In the second recent trial involving claims under Section 36(b) of the Investment Company Act, Judge Renee Marie Bumb of the District of New Jersey ruled in favor of the defendant, a mutual fund advisor, finding that the plaintiffs had failed to demonstrate that the advisory fees at issue were excessive. See Kasilag v. Hartford Inv. Fin. Svcs., LLC, No. 1:11-cv-01083 (Feb. 28, 2017). To prove a Section 36(b) case, a plaintiff must show that the advisory fee at issue was "so disproportionate that it does not bear a reasonable relationship to the service the defendant rendered and could not have been negotiated at arm's-length." Courts may consider all relevant factors, including (1) the independence and conscientiousness of the fund's board of directors charged with approving the advisor's fee, (2) the nature and quality of the services provided by the advisor (which may include the fund's performance), (3) the advisor's profitability, (4) any fallout benefits received by the advisor, (5) whether economies of scale in operating the fund were shared with the fund's shareholders, and (6) the comparative fee structures of other similar funds.
In Hartford, the court held prior to trial that the mutual fund board's decision to approve the advisory fee would be "entitled to considerable, but not conclusive weight," and that the plaintiffs' criticisms amounted to "no more than nit-picking the Board's process." At trial, the plaintiffs failed to overcome that deference, and could not demonstrate that the advisory fees at issue were excessive.
The plaintiffs argued that the advisor relied on subadvisors to do most of the work in managing the funds but kept most of the advisory fee. This, according to the plaintiffs, demonstrated that the advisory fee was excessive because it was not proportionate to the value of the advisor's services. The court, however, rejected this theory for several reasons. The court rejected the plaintiffs' efforts to differentiate between the portion of the advisory fee retained by the advisor and the portion used to hire subadvisors. The court stated that it would not "divide the unitary fees pursuant to the [investment management agreements] into components earmarked for Defendants or the sub-advisers." Rather, the court considered the advisory fees as a whole in light of the totality of services provided to the funds. In addition, the court found a number of services provided by the advisor separate and in addition to the services provided by subadvisors, and credited testimony regarding the advisor's entrepreneurial, reputational and legal or regulatory risks not shared by the subadvisors. Plaintiffs also failed to demonstrate that the funds at issue were particularly more expensive or less successful than their peer funds. The court noted that evidence demonstrated that all but one fund had outperformed its peers over a 10-year period, and the lesser performing fund had gone through a management "shakeup" during the period. Further, the plaintiffs did not attempt to prove at trial that the advisory fees at issue were excessive in comparison to peers.
The Hartford decision is among a trend of developments over the past year favorable to mutual fund advisors. Prior to the ruling in Hartford, a different advisor had prevailed in August 2016 after a 25-day bench trial. See Sivolella v. AXA Equitable Life Ins. Co., No. 11-cv-4194 (D.N.J. Aug. 25, 2016). Seven other cases have also been dismissed or resolved by settlement in the past year, including one dismissal at the pleading stage and one at summary judgment. However, a number of similar cases remain pending, which focus—like Hartford and AXA—on the use of subadvisors. This year is likely to bring further developments in the wave of litigation focused on subadvisory fees.