Mutual fund advisers and boards of directors should not read too much into the most recent court decision in the ongoing excessive fee litigation story. Last week’s district court decision in Gallus v. Ameriprise Financial,1 a closely watched case that was expected to interpret the recent United States Supreme Court decision in Jones v. Harris Associates L.P.,2 is being hailed by the industry as a victory even though it does not address key issues. The Gallus decision does not diminish advisers’ obligation to deal with their boards in an honest and forthright fashion, nor boards’ obligation to vigorously review and consider advisory fees on behalf of fund shareholders. The decision also does not provide guidance on how Jones’ discussion of comparisons between institutional and mutual fund fees is to be applied.
The Gallus case occupies an interesting place in the advisory fee litigation story. In 2004, a group of shareholders of mutual funds advised by Ameriprise sued Ameriprise, alleging that advisory fees on the funds were too high, particularly in light of the fees charged by Ameriprise to institutional clients, and that Ameriprise had not been candid in disclosing its institutional fees. The district court refused to throw out the case at the early stages and ordered limited discovery. In 2007, however, the district court granted summary judgment in favor of Ameriprise, essentially finding that the plaintiffs had not proved that the fees were excessive. The district court relied on Gartenberg to reach its conclusion. Plaintiffs appealed. The United States Court of Appeals for the Eighth Circuit reversed. The Eighth Circuit concluded that while the district court had properly applied Gartenberg in assessing whether the fees were excessive, the court had erred in two ways: first, by rejecting a comparison between the fees charged to institutional clients and the fees charged to the mutual funds, and, second, by failing to consider whether Ameriprise had properly informed the fund board about the fee discrepancy between the different types of clients. This time, the defendants appealed.
While Gallus was wending its way through the Eighth Circuit, Jones was progressing through the Seventh Circuit, and Jones arrived at the United States Supreme Court first. Shortly after the Supreme Court decided Jones, the Court took the Gallus case, vacated the Eighth Circuit decision, and sent Gallus back to the Eighth Circuit for further consideration in light of Jones. The Eighth Circuit in turn sent Gallus back to the district court. Last week, the district court, in a very brief decision, reinstated its original summary judgment ruling. The district court noted that the Eighth Circuit had specifically stated that the court had properly applied the Gartenberg factors and that accordingly there was nothing left for the court to decide. In effect, the court concluded that Jones confirmed that the court had gotten it right the first time. Interestingly, the court made no mention of the concern raised by the Eighth Circuit about the adequacy of information provided to the fund board during the fee negotiations. The court also did not discuss the concern raised by the Eighth Circuit about the comparison of institutional and mutual fund fees, an issue addressed in detail by the Supreme Court in Jones.
In Jones, the Supreme Court concluded that the basic formulation of what Section 36(b) of the Investment Company Act requires, as set forth in Gartenberg, was correct: “to face liability under § 36(b), an investment adviser must charge a fee that 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.”3 The Supreme Court indicated that under the Investment Company Act, “scrutiny of investment adviser compensation by a fully informed mutual fund board is the ‘cornerstone of the…effort to control conflicts of interest within mutual funds’” and highlighted the role of disinterested directors as “‘independent watchdogs’” of the relationship between a fund and its adviser.4 The Court noted that Congress intended for Section 36(b) lawsuits and director approval of adviser contracts to act as “‘independent checks on excessive fees.’”5
However, the Supreme Court was also clear that judicial deference to directors’ business judgment has limits, as the Investment Company Act instructs courts to give board approval only such consideration “‘as is deemed appropriate under all the circumstances.’”6 The Court therefore inferred that deference to a board’s judgment may be appropriate in some instances, and the appropriate measure of deference varies depending on the circumstances. Importantly for Gallus, the Supreme Court noted that “an adviser’s compliance or noncompliance with its disclosure obligations is a factor that must be considered in calibrating the degree of deference that is due a board’s decision to approve an adviser’s fees.”7
In Jones, the Supreme Court also addressed comparisons of institutional and mutual fund fees, stating that “courts may give such comparisons the weight that they merit in light of the similarities and differences between the services that the clients in question require, but courts must be wary of inapt comparisons.”8 The Court stated that if the services rendered are sufficiently different that a comparison is not probative, then courts must reject the comparison, and the Court went on to note that even if the comparison is relevant, the Investment Company Act “does not necessarily ensure fee parity between mutual funds and institutional clients…[.]”9
As noted above, the Gallus district court was silent as to the adequacy of the information provided by the fund board during the fee negotiations and did not address in any detail the Eighth Circuit’s concern regarding the comparison of institutional and mutual fund fees. It remains to be seen if the Eighth Circuit will decide that these matters should have been addressed differently. In the meantime, mutual fund advisers and boards of directors cannot go wrong by heeding the lessons of Jones: advisers should be thorough and forthright in providing the necessary information to boards, and boards should conduct their advisory agreement reviews in a manner that is demonstrably careful, thoughtful and rigorous, so that board decisions are given the greatest degree of deference.
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