On August 24, 2011, the U.S. Court of Appeals for the Ninth Circuit upheld the district court’s ruling in favor of Capital Research and Management Co. (“Capital Research”) in the case Jelinek v. Capital Research and Management Co., finding that the plaintiffs failed to prove that Capital Research breached its fiduciary duty under Section 36(b) of the 1940 Act. The decision in this excessive-fee lawsuit may indicate how lower courts will interpret and apply the Supreme Court’s recent decision in Jones v. Harris.
In affirming the district court’s decision in Jelinek, the Ninth Circuit rejected the plaintiffs’ claim that Jones had expanded the standard set forth in the seminal case Gartenberg v. Merrill Lynch Asset Management, Inc. to allow plaintiffs to prevail if they could show a flawed board approval process. The Ninth Circuit reasoned that the 1940 Act, Jones and Gartenberg “all require the court to calibrate the degree of deference afforded the independent directors’ expertise based on the case and the conscientiousness with which they performed their duties” and found that the district court had “meticulously” applied the proper standard to the case. The Ninth Circuit noted that, in light of the flaws the district court identified in the independent directors’ fee approval process, the district court gave the directors’ fee approval less deference than it otherwise would have, but correctly concluded that “overall the conduct of the directors met the Gartenberg standard.”
The Ninth Circuit’s decision reinforces the view that Jones upheld Gartenberg as the standard for evaluating mutual fund adviser compensation and rejects the argument that Gartenberg does not apply in cases where plaintiffs can provide evidence of a flawed board approval process. The Jelinek decision also affirms the role of independent directors in setting advisory fees and the degree of deference that courts continue to afford to independent fund boards.