The U.S. District Court for the District of Arizona granted a motion to dismiss a complaint brought by a mutual fund shareholder against the fund’s adviser and distributor, alleging (a) the adviser and distributor violated Section 36(b) of the Investment Company Act of 1940, as amended (the “1940 Act”), by receiving excessive Rule 12b-1 distribution fees; (b) the adviser violated Section 36(b) by receiving excessive management fees; and (c) the adviser and distributor violated Section 47(b) of the 1940 Act by entering into unlawful contracts.
Standing. The court first resolved a threshold issue by holding that the plaintiff, owner of one class of shares in the fund, had standing to bring Section 36(b) claims on behalf of all classes of shareholders in that particular fund, even if the different share classes are assessed different levels of fees.
Section 36(b) – Excessive Fees. The court then went on to consider whether the plaintiff stated a claim under Section 36(b). It applied the standard first articulated in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982) – which the United States Supreme Court recently confirmed in Jones v. Harris Associates, L.P., 130 S. Ct. 1418 (2010) – that the plaintiff must allege “that the adviser-manager . . . charge[d] 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.” The court applied the six Gartenberg factors and found that the plaintiff’s allegations “largely consist of general conclusions, not facts,” and failed to show how a particular fee met that standard.
For example, the court noted that the plaintiff’s allegation that the fund charged the maximum fee allowed by law “does not mean the fee is per se excessive,” and rejected as irrelevant the plaintiff’s point that the Rule 12b-1 fees were nearly as large as the advisory fees. The court also noted that advisers are entitled to make a profit and that the pure dollar amounts of the fees does not necessarily make them excessive. The court further rejected the plaintiff’s comparison of fees for the actively managed fund at issue with fee levels of various index funds because the services were different, and noted that “[a]lleging under‑performance in a down economy is particularly unavailing.” The plaintiff’s allegation of excessive fall-out benefits also failed because he attempted to aggregate the Rule 12b-1 fees and advisory fees to state his claim. Regarding economies of scale, the court pointed out that the fund has breakpoints “that are more beneficial to shareholders than other comparable funds.” The court stated that the plaintiff failed to provide any facts to show that the breakpoints were inadequate, and that mere allegations that the fund was large are insufficient. The court further found that the plaintiff failed to state the cost of any service to show that the fee was disproportionate to the service provided. Lastly, the court rejected the plaintiff’s argument that the directors were “interested” rather than independent because they were busy and/or received their information from the investment adviser.
Section 47(b) – Rescission. The court also held that the plaintiff could not assert a claim under Section 47(b), which permits the remedy of rescission for contracts that violate the 1940 Act, because such a claim must be brought by a party to the contract. Although Section 36(b) claims may be brought by a fund shareholder on the fund’s behalf without complying with the process for derivative actions, the court concluded that the plaintiff here was not “standing in the shoes of the Fund” and thus was not a party to the contracts at issue for purposes of his Section 47(b) claim.
Dismissal with Prejudice. Because the plaintiff failed to indicate how he could amend his complaint to state a claim, the court denied leave to amend and dismissed the complaint with prejudice. Turner v. Davis Select Advisers LP, et al., No. 08-CV-00421-TUC-AWT (D. Ariz. June 1, 2011).