On January 18, 2013, two union pension plans sued BlackRock’s exchange traded funds iShares Trust and iShares Inc. (the “Trusts”), the Trusts’ investment adviser, affiliated securities lending agent and certain other affiliates (collectively, “BlackRock”) as well as the Trust’s directors and/or trustees (the “Directors”), alleging that the defendants violated their fiduciary duties by setting up an “excessive fee structure designed to loot securities lending returns properly due to iShares investors.”1 Specifically, the plaintiffs claim that the 60/40 securities-lending fee split is excessive and demonstrates a breach of fiduciary duty on the part of the defendants under Sections 36(a) and (b) of the Investment Company Act of 1940 (the “1940 Act”), and that the contracts between BlackRock and the Trusts obligating the Trusts to compensate BlackRock for securities lending transactions are unenforceable and voidable under Section 47(b) of the 1940 Act.
Plaintiffs allege that the securities lending arrangement affords BlackRock “a fee of 35% of the ‘net amount earned on securities lending activities’” under the Director-approved contracts in addition to 5% representing “fees [believed to be] derived from securities lending…such as…fees charged by [BlackRock] for investing collateral,” which sometimes allegedly involved the use of BlackRock-affiliated investment vehicles, amounting to an effective 60/40 securities-lending fee split. Moreover, plaintiffs claim that the Trusts also paid borrowers additional fees where securities loans were collateralized by cash, and that in some cases this revenue benefitted BlackRock affiliates.
The claim raises excessive fee allegations, typically litigated in the advisory fee context, in respect of securities lending fees. To prevail on their claim under Section 36(b), the plaintiffs must establish that the fees are “so disproportionately large that [they] bear[ ] no reasonable relationship to the services rendered and could not have been the product of arm’s length bargaining.”2 Plaintiffs’ arguments in support of their excessive fee claim largely hinge on comparisons to other securities lending fee splits in the industry that are allegedly more favorable to funds and academic studies concluding that the conflicts of interest arising from affiliated securities lending arrangements diminish returns on the securities lent. BlackRock has claimed in public statements that their “securities lending program has delivered above average returns to…ETF shareholders over time.”3