A putative class action complaint has been filed against the adviser and distributor (collectively, "defendants") of the American Funds' EuroPacific Growth Fund ("Fund") to recover allegedly "excessive" and "disproportionate" Rule 12b-1 fees ("12b-1 fees") paid by the Fund to the defendants.

Alleged Breach of Fiduciary Duty. The complaint asserts a claim for breach of fiduciary duty under Section 36(b) of the Investment Company Act of 1940 ("1940 Act") against the Fund's distributor, American Funds Distributors, Inc. ("AFD"), on the following grounds:

(1) that the 12b-1 fees paid by the Fund were not "primarily intended to result in the sale of shares issued by" the Fund;

(2) even if primarily intended to result in the sale of Fund shares, the 12b-1 fees

(a) paid for services that the broker-dealers were legally obligated to provide existing account holders at the broker-dealers own expense; or

(b) were excessive and disproportionate, including but not limited to excessive and disproportionate commissions;

(3) there is no reasonable likelihood that the 12b-1 fees will benefit both the Fund and its shareholders; and 

(4) there are no problems or circumstances that make the continuation of the 12b-1 fees necessary or appropriate.

The complaint does not name the Fund or its directors as parties, but alleges that the Fund's board of directors breached its fiduciary duty by "continually" approving the Fund's 12b-1 plans while giving only "perfunctory" consideration to whether the plans should be continued, and by approving plans that allegedly provided no benefits to the Fund or its shareholders for a number of years. The complaint also alleges that the Fund's board breached its fiduciary duty by failing to negotiate lower 12b-1 fees.

Alleged Control Person Liability. The complaint also asserts a claim for control person liability under Section 48(a) of the 1940 Act against the Fund's adviser, Capital Management and Research Company ("Capital Management"), on grounds that, as a "control person" of AFD, it caused AFD to commit the alleged breaches of fiduciary duty.

Relief Requested. The complaint seeks declaratory and injunctive relief:

(1) declaring that the defendants' 12b-1 fees are "unreasonable, excessive andunlawful;"

(2) rescinding the 12b-1 plans adopted by the Fund;

(3) removing each independent director or trustee of the Fund identified in thecomplaint and replacing them with "truly" independent directors; and 

(4) removing the adviser and the distributor.

The complaint also seeks an unstated amount of compensatory damages, as well as pre- and post-judgment interest, attorney's fees and costs, and further relief the court deems just and equitable.

Discussion. The complaint relies heavily on the assertion that most of the Fund's 12b-1 fees are not primarily intended to result in the sale of Fund shares and, therefore, are excessive and disproportionate as a matter of law. Specifically, the complaint asserts that over half of the more than $250 million of the Fund's 12b-1 fees for 2007 was used to pay a "service fee" for post-sale servicing efforts including, among other activities:

  • Ministerial, operational and compliance issues with respect to the shareholder's brokerage account, such as providing monthly or quarterly account statements, confirmations of transactions, and suitability analyses of the client's account;
  • Assisting customers in rebalancing their portfolios;
  • Reviewing customer holdings on a regular basis;
  • Reassessing customer needs and investment strategies;
  • Assisting customers with lost dividend checks and certificates;
  • Assisting inactive customers;
  • Answering tax questions;
  • Answering other customer questions; and
  • Helping investors generally understand their investments.

Section 12(b) and Rule 12b-1 thereunder, of course, do not prohibit a mutual fund from securing otherwise lawful shareholder services for its shareholders. Rather, they prohibit a mutual fund from acting as a distributor of its own shares except in compliance with the Rule, which deems a fund to be acting as a distributor of its own shares if the fund "engages directly or indirectly in financing any activity which is primarily intended to result in the sale of shares issued by such company." A mutual fund that does not finance such a "primarily intended" activity would not be deemed to be acting as a distributor of its shares under Rule 12b-1 and would not need to comply with the Rule. However, as the SEC staff noted in its 2000 Report on Mutual Fund Fees and Expenses, given uncertainty as to what might constitute a direct or indirect financing of activities "primarily intended" to result in the sale of mutual fund shares, some funds, out of an abundance of caution, have adopted Rule 12b-1 plans even where no assets are used for distribution purposes, while others that do use their assets to pay for distribution also may include non-distribution operating expenses within the scope of their Rule 12b-1 plans.

By asserting that the Fund's shareholder services were not "primarily intended to result in the sale of" Fund shares, the complaint would appear to be arguing, in effect, that these shareholder services need not be covered by Rule 12b-1 in the first instance, in which case the 12b-1 fees arguably would be neither excessive nor disproportionate as a matter of law.

The complaint goes on to argue that even if the Fund's 12b-1 fees were primarily intended to result in the sale of Fund shares, the fees are excessive and disproportionate under certain of the factors developed by the SEC for consideration by mutual fund boards in approving Rule 12b-1 plans. One factor discussed at length in the complaint is the effect of the Rule 12b-1 plan on existing shareholders. Regarding this factor, the complaint alleges that the Fund's shareholders do not benefit from economies of scale and therefore there is no "reasonable likelihood" that the Fund's Rule 12b-1 plan will benefit the Fund and its shareholders. The complaint, however, offers no specific facts to support this allegation. To the contrary, the complaint concedes that the Fund's advisory fees offer breakpoints that reflect some economies, but argues that these economies are "miniscule" compared to the amount of 12b-1 fees paid.