Impact of board approval. The court had previously ruled on summary judgment that the independent trustees’ approval of the fund fees “was entitled to substantial weight.” In its new decision, the court reiterated that “a determination of an informed and disinterested Board is entitled to considerable, but not conclusive weight.” It is not clear, however, that the court’s conclusion about the board had any impact on the court’s analysis of the other Gartenberg factors. Rather, the court ruled that to prevail, the plaintiffs must prove “their case by a preponderance of the evidence,” which is the usual standard in a civil case, and not some higher standard because of the board’s approval. Moreover, after a short discussion of the board’s approval in the introductory pages of the decision, the opinion does not mention it again until a passing reference in the final few pages. The balance of the opinion addresses in detail the nature and quality of the services and the adviser’s profitability, with a less detailed discussion of the other Gartenberg factors.
Nature and quality of the services. The court divided the first Gartenberg factor in two and considered separately the (i) nature and (ii) quality of the services. Rejecting the plaintiffs’ argument that the court ignore any services provided by the subadviser, the court found that in assessing both the nature and the quality of services, the court should consider all the services provided, “whether [the adviser] performed them or hired others to fulfill their obligations.” The court found that in addition to delegating portfolio management duties to the subadviser, the adviser performed a number of services relating to the funds, including establishing and re-evaluating fund strategy, selecting and monitoring subadvisers, monitoring fund performance, providing legal and compliance services, providing personnel and office space to the funds, and assisting with board meetings. The court also found that the adviser bore entrepreneurial, reputational, and legal/regulatory risks.
The court limited its analysis of the quality of services provided, however, to an evaluation of the funds’ performance, and made no effort to evaluate the quality of the other services that the court found the adviser had performed. The court further limited its evaluation of performance by comparing it to the performance of peer funds, and rejected the plaintiffs’ attempt to evaluate performance based solely on comparison to fund benchmarks. The court found that all but one fund at issue had average or above average performance. In so ruling, the court also rejected a challenge by plaintiffs to the adviser’s reliance on data from Lipper. With respect to one fund that had underperformed for certain periods in comparison to its peer group, the court concluded that the “generally weak performance tips very mildly in Plaintiffs’ favor” with respect to that fund only.
Profitability. The plaintiffs’ central argument on profitability was that the adviser’s subadvisory fee payment to the subadviser should not be treated as an expense, but instead should be considered “contra-revenue” deducted from the advisory fee, resulting in a “retained fee” for the adviser. Using this methodology, the plaintiffs’ expert calculated that the adviser’s costs per fund never exceeded $1 million per year, resulting in a profit margin exceeding 98%. The court rejected that argument. It pointed out that the plaintiffs’ own expert conceded that GAAP requires the subadvisory fee’s treatment as an expense, and that doing so reduced the adviser’s profit margin considerably. The court also rejected the opinion of a second plaintiffs’ expert that an agreement reached at arm’s length would necessarily have a lower profit margin. The court concluded that by the expert’s own admission, he had engaged in an impermissible “cost-plus” analysis of profitability and that it was not permissible under Section 36(b) to simply argue “that the adviser ‘just plain made too much money.’” The court also declined to draw any inference from a comparison of the profitability of the adviser to the profitability of the subadviser, and instead stated that any differences were “not that significant or surprising given the businesses are different.”
Other Gartenberg factors. The court noted that the plaintiffs had put on no evidence regarding either fall-out benefits or economies of scale, and therefore had not met their burden with respect to these Gartenberg factors. The court did address evidence introduced by the adviser regarding comparative fees. The court ruled that the funds’ fees were in the middle of the pack compared to peers. Observing that the adviser had presented evidence about both management fees and expense ratio, the court decided that it was not necessary for the court to address the latter. The court rejected the plaintiffs’ argument that comparisons to the fees of other mutual funds should be given no weight. The court noted that although the Supreme Court had cautioned in Jones v. Harris that “courts should be wary of giving undue weight to fees charged by other mutual funds” because those other fees might not be the product of arm’s length negotiation, “‘not relying too heavily’ on comparisons does not mean ‘not relying at all.’”
Michael K. IsenmanPartner
Mark HollandRetired Partner