The U.S. Court of Appeals for the Eighth Circuit recently added another possibility to be considered by the U.S. Supreme Court in its October 2009 term when it decides Jones v. Harris Associates L.P., 527 F.3d 627 (7th Cir. 2008), cert. granted, (U.S. Mar. 9, 2009) (No. 08-586). At issue is what standard of review should be applied in reviewing claims of excessive compensation under Section 36(b) of the Investment Company Act of 1940, as amended.  

For many years, mutual fund directors have evaluated advisory agreements and the fees charged by the investment advisor using a multi-factor test established by the Second Circuit in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982). In 2008, the Seventh Circuit decided Jones and repudiated Gartenberg, stating that as long as an investment advisor “make[s] full disclosure and play[s] no tricks . . . [t]he trustees (and in the end the investors, who vote with their feet and dollars), rather than a judge or jury, determine how much advisory services are worth.”  

In Gallus v. Ameriprise Financial, Inc., No. 07-2945 (8th Cir. Apr. 8, 2009), the Eighth Circuit offered its own interpretation, and while the Court approved of the lower court’s analysis using the Gartenberg factors, unlike in other cases, the Court concluded that a Section 36(b) review should include a comparison of the fees charged by the advisor to mutual fund clients and institutional clients, particularly where “the investment advice may have been essentially the same for both accounts.” The Court further held that dishonesty or unscrupulous behavior with respect to either the negotiation of fees or the end result (i.e., the reasonableness of the amount of advisory fees) can constitute a breach of fiduciary duty under Section 36(b).  

The Gallus opinion is available here.