On July 13, 2015, the United States District Court for the Eastern District of Pennsylvania issued a decision in the defendants’ motion to dismiss the case of Curd v. SEI Investments Management Corp., Civ. Action No. 13-7219. On behalf of five SEI mutual funds (the “SEI Funds”) in which they own shares, the plaintiffs brought an action under Section 36(b) of the Investment Company Act of 1940, as amended, against the investment adviser (SIMC) and administrator (SIGFS) to the SEI Funds.

Pursuant to Section 36(b), an investment adviser has a fiduciary duty with respect to the receipt of compensation for services that are paid by the investment company or, ultimately, its shareholders. The Supreme Court has held that in order to establish a breach of fiduciary duty, a plaintiff must demonstrate that the fee an investment adviser charged was “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.”[1]  In the Gartenberg cases of the early 1980s, the Second Circuit adopted a fact intensive multi-factor test to determine whether arm’s length bargaining was observed by an investment company board when considering approval of an advisory contract.[2] The Supreme Court later affirmed this approach. Fund managers and their boards have come to know this process as the annual “15(c) meeting” at which the investment advisory contract is reviewed and approved by the board, after a lengthy comparative analysis.

In the present case, the plaintiffs alleged that SIMC hired enough sub-advisers that it essentially had no advisory duties remaining, yet SIMC retained 40% of the management fees charged, based on assets under management, to the SEI Funds.

The court found that the allegations presented by the plaintiffs against SIMC, when taken together, “raise a plausible inference that SIMC’s fees are so disproportionately large that they bear no reasonable relationship to the services provided to the SEI Funds and could not have been the product of arm’s length bargaining.” Thus, SIMC’s motion to dismiss was denied.

In addition to the claims against SIMC, the plaintiffs brought Section 36(b) claims against SIGFS, who performed administrative, regulatory, and back-office services to the SEI Funds. However, unlike the outcome for SIMC, the court dismissed the claims against SIGFS because it concluded SIGFS was not a person covered by the language of Section 36(b). The court found that SIGFS did not fall into any of the three categories of persons who may have a breach of fiduciary duty brought against them, (i) an investment adviser to a registered fund, (ii) an affiliated person of the investment adviser, or (iii) any other person enumerated in subsection (a) of 15 U.S.C.§ 80a-35 (an officer, director, member of any advisory board, investment adviser, or depositor; or as principal underwriter, if such registered company is an open-end company, unit investment trust, or face-amount certificate company) who has a fiduciary duty concerning such compensation or payments.

Unfortunately for investment advisers to registered funds who employ the “manager of managers” approach, this is another case where a motion to dismiss a Section 36(b) excessive fee case has failed. The case against SEI is not uncommon. There are currently cases pending against 14 investment advisers in U.S. federal courts for alleged Section 36(b) liability. While a 36(b) defendant’s motion to dismiss is typically denied, in the years since the Gartenberg ruling, the outcome of cases has almost always been in favor of the defendants[3]. The judgment on the motion to dismiss is a positive outcome for administrators and other service providers who do not fall squarely within the enumerated persons of Section 36(b) as it indicates courts will require clear facts supporting Section 36(b) claim against each person named in a suit.