An investment adviser to a mutual fund may be liable for breach of fiduciary duty under §36(b) of the Investment Company Act of 1940 if the advisory fees charged the fund are so disproportionately large that they bear no reasonable relationship to the services rendered and could not have been the product of arm’s length negotiations.
Goodman vs. J.P. Morgan Investment Management, Inc., No. 2:14-cv-414 (S.D. Ohio, 3/4/15).
The Mutual Fund Shareholders Complain
Defendant serves as the investment adviser to three JP Morgan mutual funds (the “Funds”) and receives annual fees from each fund based on each fund’s assets under management. Plaintiffs, shareholders in one or more of the Funds, brought this action alleging that Defendant breached its fiduciary duties in violation of §36(b) of the Investment Company Act of 1940 (“ICA”) by charging the Funds millions of dollars in excessive fees. Plaintiffs’ complaint contained three primary allegations. First, Plaintiffs alleged that the rates Defendant charged the Funds were anywhere from 25% to 525% higher than the rates Defendant charged when acting as a subadviser to similar funds not affiliated with Defendant. Second, Plaintiffs alleged that, as the Funds grew in size, Defendant enjoyed economies of scale that reduced its costs and increased its profitability. According to Plaintiffs, Defendant should have lowered its fees as its costs decreased, but failed to do so. Finally, Plaintiffs attacked the decision making process of the Funds’ boards, alleging that the boards did not act in the best interest of the Funds or shareholders when approving the Funds’ advisory agreements. Instead of engaging in bona fide arms’ length negotiations with Defendant regarding the advisory fees, Plaintiffs alleged that the boards merely rubber-stamped information supplied by Defendant. Defendant filed a Rule 12(b)(6) motion to dismiss, and the issues were extensively briefed by the parties.
The Court Rules
The Court begins its Twombly analysis by stating that its review of the complaint is informed by the factors set out in Gartenberg v. Merrill Lynch Asset Mgmt. Inc., 694 F.3d 923 (2d Cir. 1982), which the Supreme Court adopted in Jones v. Harris Assocs., L.P., 559 U.S. 335 (2010). Those factors include an examination of (1) the nature and quality of the services provided; (2) the profitability of the fund to the adviser; (3) any collateral benefits enjoyed by the adviser as a result of the relationship with the fund; (4) a comparison of the fees at issue with those paid by similar funds; and (5) the independence, expertise, care and conscientiousness of the fund’s board in evaluating adviser compensation. Using these factors as a guide, the Court finds that, taken as a whole, the complaint pleads sufficient facts about the fees paid to Defendant, the notable disparity between those fees and the fees charged to other funds, and the manner in which the fees were approved to present a plausible claim that the fees were disproportionately large. Accordingly, the Court denies the motion to dismiss. The Court is careful to note, however, that it is not expressing any opinions at this time as to whether Plaintiffs will ultimately produce sufficient evidence to meet the high standard for liability under ICA §36(b) or as to the merits of Defendant’s explanations and arguments in support of the fees.
(SLC Ref. No. 2015-12-10)
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