Last April, the issue of mutual fund adviser’s fiduciary duties concerning fees was before the United States Court of Appeals for the 8th Circuit in the case Gallus v. Ameriprise. Gallus considered the scope of a mutual fund adviser’s fiduciary duties under Section 36(b) of the Investment Company Act of 1940 (“1940 Act”) codified as 15 U. S. C. §80a–35(b).
The Court of Appeals reversed the decision of the United States District Court for the District of Minnesota holding that an inquiry into Section 36(b) does not rely solely on the Gartenberg factors laid out by the Second Circuit in Gartenberg v. Merrill Lynch Asset Management, Inc. The Gartenberg test looks at whether the “fee is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.”
The Court explained that while Gartenberg provides a “useful framework for resolving the claims of excessive fees”, the size of the fee should be considered alongside the mutual fund adviser’s conduct. Thus, the Eighth Circuit read the plain language of Section 36(b) to impose a “duty to be honest and transparent throughout the negotiation process.” In its decision, the Court heavily relied on the decision reached by the 7th Circuit in Jones v. Harris Associates L.P. In Jones, Chief Judge Easterbrook also rejected the proposition that Gartenberg should be the sole test applied to determine the reasonableness of an adviser’s fee. Instead, the Seventh Circuit declared that the focus should be on the fairness and transparency of the process for approving mutual fund adviser fees.
On March 30, 2010, the U.S. Supreme Court rejected the test proposed in the 7th Circuit (and subsequently adopted by the 8th Circuit). The Supreme Court unanimously agreed that Section 36(b) does not extend a duty to the negotiation process between mutual fund advisers and their clients. In addition to reinforcing the Gartenberg test as the appropriate approach in resolving Section 36(b) claims, the Court also clarified several points to create uniform application amongst the Circuits. Namely, the Court explicitly stated:
§ The weight given to comparison of fee size will depend on the circumstances surrounding the parties.
§ It is appropriate for a court to look at the fees an investment adviser charges a captive mutual fund versus the fees charged to independent clients.
§ Courts should give deference to the fee size because pursuant to the ’40 Act, fees must be approved by a “fully informed mutual fund board.” However, the level of deference may vary depending on the approval procedure of the board.
To read the Supreme Court’s full opinion, please click here.