Chris Lazarini Outlines Factors to Determine Whether Adviser’s Fees Violate Investment Company Act

May 28, 2020
Securities Online Litigation Alert

Bass, Berry & Sims attorney Chris Lazarini outlined the factors courts must consider in determining whether the fees an adviser charges a mutual fund are excessive and in violation of the Investment Company Act. All the relevant factors to consider include:

  • The nature, extent, and quality of the services the adviser provides to the shareholders.
  • The profitability of the mutual fund to the adviser.
  • “Fall-out” benefits, such as indirect profits to the adviser.
  • Economies of scale achieved by the adviser because of growth in assets under the fund’s management and whether savings generated from the economies of scale are shared with shareholders.
  • Comparative fee structures used by other similar funds.
  • The level of expertise, conscientiousness, independence, and information with which the fund’s board acts.

Chris provided the analysis for Securities Online Litigation Alert (SOLA). The full text of the analysis is below and used with permission from the publication. If you would like to receive additional content from the SOLA, please visit the SOLA website to sign up for the newsletter.

Goodman vs. JP Morgan Investment Management, Inc., Nos. 18-3238 & 18-3239 (6th Cir., 3/30/20)

To determine whether the fees an adviser charges a mutual fund are excessive and in violation of the Investment Company Act, a court must consider all relevant factors, including:  (1) the nature, extent, and quality of the services the adviser provides to the shareholders; (2) the profitability of the mutual fund to the adviser; (3) “fall-out” benefits, such as indirect profits to the adviser; (4) economies of scale achieved by the adviser because of growth in assets under the fund’s management and whether savings generated from the economies of scale are shared with shareholders; (5) comparative fee structures used by other similar funds; and (6) the level of expertise, conscientiousness, independence, and information with which the fund’s board acts.

Plaintiffs in these consolidated appeals are shareholders in five mutual funds (the “Funds”) who alleged Defendant (“JPMIM”) charged the Funds’ shareholders excessive fees, in violation of Section 36(b) of the Investment Company Act of 1940 (“ICA”). To impose liability under the ICA, a shareholder must prove the challenged fee “‘is so disproportionally large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s length bargaining.'” Jones v. Harris Assocs. L.P., 559 U.S. 335, 346 (2010) (instructing courts to consider all factors relevant to the challenged fee, including those set forth in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982)).

Applying the Gartenberg factors, the Court affirms summary judgment for Defendants. The Court finds the first and fifth factors – comparative fee structures and nature, extent, and quality of the services provided – particularly important, although not dispositive. The “heart” of the issue for these factors, the Court notes, is which funds are comparable. The Court rejects Plaintiffs’ effort to use funds for which JPMIM acts as subadviser for the comparison because JPMIM’s role as subadviser differs from its role as adviser to the Funds. Citing Lipper’s peer reports (the wide use of which Plaintiffs’ expert acknowledged), the Court finds no issue of material fact, because the Funds outperformed their peers and the fees paid by the Funds were in line with those peer funds. Outperformance, the Court notes, indicates delivering value for the money.

The Court similarly finds no issue of material fact regarding the fourth factor – economies of scale – because the proof showed economies were achieved and were passed to shareholders as fee waivers. Finally, the Court finds no material issue of fact regarding the sixth factor – board oversight. The Court finds the Funds’ board included experienced, independent trustees, who met several times per year and thoughtfully acted on information obtained from independent third parties, including Lipper and Casey Quirk and the Board’s independent counsel, and the Funds’ senior officer and chief compliance officer. That Plaintiffs would have had more information provided to the board, the Court concludes, is “nit-picking” the process, and not something that creates a triable issue of fact.