March 2010 / Issue 8 A legal upate from Dechert s Financial Services Group The Unite States Supreme Court Uphols the Gartenberg Stanar for Claims Alleging Excessive Avisory Fees Introuction On March 30, 2010, the Supreme Court hane own its long-awaite ecision in Jones v. Harris Associates L.P., 1 the Supreme Court s first ecision interpreting section 36(b) of the Investment Company Act of 1940, as amene (the 1940 Act ) in roughly a quarter century. 2 In a unanimous opinion written by Justice Samuel Alito, the Court hel that the correct stanar in etermining whether a fun s investment aviser has breache its fiuciary uty with respect to the receipt of compensation was the stanar applie by the Secon Circuit Court of Appeals in Gartenberg v. Merrill Lynch Asset Mgmt., Inc. 3 The Court note that Gartenberg has provie a workable stanar for nearly three ecaes. 4 The Supreme Court 1 No. 08-586, 2010 WL 1189560 (U.S. Mar. 30, 2010). 2 Before Jones, the last Supreme Court ecision on section 36(b) was Daily Income Fun, Inc. v. Fox, 464 U.S. 523 (1984). Interestingly, while serving as Assistant to the Solicitor General, Department of Justice, Justice Alito, who authore the Jones opinion, helpe raft the Securities an Exchange Commission's amicus curiae brief in Daily Income Fun. 3 964 F.2 923, 928 (2 Cir. 1982). 4 Jones, 2010 WL 1189560, at * 11. Justice Thomas wrote a concurring opinion, stating that he agree with the Court s approach which efers to the informe conclusions of isintereste boars an hols plaintiffs to their heavy buren of proof in the manner the 1940 Act requires but i not agree that this approach enorses the Gartenberg stanar, which coul be viewe as authorizing a free-ranging juicial fairness review of fees. vacate the ecision of the Seventh Circuit Court of Appeals, which ha rejecte the Gartenberg stanar in favor of a market competition-base approach, an remane the case to the Seventh Circuit for further proceeings consistent with the Court s ecision. Discussion The Gartenberg Stanar Section 36(b) of the 1940 Act provies in part that the investment aviser of a registere investment company shall be eeme to have a fiuciary uty with respect to the receipt of compensation for services, or of payments of a material nature, pai by such registere investment company, or by the security holers thereof, to such investment aviser. 5 In Gartenberg, the Secon Circuit Court of Appeals hel that [t]o be guilty of a violation of 36(b)... the aviser-manager must charge a fee that is so isproportionately large that it bears no reasonable relationship to the services renere an coul not have been the prouct of arm's-length bargaining. 6 The Jones petitioners (the plaintiff shareholers who lost the case in the lower courts on summary jugment) urge the Supreme Court 5 84 Stat. 1429 (coifie at 15 U. S. C. 80a 35(b)). 6 Gartenberg, 964 F.2 at 928.
to aopt the arm s-length bargaining result element of the test, but to reject the isproportionately large" element as setting a higher buren than intene by Congress for claims of excessive fees. 7 The high court ecline to o so. Uner the Gartenberg stanar, as articulate by the Supreme Court, to face liability [ue to a breach of fiuciary uty] uner 36(b), an investment aviser must charge a fee that is so isproportionately large that it bears no reasonable relationship to the services renere an coul not have been the prouct of arm s length bargaining. 8 Fiuciary Duty For purposes of section 36(b), the Supreme Court hel that fiuciary uty means what the Court sai it meant in 1939, when the Supreme Court state, in an analogous context, the essence of the test is whether uner all the circumstances the transaction carries the earmarks of an arm s length bargain. 9 Accoring to the Supreme Court, Gartenberg incorporates this meaning of fiuciary uty as set out in 1939 by using the range of fees that coul result from an arm s-length negotiation as the benchmark for reviewing challenge fees. 10 The Supreme Court note, however, that section 36(b) eparte from this concept in a significant way by shifting the buren of proof from the fiuciary to the investor claiming a breach. 11 In arriving at the meaning of fiuciary uty for purposes of section 36(b), the Supreme Court expressly recognize that Congress rejecte a reasonableness stanar. 12 In oing so, the Court foun, Congress 7 The petitioners state, [A]lthough the Gartenberg court correctly ientifie the test as whether the fee is comparable to an arm s-length eal, it ae the erroneous aitional concept that, [t]o be guilty of a violation of 36(b), the aviser must charge a fee that is so isproportionately large that it bears no reasonable relationship to the services renere an coul not have been the prouct of arm slength bargaining. Brief of Petitioner, 2009 WL 1640018, at * 31, Jones v. Harris Associates L.P. No. 08-586, 2010 WL 1189560 (U.S. Mar. 30, 2010). 8 Jones, 2010 WL 1189560, at * 7. 9 I. at *8 (emphasis ae by the Supreme Court) (citing to Pepper v. Litton, 308 U. S. 295, 306-307 (1939)). 10 Jones, 2010 WL 1189560, at * 8. recognize that courts are not well-suite to make such precise calculations. 13 Rather, the Court sai, Gartenberg s so isproportionately large stanar... reflects this congressional choice to rely on inepenent irectors to act as watchogs to protect investors interests. 14 Role of the Boar of Directors Consistent with this view, the Supreme Court emphasize the role of the boar of irectors in a court s etermination of whether an investment aviser has breache its fiuciary uty in regar to receipt of compensation. It state that [w]here a boar s process for negotiating an reviewing investment-aviser compensation is robust, a reviewing court shoul affor commensurate eference to the outcome of the bargaining process. 15 [I]f the isintereste irectors consiere the relevant factors, their ecision to approve a particular fee agreement is entitle to consierable weight, even if a court might weigh the factors ifferently. 16 That is not to say, however, that a well informe boar s ecision is ispositive. The Court note that a fee may be excessive even if it was negotiate by a boar in possession of all relevant information, but such a etermination must be base on evience that the fee is so isproportionately large that it bears no reasonable relationship to the services renere an coul not have been the prouct of arm s-length bargaining. 17 The Court state: it woul have been paraoxical for Congress to have been willing to rely largely upon [boars of irectors as] watchogs to protect shareholer interests an yet, where the watchogs have one precisely that, require that they be totally muzzle. 18 Notwithstaning the importance of that role, the Court ecline to aopt petitioners argument that a efective process alone might give rise to a breach of fiuciary uty claim uner section 36(b), 19 as the Eighth 13 I. 14 I. 15 I. 16 I. 17 I. (emphasis supplie). 11 I. 12 I. at * 10. 18 I. at *8 (citing Burks v. Lasker, 441 U.S. 471, 485 (1979)). 19 Brief of Petitioner, 2009 WL 1640018, at * 3, Jones v. Harris Associates L.P. No. 08-586, 2010 WL 1189560 (U.S. Mar. 30, 2010). March 2010 / Issue 8 2
Circuit ha rule in Gallus v. Ameriprise Fin., Inc. 20 Rather, the Court sai, where the boar s process was eficient or the aviser withhel important information, [a reviewing] court must take a more rigorous look at the outcome of the bargaining process. 21 Fee Comparisons A major component of the petitioners claim reste on their contention that the lower fees charge to institutional clients was critical evience that the higher fees assesse against retail investors were excessive. The responent (the efenant aviser) isagree. The Supreme Court steere a mile course, eclining to aopt a categorical rule regaring the comparisons of the fees charge to ifferent types of clients. The Court hel that comparisons between fees charge by an investment aviser to its mutual funs versus the fees charge to its inepenent or institutional clients may be appropriate an shoul be given the weight that they merit in light of the similarities an ifferences between the services that the clients in question require. 22 The Court warne, however, that a reviewing court must be wary of inapt comparisons 23 an that where services provie to clients are sufficiently ifferent that a comparison is not probative the reviewing court must reject the comparison. 24 The Court commente that there may be significant ifferences between the services provie by an investment aviser to a mutual fun an those it provies to a pension fun which are attributable to the greater frequency of shareholer reemptions in a mutual fun, 20 561 F.3 816 (8th Cir. 2009). In Gallus, the Eighth Circuit Court of Appeals hel that a proper analysis of section 36(b) has two separate an inepenent elements, each of which alone constitutes a breach of fiuciary uty. Uner this stanar, a court properly looks to both the aviser s conuct uring negotiation an the en result; unscrupulous behavior with respect to either can constitute a breach of fiuciary uty uner Section 36(b). I. at 823. As a result, the Eighth Circuit hel that the plaintiffs coul state a claim uner section 36(b) base on the aviser s allege misconuct uring the contract approval process, even where the resulting fee was not excessive an thus passe muster uner the Gartenberg stanar. I. 21 Jones, 2010 WL 1189560, at *10. the higher turnover of mutual fun assets, the more burensome regulatory an legal obligations, an higher marketing costs. 25 Unerscoring the limite utility of fee comparisons, the Supreme Court note that [e]ven if the services provie an fees charge to an inepenent fun are relevant, courts shoul be minful that the Act oes not necessarily ensure fee parity between mutual funs an institutional clients contrary to petitioners contentions. 26 Aressing inustry concerns that permitting claims premise on fee comparisons woul prolong burensome fee litigation, the Court commente that [c]omparisons with fees charge to institutional clients... will not oom any fun to trial. 27 Elaborating, the Court state that to go to trial for a breach of fiuciary uty uner section 36(b): [f]irst, plaintiffs bear the buren in showing that fees are beyon the range of arm s-length bargaining. Secon, a showing of relevance requires courts to assess any isparity in fees in light of the ifferent markets for avisory services. 28 Thus, [o]nly where plaintiffs have shown a large isparity in fees that cannot be explaine by the ifferent services in aition to other evience that the fee is outsie the arm s-length range will trial be appropriate. 29 In reaching to set the bar high for a plaintiff to avoi summary jugment in an excessive fee case, Jones leaves less certain what impact its stanar will have at the motion to ismiss stage or on the scope of proper iscovery in cases that survive such motions. Finally, the Court expresse some skepticism on the value of comparisons of fees that an investment aviser charges to its mutual funs compare with fees charge by other investment avisers to their mutual funs. Consistent with the views articulate by the Secon Circuit in Gartenberg, it commente that [c]ourts shoul not rely too heavily on comparisons with fees charge to mutual funs by other avisers as they may not be the prouct of negotiations conucte at arm s length. 30 This skepticism oes not suggest that such comparisons woul be inappropriate for a boar to consier in the 25 I. 26 I. 27 I. at *9 n.8. 22 I. at *9. 28 I. 23 I. 29 I. 24 I. 30 I. at *9. March 2010 / Issue 8 3
15(c) process but oes encourage a eeper an fuller assessment of the fees relative to the services provie to the funs that the boar oversees. Impact This case has important implications both for the future of fun fee litigation an the conuct of the contract approval process uner section 15(c) of the 1940 Act. While it is ifficult to preict the long-term effect on the number an success of section 36(b) cases that may be brought, generally the Court's opinion appears to iscourage rather than encourage such complaints, by reinforcing an perhaps even raising the bar for alleging an proving these cases. As to the impact on the section 15(c) process, this will epen on the practices currently engage in by iniviual boars. Where the process is robust an a boar receives an consiers information on all of the Gartenberg factors, as well as fees pai to other clients of the aviser an the services provie, the opinion may have little impact. However, by emphasizing the importance of the boar's process, both in protecting fun investors an in etermining how much eference courts shoul give a boar's ecision, the opinion may well encourage both avisers an boars to strengthen an further ocument that process. Uner the Court s approach, the aviser s provision an the boar s robust consieration of all material information coul reuce the scrutiny courts will apply to the boar s ecision. The Court s iscussion of the factors an the relevant consierations may also affect certain aspects of fun isclosures of the boar process an factors consiere in the contract approval process. This upate was authore by G. Eric Brunsta, Jr. (+1 860 524 3960; eric.brunsta@echert.com), William K. Dos (+1 212 698 3557; william.os@echert.com), Ruth S. Epstein +1 202 261 3322; ruth.epstein@echert.com), Robert W. Helm (+1 202 261 3356; robert.helm@echert.com), an Evan S. Posner (+1 860 524 3922; evan.posner@echert.com). Practice group contacts For more information, please contact the authors, one of the attorneys liste, or any Dechert attorney with whom you regularly work. Visit us at www.echert.com/financialservices. Karen L. Anerberg Lonon +44 20 7184 7313 karen.anerberg@echert.com Julien Bourgeois +1 202 261 3451 julien.bourgeois@echert.com Douglas P. Dick +1 202 261 3305 ouglas.ick@echert.com Margaret A. Bancroft +1 212 698 3590 margaret.bancroft@echert.com G. Eric Brunsta, Jr. Hartfor +1 860 524 3960 eric.brunsta@echert.com William K. Dos +1 212 698 3557 william.os@echert.com Saner M. Bieber +1 202 261 3308 saner.bieber@echert.com Kevin F. Cahill Orange County +1 949 442 6051 kevin.cahill@echert.com Ruth S. Epstein +1 202 261 3322 ruth.epstein@echert.com Stephen H. Bier +1 212 698 3889 stephen.bier@echert.com Christopher D. Christian +1 617 728 7173 christopher.christian@echert.com Joseph R. Fleming +1 617 728 7161 joseph.fleming@echert.com Thomas C. Bogle +1 202 261 3360 thomas.bogle@echert.com Elliott R. Curzon +1 202 261 3341 elliott.curzon@echert.com Brenan C. Fox +1 202 261 3381 brenan.fox@echert.com March 2010 / Issue 8 4
Robert M. Frieman +1 212 649 8735 robert.frieman@echert.com Jack W. Murphy +1 202 261 3303 jack.murphy@echert.com Jeremy I. Senerowicz +1 212 641 5669 jeremy.senerowicz@echert.com Davi M. Geffen +1 617 728 7112 avi.geffen@echert.com Tram N. Nguyen +1 202 261 3367 tram.nguyen@echert.com Freerick H. Sherley Charlotte +1 704 339 3100 freerick.sherley@echert.com Davi J. Harris +1 202 261 3385 avi.harris@echert.com John V. O Hanlon +1 617 728 7111 john.ohanlon@echert.com Stuart Strauss +1 212 698 3529 stuart.strauss@echert.com Christopher P. Harvey +1 617 728 7167 christopher.harvey@echert.com Reza Pishva +1 202 261 3459 reza.pishva@echert.com Patrick W. D. Turley +1 202 261 3364 patrick.turley@echert.com Robert W. Helm +1 202 261 3356 robert.helm@echert.com Ewar L. Pittman +1 202 261 3387 ewar.pittman@echert.com Brian S. Vargo Philaelphia +1 215 994 2880 brian.vargo@echert.com Richar M. Hervey +1 212 698 3568 richar.hervey@echert.com Jeffrey S. Puretz +1 202 261 3358 jeffrey.puretz@echert.com Jennifer O. Woo Lonon +44 20 7184 7403 jennifer.woo@echert.com Richar Horowitz +1 212 698 3525 richar.horowitz@echert.com Jon S. Ran +1 212 698 3634 jon.ran@echert.com Anthony H. Zacharski Hartfor +1 860 524 3937 anthony.zacharski@echert.com Jane A. Kanter +1 202 261 3302 jane.kanter@echert.com Robert A. Robertson Orange County +1 949 442 6037 robert.robertson@echert.com Geoffrey R.T. Kenyon +1 617 728 7126 geoffrey.kenyon@echert.com Keith T. Robinson Hong Kong +1 852 3518 4705 keith.robinson@echert.com Matthew Kerfoot +1 212 641 5694 matthew.kerfoot@echert.com Alan Rosenblat +1 202 261 3332 alan.rosenblat@echert.com George J. Mazin +1 212 698 3570 george.mazin@echert.com Kevin P. Scanlan +1 212 649 8716 kevin.scanlan@echert.com March 2010 / Issue 8 5
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