Filed: August 23, 2016
Opinion by: James K. Bredar
Holding: In a claim alleging breach of fiduciary duty under section 36(b) of the Investment Company Act of 1940, with respect to the receipt of compensation for services by the investment advisor of a registered investment company, a pleading of comparable fund fees is not required in order to state a viable claim.
Facts: Plaintiffs were investors in mutual funds and brought suit on behalf of those funds against Defendant, the investment advisor to the funds. Plaintiffs alleged Defendant violated its fiduciary duties with respect to the fees paid by the funds to the Defendant. Plaintiffs alleged, among other matters, that (i) the fees received by Defendant were so disproportionately large that they bore no relationship to the value of the services provided and were not the product of arm’s-length negotiation, (ii) Defendant delegated to subadvisors substantially all of Defendant’s responsibilities while retaining over half of the fees received from the funds and (iii) most of the money received by Defendant as fees represented pure profits and not compensation for services rendered.
Plaintiffs made further allegations as to each of the funds growth in assets under management and compared the responsibilities of Defendant and the subadvisors under the applicable management agreements. Each of the funds is required to pay Defendant an annual fee (the “Advisor Fee”) calculated as a percentage of the applicable assets under management. The Defendant pays the subadvisor an annual fee that, Plaintiffs alleged, equals approximately 50% of the Advisor Fee “for the nearly identical services” required of Defendant.
While recognizing the affiliations between the Defendant and subadvisors, Plaintiffs alleged that the subadvisors had an incentive to negotiate the highest possible fees and that these negotiations were therefore conducted at arm’s length. Consequently, Plaintiffs alleged that the fees negotiated by the subadvisors were indicative of a reasonable fee for services required under the Defendant’s management agreements with the funds. Plaintiffs made a series of additional allegations regarding Defendant’s lack of care in negotiation of advisory fees and the fund’s boards.
Analysis: Section 36(b) of the Investment Company Act of 1940 provides that an investment advisor of a registered investment company has a fiduciary duty with respect to “receipt of compensation for services.” Security holders are permitted to sue the investment advisor, on behalf of the funds, for breach of this duty and may recover damages resulting from such breach up to the amount of compensation received by the advisor. The Supreme Court has provided that to face liability under Section 36(b), “an investment adviser must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not” have been negotiated at arm’s length. Jones v. Harris Assocs. L.P., 559 U.S. 335 (2010). In analyzing whether an investment advisor has breached its duty, the Supreme Court has: (i) noted that all relevant circumstances must be considered; (ii) declined to implement a “categorical rule regarding the comparisons of the fees charged”; and, (iii) explained that “the appropriate measure of deference to a board’s judgment in approving an investment advisor’s compensation varies according to the circumstances.”
Defendant moved to dismiss for failure to state a claim on the basis of three arguments. First, Defendant argued that the complaint did not include any facts about fees paid by comparable funds. The Court believed that this argument misstated precedent and explained that, at least for purposes of the Fourth Circuit, Jones does not require pleading of comparable fund fees to state a viable claim.
Second, Defendant argued that the complaint improperly challenged the “manager of managers” structure used by the funds, which is widely used by other funds and approved by the SEC. The Court noted that the structure is not being attacked. Rather, Plaintiffs challenged the amount of fees.
Third, Defendant argued that Plaintiffs did not sufficiently offer allegations to “overturn the Independent Trustees’ business judgment” in their approval of the management agreements. The Court explained that Plaintiff’s allegations regarding what “entities are actually performing” the services allow an inference either that a business judgment to approve the compensation was not one based on full information or that it was not reached through arm’s length negotiation. Accordingly, the Court denied Defendant’s motion to dismiss for failure to state a claim.