The U.S. Court of Appeals for the Eighth Circuit is the latest court to establish a standard for evaluating excessive fee claims under Section 36(b) of the Investment Company Act of 1940, a standard that focuses on the adviser's conduct during the negotiation process and the end result. The Court, in a unanimous decision by a three-judge panel in Gallus v. Ameriprise Financial , No. 07-2945 (8th Cir. Apr. 8, 2009), reversed and remanded for further proceedings a district court's grant of summary judgment in favor of an Ameriprise-affiliated mutual fund adviser and certain of its affiliates ("Ameriprise") in an excessive fee case brought under Section 36(b) of the Investment Company Act. It comes at a time when the U.S. Supreme Court has agreed to resolve a split of authority in how courts should analyze excessive fee claims under Section 36(b), arising between the Second Circuit's decision in Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923 (2d Cir. 1982), which for more than 25 years had served as the touchstone for all Section 36(b) cases, and the Seventh Circuit's more recent decision in Jones v. Harris Associates, 527 F.3d 627 (7th Cir. 2008), which expressly rejected the Gartenberg approach.
Section 36(b) provides that a mutual fund's adviser "shall be deemed to have a fiduciary duty respect to the receipt of compensation for service...." The plaintiffs alleged that Ameriprise breached its fiduciary duty under Section 36(b) by misleading the funds' board of directors (the "Board") in the negotiation of the fees paid to Ameriprise for advising certain mutual funds and demanding excessive fees. After allowing limited discovery, the district court granted Ameriprise's motion for summary judgment on all of the plaintiffs' claims based on an analysis of the factors set out in Gartenberg . The district court also determined that the statutory damages period under Section 36(b), which provides that "[n]o award of damages shall be recoverable for any period prior to one year before the action was instituted," was restricted to the year preceding the filing date.
On appeal, the plaintiffs argued that "the district court improperly interpreted § 36(b) and overlooked important questions of material fact." In rendering its opinion, the Court of Appeals noted that "Ameriprise entered the negotiation with a pricing philosophy wherein it attempted to establish fees that were in the middle of the pack of funds with a similar size, objective and distribution model," and that the funds' Board had "acquiesced in this goal of tethering fees to the industry median." The case, however, centered around a report, prepared by Ameriprise at the request of the Board after becoming aware that Ameriprise charged comparatively lower fees to its institutional clients than its mutual fund clients, "explaining the similarities and differences between the two types of accounts."
"The plaintiffs' experts," according to the Court, claimed that "the report omitted or obfuscated information to make the fee discrepancy seem smaller and more justifiable than it really was," leading plaintiffs to "suggest that the Board might not have ratified the fee agreement had it been given accurate information." The Court noted that, although Ameriprise objected to the plaintiffs' characterization of the report, its main argument was that "the contents of the report were irrelevant." "In effect," the Court stated, "Ameriprise contends that an adviser cannot be liable for a breach of fiduciary duty as long as its fees are roughly in line with industry norms."
In analyzing the applicable case law, the Court, although critical of the economic analysis underlying the Seventh Circuit's decision in , essentially attempted to harmonize the approaches taken by the Gartenberg and Harris Harris AssociatesAssociates courts, while at the same time fashioning another standard for evaluating excessive fee claims. In the Court's view, "the proper approach to § 36(b) is one that looks to both the adviser's conduct during negotiation and the end result.... Unscrupulous behavior with respect to either can constitute a breach of fiduciary duty."
The Court concluded that the district court erred in holding that:
no § 36(b) violation occurred simply because Ameriprise's fee passed muster under the Gartenberg standard. Although the district court properly applied the Gartenberg factors for the limited purpose of determining whether the fee itself constituted a breach of fiduciary duty, it erred in rejecting a comparison between the fees charged to Ameriprise's institutional clients and its mutual fund clients....
... Given the relevance of this evidence, the district court should have explored the disputed issues of material fact concerning the similarities and differences between mutual funds and institutional accounts.
The Court also faulted the district court for having "engaged in so limited a scope of review." According to the Court, "Ameriprise's conduct must be evaluated independent from the result of the negotiation. The district court concluded that Ameriprise did not breach its fiduciary duty in one way (by setting a fee that was exorbitant relative to that of other advisers), but it should have also considered other possible violations of § 36(b). Specifically, the court should have determined whether Ameriprise purposefully omitted, disguised, or obfuscated information that it presented to the Board about the fee discrepancy between different types of clients."
The Court rejected, however, the plaintiffs' argument that the "external focus" of the fee negotiation "was a per se breach of Ameriprise's fiduciary duty." In the Court's view, "while tethering fees to an industry median will not provide sure-fire protection from § 36(b) liability, a negotiation strategy similar to that employed in this case is not necessarily suspect. An effort to meet or surpass the value offered by one's primary competitors is a common business strategy, and there is no reason to assume it indicates bad faith."
Significantly, the Court also addressed the question "whether the statutory damage period ends with the filing of a § 36(b) lawsuit or continues throughout the litigation." The Court concluded that "where the plaintiffs have continued to suffer damage during the litigation, both the language of the statute and the interests of judicial economy suggest that redress should be available in a single action." It thus appears the Court would allow, at least in theory, a plaintiff in a successful Section 36(b) lawsuit to recover damages suffered after the plaintiff filed suit.
What impact the Gallus decision will ultimately have remains to be seen. The decision is certainly well-timed to potentially influence the Supreme Court's pending review of Harris Associates. It is possible that the Supreme Court could adopt any of the now three different approaches to Section 36(b) or an entirely different standard. It is noteworthy, also, that the issue of the appropriate statutory damages period is not before the Supreme Court.