On July 24, 2017, the U.S. Court of Appeals for the Eighth Circuit affirmed a district court’s finding that a shareholder in a mutual fund operating as a fund of funds does not have standing to sue the fund’s investment adviser under Section 36(b) of the Investment Company Act of 1940 for fees charged by the underlying funds owned by the fund of funds.

The plaintiff invested in a fund of funds advised by the investment adviser, who also advised the underlying funds in which the fund of funds invested. Section 36(b) allows fund shareholders to bring an action against the fund’s investment adviser for excessive fees it receives from the fund. In this case, the plaintiff did not allege that the investment adviser breached its duty under Section 36(b) with respect to the fund of funds, but rather as a result of the fees charged by the underlying funds in which the fund of funds invested. The district court held that the plaintiff lacked standing under Section 36(b) to challenge the fees charged by the underlying funds (commonly known as “acquired fund fees and expenses”), as the plaintiff was not bringing a claim against the investment adviser with respect to the fund of which the plaintiff was a shareholder.

On appeal, the plaintiff argued that the acquired fund fees and expenses represented payments the investment adviser received from the shareholders of the fund of funds. The Court of Appeals noted that the acquired fund fees and expenses reflect compensation or payments made by the underlying funds, not by the fund of funds. The court further stated that the acquired fund fees and expenses merely reduced the value of the fund of funds’ investment in the underlying funds and that such a reduction in an asset’s value could not be construed as compensation paid by the shareholder of the fund of funds.

The Court of Appeals decision makes it clear that a shareholder may only bring a Section 36(b) excessive fee action against an investment adviser with respect to the fees paid by the specific fund in which the shareholder has invested.