The U.S. District Court for the Central District of California (In Re American Mutual Funds Fee Litigation, C.D. Cal. Case No. CV 04-5593, 12/28/09) recently ruled for the defendants against the plaintiff, mutual fund investors, with respect to claims that American Funds violated the provisions of Section 36(b) of the Investment Company Act of 1940 by imposing excessive fees. The Court applied the standards in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2nd Cir. 1982), which concluded that a violation of Section 36(b) arises from an advisory fee that is “so disproportionately large that is bears no reasonable relationship to the services rendered and could not be the product of arm's-length bargaining.” The Court commented that “this standard establishes a very low threshold of the registered mutual fund company and a very high hurdle for a plaintiff.”
The question of what is an excessive fee for purposes of Section 36(b) of the Investment Company Act of 1940 is currently being considered by the U.S. Supreme Court in Jones v. Harris Associates L.P., U.S. No. 08-586. In that case, a divided U.S. Court of Appeals for the Seventh Circuit rejected the Gartenberg standard ruling that marketplace competition should govern.
In this case, the plaintiffs were investors in one or more of eight American Funds. The investment adviser to the funds received management fees, an affiliate broker-dealer received distribution and marketing fees, and the funds also received 12b-1 fees from investors that were paid out as a method of compensating broker-dealer distributors and for providing certain other administrative services to investors.
In effect, the Court determined that the plaintiffs failed to prove that all of the fees received by the investment adviser and its related parties “were so disproportionate to the services rendered such that the fees could not have been the product of arms-length bargaining.” Accordingly, the Court ruled that plaintiffs did not meet the Gartenberg standard.