Sub-Adviser Fee Litigation: Will Section 36(b) Acquire Teeth?; Outside Counsel
New York Law Journal, March 17, 2015
6 Pages Posted: 12 Jun 2019
Date Written: 2015
Section 36(b) of the Investment Company Act establishes a private breach of fiduciary duty cause of action for shareholders in an investment company, or mutual fund, to challenge the fees charged by the mutual fund’s investment adviser, in recognition of the fact that the adviser or one of its affiliates customarily creates the mutual fund and has a great deal of influence over the composition of the mutual fund’s board of directors or trustees, which negotiates the fees paid to the investment adviser. Under the Gartenberg standard, which was substantially adopted by the Supreme Court in Jones v. Harris Associates, succeeding on an excessive fee claim is difficult, however, because Section 36(b) is violated only when the adviser charges a “fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.”
In the last several years, creative plaintiffs have looked to the fees paid by mutual funds to advisers and sub-advisers of mutual funds as a measuring tool to argue that fees are excessive. The plaintiffs have focused on the services provided to a mutual fund by the adviser and sub-advisers and have argued that the services are largely duplicative. If this is so, the logic goes, then why is the adviser paid such a large fee?
This argument gained traction in Kasilag v. Hartford Investment Financial Services, where the plaintiffs survived a motion to dismiss. As we predicted in a prior article, a large number of new Section 36(b) actions against mutual fund advisers have followed the Kasilag ruling, at least 11 as of today. We based our prediction in large part on the fact that section 36(b) litigation has been characterized by the entrepreneurial activities of plaintiffs’ law firms that develop legal theories that are then more broadly adopted, leading to waves of litigation each characterized by different legal theories. This article examines the current state of this litigation, focusing in particular on two additional motions to dismiss that have been decided in plaintiffs’ favor.
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