4.9.2009 The Eighth Circuit, in Gallus v. Ameriprise Financial, Inc., No. 07-2945, 2009 WL 928920 (8th Cir. Apr. 9, 2009), held that the factors set forth in Gartenberg v. Merrill Lynch Asset Management Inc., 694 F.2d 923 (2d Cir. 1982) provide a useful framework for evaluating whether an investment adviser violated its fiduciary duty under § 36(b) of the Investment Company Act of 1940 (1940 Act) by charging an excessive fee. The Eighth Circuit’s decision comes after the recent Seventh Circuit decision in Jones v. Harris Associates, 527 F.3d 627 (7th Cir. 2008), which rejected the Gartenberg standards. The Seventh Circuit established a new standard by holding that an investment adviser will not violate its fiduciary duty under § 36(b) when setting its fee provided that it makes “full disclosure and play[s] no tricks” to the board of directors approving the fee. However, the Eighth Circuit in Gallus went beyond Gartenberg by ruling that an investment adviser may violate its fiduciary duty to the mutual funds in ways in addition to charging an exorbitantly high fee, namely omitting or obfuscating facts presented to the board during the 15(c) process. Furthermore, the court may have added a new factor that boards must consider when approving advisory fees, which is a comparison of the fee the investment adviser charges for the mutual fund with the fee it charges for similarly managed non-mutual fund accounts. Thus, Gallus case has increased the existing split among the circuits as to the appropriate test for analyzing excessive fee claims. Adding to the confusion, the U.S. Supreme Court granted certiorari in the Harris case and will probably resolve the split in the circuits on the appropriate standard for reviewing excessive fee claims.
The Eighth Circuit did not find that the U.S. District Court for the District of Minnesota in Gallus v. Ameriprise Financial, Inc., No. 04-4498 (July 6, 2007) erred because it found that the directors considered the Gartenberg factors in approving the investment advisory contract. In this way the Eighth Circuit’s decision differs from the Seventh Circuit in Harris, which disapproved of the Gartenberg standard, and set a new “disclosure-based” standard for evaluating excessive fee claims. While it preserved the Gartenberg factors, it modified those standards by focusing on the process by which the adviser negotiates with the board and adding a new standard that compares the advisory fee charged to the mutual fund with those charged to similarly managed institutional accounts.
In Gallus, investors in eleven retail mutual funds managed by Ameriprise Financial, Inc. (Ameriprise) brought suit in the U.S. District Court for the District of Minnesota against Ameriprise and some of its subsidiaries alleging that Ameriprise breached its fiduciary duty under § 36(b) of the 1940 Act by misleading the funds’ board during the negotiations and demanding excessive fees. Specifically, plaintiffs alleged that Ameriprise: (1) misled the funds’ board about its arrangement with institutional clients to prevent the board from questioning the higher fees for the retail funds; (2) provided comparable advisory services to institutional clients at substantially lower fees; and (3) skewed the fee negotiation process by stressing fee arrangements of similar mutual funds and not Ameriprise’s actual costs and profits of servicing the retail funds.
Following the standard set by the Second Circuit in Gartenberg, the District Court dismissed the plaintiff’s claim because the facts supported the conclusion that Ameriprise met the Gartenberg factors, including by not charging a fee so exorbitantly high (relative to other advisers) to cause it to violate its fiduciary duty under § 36(b).
The Eighth Circuit found that the District Court erred by failing to consider other ways that Ameriprise may have violated its fiduciary duty under § 36(b). One way that Ameriprise could have violated its fiduciary duty was to have purposefully omitted, disguised or obfuscated information that it presented to the Board when it was considering the Gartenberg factors, including information that it presented to the Board about the fee discrepancy between mutual fund and institutional clients. The Eighth Circuit read § 36(b) to impose on advisers a duty to be honest and transparent throughout the negotiation process. It remanded the case to the District Court to consider both the adviser’s conduct during the fee negotiation process and the end result of determining the fees, because unscrupulous behavior with respect to either can constitute a breach of fiduciary duty.
Furthermore, the Eighth Circuit found that the District Court erred by rejecting a comparison between the fees charged to Ameriprise’s institutional clients and its mutual fund clients. The District Court was wronged to have rejected this comparison because the court in Gartenberg refused to compare the adviser’s fees between money market funds and equity pension funds. In this case, the Eighth Circuit found that a comparison may be relevant because there potentially is greater similarity between the Ameriprise funds and Ameriprise advised-institutional accounts than between money market funds and equity pension funds. It added that the argument for comparing mutual fund advisory fees with the fees charged to institutional accounts is particularly strong in this case because the investment advice may have been essentially the same for both accounts.
The Eighth Circuit’s opinion resonates closely with Judge Posner’s dissent in the Harris case. It cited Posner’s statement that a “particular concern in [the Harris case] is the adviser’s charging its captive funds more than twice what it charges independent funds.” In potentially expanding the Gartenberg standard by siding with Judge Posner’s dissent in Harris, the Eighth Circuit accentuated a philosophical split among the circuits—with the Second and the Fourth Circuits applying a judicially determined reasonableness standard under Gartenberg, and the Third, Seventh and now Eighth Circuits largely focusing on the sufficiency of disclosure and the behavior by fiduciaries as the proper touchstone for analysis of advisers’ fees.
It is also notable that the Eighth Circuit did not stay its decision pending the review by the U.S. Supreme Court of the Harris case—perhaps the Eighth Circuit hopes to influence the U.S. Supreme Court’s decision. It is now less certain which circuit’s standard the U.S. Supreme Court will take, if any.
Click http://caselaw.findlaw.com/data2/circs/8th/072945P.pdf to access the case.