RECENT CASE LAWS ON INVESTMENT ADVISORY FEES

On March 30, 2012, the U.S. Court of Appeals for the 8th Circuit upheld a grant of summary judgment in favor of the investment advisers to nine mutual funds, dismissing fund shareholders' claim of excessive advisory fees in violation of Section 36(b) of the Investment Company Act (the "ICA"). Gallus v. Ameriprise, 2012 U.S. App. LEXIS 6424 (8th Cir. Mar. 30, 2012).

Section 36(b) of the ICA provides that an investment adviser to a registered investment company owes "a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser" or any affiliate thereof. In 2009, the 8th Circuit vacated the district court's grant of summary judgment in favor of the investment advisers and found that the district court had erred in concluding that there was no Section 36(b) violation merely because the fees were not noticeably excessive and that the proper analysis under Section 36(b) should consider "both the adviser's conduct during the negotiation and the end result," Gallus v. Ameriprise Financial, Inc., 561 F.3d 816 (8th Cir. 2009). Following the 8th Circuit's such decision, however, the U.S. Supreme Court decided Jones v. Harris Associates and vacated the 8th Circuit's initial holding in Gallusand remanded the case for further consideration in light of Jones. The 8th Circuit then remanded to the district court which, in applying Jones, again granted summary judgment in favor of the investment advisers.

The 8th Circuit reviewed the district courts' decision de novo, and applied the Jones' standard which is whether defendants-investment advisers charged "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." The 8th Circuit concluded that after Jones, a process-based failure alone, such as a deficiency in the funds' board deliberations or in the fee information provided to the board, does not constitute a violation of Section 36(b), because Section 36(b) "is sharply focused on the question of whether the fees themselves were excessive" and not of whether the process was defective. The 8th Circuit, however, stated that "[t]he fee negotiation process remains critically important, as it allows the court to determine the amount of deference to give to the board's decision to approve the fee." In other words, if the board's approval process is sound, the court should give deference to its decision on advisory fees, but if it is deficient or significant information is withheld from the board, then the court must conduct a more rigorous review.

The 8th Circuit found that the board's process in this case could "fairly be described as robust," and concluded that it, therefore, should give deference to the board's decision. In the meantime, however, the court noted that more deference would have been given "had the [b]oard not focused primarily on tethering the fees to the industry median" since Jones had "cautioned courts that [fee] comparisons [in the investment advisory industry] are problematic because the comparison of fees, like those challenged, may not be the product of negotiations conducted at arm's length." The 8th Circuit also found that the disparity in the fees charged by the investment adviser to different clients helps address the issue of whether the investment advisory fees are excessive, but that the plaintiffs had failed to present additional evidence that the fees were outside of arm's length range, as required by Jones.**********

On April 16, 2012, the U.S. Court of Appeals for the 3d Circuit upheld a district court's dismissal of excessive fee claims brought by three individuals against John Hancock Life Insurance Company (U.S.A.) and its affiliates ("John Hancock") alleging that John Hancock had charged plaintiffs' retirement plans excessive fees in violation of Section 36(b) of the Investment Company Act. Santomenno v. John Hancock Life Insurance Company (U.S.A.), et al., No. 11-2520 (3d Cir. Apr. 16, 2012). The 3d Circuit affirmed the district court's decision to grant John Hancock's motion to dismiss on the grounds that plaintiffs lacked standing to bring the Section 36(b) claims because they did not own the securities in question during the course of the entire litigation. Under Section 36(b), a civil action may be brought by the SEC or by a security holder (of a fund that is registered as an investment company under the ICA). In its decision, the 3d Circuit noted that "Section 36(b) plainly requires that a party claiming a breach of the fiduciary duty imposed by that legislative provision be a security holder of the investment company at the time the action is initiated" and that "[i]mposing a continuous ownership requirement throughout the pendency of the litigation assures that the plaintiff will adequately represent the interests of the security holders in obtaining a recovery for the benefit of the company."

The 3d Circuit rejected plaintiffs' argument that the district court erred in dismissing their claims under Section 26(f) (which requires that investment advisory fees be "reasonable in relation to the services rendered") and Section 47(b) (which provides that a contract made in violation of the ICA is unenforceable). The court rejected the plaintiff's argument that Section 47(b) should be viewed as creating a private right of action given that the U.S. Supreme Court had found such a right in Section 215 of the Investment Advisers Act of 1940, noting instead the significant "differences in text and structure" between the two provisions. Finding that Section 36(b) provides the "exclusive" private right of action under the ICA, the 3d Circuit concluded that Section 47(b) does not create a private right of action and the plaintiffs could not bring an action under Section 47(b) to enforce the standards of Section 26(f).

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