations' internal financial statements, some audited and some
not, are persuasive, because they qualify as business records and they deal with timely market values. Arthur Andersen & Co., auditor for plaintiff, on the other hand, was unfamiliar with the daily facts and originally only considered book value instead of market value. The two witnesses from that company were not persuasive, and the court is not confident of the validity of their work product, except that regarding trading activity shown on the last three lines of the following table. Certain statistics are displayed on TABLE 1, infra, which the court has concluded to be factual. It is helpful to examine the financial statistics from 1979,*fn8 the year when Seward began as full time investment manager, until the end of 1985, when the assets had been liquidated and placed with outside money managers.
STATISTICAL FINDINGS FOR THE COMBINED
Value of Corpus $103.7 $108.6 $109.7 $126.3
Investments $12.2 $9.4 $6.1 $24.0
Incl. Div/Int 13.1% 9.3% 5.8% 22.6%
Incl. Div/Int 18.7% 32.4% (5.3%) 21.5%
Funds Index 11.8% 19.3% 1.7% 23.8%
(Book Value) $111.5 $117.6 $123.9 $142.9