November 6, 2018

Another Court Partially Denies Summary Judgment, Sends Case to Trial in Section 36(b) Excessive Fee Action

On October 25, 2018, Judge George Wu of the U.S. District Court for the Central District of California in Los Angeles largely denied an investment adviser’s motion for summary judgment in an action against Metropolitan West Asset Managers (MetWest) under Section 36(b) of the Investment Company Act of 1940. The decision is notable for several reasons. First, like a decision in early October in a similar action against Calamos Advisors, the court in MetWest refused to grant summary judgment with respect to board process. Instead, that will be an issue for trial, which is scheduled for December 11, 2018. Second, the MetWest mutual fund at issue has delivered above-average performance while paying advisory fees that are at or below the median for peer funds.

The MetWest complaint was premised on “subadvisory fee comparison” allegations:  that the adviser provided investment advisory services to an affiliated mutual fund for one fee while providing allegedly similar advisory services for a lower fee as subadviser to unaffiliated funds. Similar complaints have been filed against Blackrock, T. Rowe Price, Davis Advisors, JP Morgan, and Calamos. 

Courts evaluate the merits of a Section 36(b) action under the so-called Gartenberg factors, which were adopted by the Supreme Court in Jones v. Harris in 2010. The court in MetWest granted summary judgment with respect to two Gartenberg factors – (1) nature and quality of services and (2) fall-out benefits – but denied summary judgment with respect to the other Gartenberg factors. In contrast to recent partial summary judgment decisions involving Hartford, Russell, and BlackRock, but like the decision in Calamos, the court in MetWest denied summary judgment with respect to board process. The court also found that facts in dispute made trial appropriate with respect to comparative fees, profitability, and economies of scale, which are the other Gartenberg factors. 

The plaintiff in the MetWest action is a shareholder of a mutual fund advised by MetWest.  According to the court, that fund has had consistently strong performance – in the top 10-20% of peer funds – and paid advisory fees at or below the median of peer funds. The fees were higher, however, than certain fees the adviser received for providing subadvisory services to other funds. The adviser contended that the comparison to fees paid by peer funds was more probative than the comparison to subadvisory fees, while the plaintiff argued the reverse, that the comparison to subadvisory fees was more probative. The court held that which comparison was entitled to more weight was an issue for trial, but cautioned  that the plaintiff’s “battle at trial would be arduous” on this issue. 

With respect to board process, the court also held that it would decide at trial whether the adviser “withheld material information or if the process bore other deficiencies.” The court’s decision at trial with respect to board process will determine the degree of deference the court accords to the board’s approval of the challenged advisory fees. Details about the nature of the allegedly withheld information and alleged deficiencies were redacted from the public version of the decision to protect the adviser’s confidential information. The court also ruled that questions of fact remained with respect to profitability and economies of scale, precluding summary judgment on those factors as well. However, the court observed that the plaintiff had not seriously contested that consideration of nature and quality of services or fall-out benefits suggested a violation of Section 36(b), and accordingly granted summary judgment to the adviser with respect to those two factors.

Thus far this calendar year, courts have granted summary judgment in Section 36(b) actions brought against Harbor Capital, JP Morgan Investment Management, and New York Life Investment Management, but have denied summary judgment in part in actions brought against Blackrock, Calamos, Great West, and now MetWest.

A copy of the court’s decision in MetWest may be found here.