North Valley GI Medical Group v. Prudential Investments LLC (Maryland U.S.D.C.)

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.

The opinion is available in PDF.

Commissioner of Financial Regulation v. Brown, Brown & Brown, P.C., et al. (Ct. of Appeals)

Filed: August 19, 2016

Opinion by: J. McDonald

Holding: A Virginia-based law firm and its managing partner were not covered by the attorney exemption to the Maryland Credit Services Business Act (“MCSBA”), which regulates the “credit services business,” because they regularly and continually engaged in the credit services business by consulting with several hundred Maryland homeowners confronted with the possibility of foreclosure and entered into paid agreements with 57 of them to renegotiate their mortgage loans over the course of nine months.

Facts: A small Virginia law firm accepted hundreds of referrals of Maryland homeowners from a Virginia-based consulting business that advertised in Spanish-language media and accepted fees to analyze a homeowner’s mortgage status. The law firm and its sole shareholder and managing partner, licensed in Virginia and D.C., but not Maryland, employed in succession two Maryland attorneys to meet with Maryland clients. The first of these Maryland attorneys (the "Maryland attorney") estimated that the majority of his workload was related to the Maryland homeowners by the time he left the firm. When the Maryland attorneys were unavailable, the managing partner or another D.C. attorney met with the homeowners.

The homeowners, mostly native Spanish-speakers who spoke little or no English, entered into retainer agreements with the law firm, paying up to $7,500 up front in exchange for negotiations with the lender to modify their loan, foreclosure defense, and possible litigation. The law firm made little effort to actually renegotiate the loans and did not obtain a loan modification for any of the homeowners.  One couple, who paid fees to the consulting company and the law firm and eventually lost their home in a foreclosure, lodged a Complaint with Commissioner of Financial Regulation.

The Commissioner investigated and issued a cease and desist order forcing the law firm to terminate its agreements with Maryland homeowners. The Maryland attorney settled but the law firm and its managing partner requested a contested hearing. The Commissioner referred the matter to an Administrative Law Judge ("ALJ"), who issued a proposed decision concluding that they had willfully violated the statute and recommending a final cease and desist order and monetary penalties. The Deputy Commissioner, the final decision-maker, adopted the ALJ’s holdings. The law firm and its managing partner requested an exceptions hearing. The Deputy Commissioner then issued a final order finding that they violated the statute and that the agreements were void, issued a cease and desist, and held them jointly and severally liable for a civil monetary penalty of $114,000 and $720,600 in treble damages. The law firm and its managing partner appealed in the Circuit Court for Baltimore County, which reversed the Commissioner’s decision, holding that their activities did not constitute “credit services business.” The Court of Special Appeals affirmed.

The question on appeal was whether the law firm and its managing partner conducted “credit services business” under the MCSBA, and if so, whether the attorney exemption applied. If they did conduct such services and the exemption did not apply, then they should have obtained a license and complied with the statute's other various requirements. It is undisputed that they did not do so.

Analysis: The MCSBA applies to any person (including legal or commercial entities) who, with respect to the extension of credit by others, sells, provides, or performs (or represents that it will do so) in exchange for consideration the enumerated services, which include obtaining a credit extension for a consumer and providing advice or assistance regarding obtaining a credit extension or improving his or her credit record. CL § 14-1901. A credit extension is defined as “the right to defer a payment of debt, or to incur debt and defer its payment, offered or granted primarily for personal, family or household purposes.” CL § 14-1901.

Providing these services qualifies one as a “credit services business.” Ten categories of individuals are exempted from the definition of “credit services business.” One category includes individuals who meet the following three conditions: is licensed as an attorney in Maryland, renders services within the course and scope of legal practice, and does not engage in the credit services business on a regular and continuing basis.

Here, the law firm and its managing partner accepted thousands in fees in exchange for renegotiating the terms of mortgage loans, which means seeking a modification of principal or interest or repayment term, and inevitably means seeking some form of deferral. Thus, renegotiating the terms of a distressed home mortgage loan means obtaining a credit extension for personal, family or household purposes, as defined under CL § 14-1901(e)(1),(f). As such, the law firm and its managing partner met the general definition under the statute. An analysis of the legislative history of the statute confirms that it is intended to provide broad protection to the consumers of credit services, and is not limited to merely credit repair agencies or lenders, as the law firm and its managing partner had argued.

As to the attorney exemption, the law firm and its managing partner did offer services on a “regular and continuing basis.” Though this term is undefined, the consultations and agreements were a very significant part of the law firm’s business and accounted for most of the work of its Maryland-licensed attorney by the time he left the law firm. The Court found hundreds of consultations and 57 agreements over the course of nine months to be significant. Notably, the Court pointed out that the ALJ had suggested that in less stark cases, there may be situations where “there is a significant question at what point an attorney who frequently provides such services has crossed the line into providing ‘regular and continuing’ credit services.” Nonetheless, the Court noted that this case sharply contrasts with that of an attorney providing occasional services to an individual client, for example. Ultimately, the mere fact that one is an attorney does not automatically qualify one for the exemption.

The Court affirmed the Commissioner’s holding that the MCSBA applied to the law firm and its managing partner's activities and that the attorney exemption did not apply because they conducted their activities on a regular and continuing basis. Because the issue of whether their violations were or were not willful was not argued on appeal, the Court remanded to the Circuit Court on that issue. 

The full opinion is available in PDF.