Alert April 03, 2012

Eighth Circuit Applies Harris Associates in Affirming District Court’s Dismissal of Mutual Fund Excessive Fee Case

The U.S. Court of Appeals for the Eighth Circuit upheld a grant of summary judgment dismissing plaintiff mutual fund shareholder claims in an action under Section 36(b) of the Investment Company Act of 1940 (the “1940 Act”) alleging that the advisory fees received by the funds’ adviser were excessive.  Gallus v. Ameriprise Financial, No. 11-1091 (8th Cir. March 30, 2012) (“Gallus II”).

Background and Procedural History. In the initial decision in this litigation, the District Court for the District of Minnesota granted the defendants’ motion for summary judgment and dismissed the plaintiffs’ claims under Section 36(b).  Gallus v. Ameriprise Financial, 497 F. Supp. 2d (D. Minn. 2007)The district court based its decision on an analysis of the factors cited in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982), and held that the plaintiffs had failed to establish a genuine issue of material fact regarding whether the fees charged were so disproportionately large that they bore no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.  On appeal (“Gallus I”), the Eighth Circuit reversed, holding that the proper analysis under Section 36(b) should consider “both the adviser’s conduct during the negotiation and the end [fee] result” and that a failure in the process of negotiating a fund’s fees (as alleged by the plaintiffs) could constitute a Section 36(b) violation regardless of the actual fee levels.

The United States Supreme Court accepted Gallus I for review after agreeing to review another Section 36(b) case, Jones v. Harris Associates, 537 F.3d 728 (7th Cir. 2008).  In conjunction with issuing its decision in Jones v. Harris Associates, 130 S. Ct. 1418 (2010) (“Harris Associates”), which was discussed in the April 6, 2010 Financial Services Alert, the Supreme Court vacated Gallus I and remanded the case to the Eighth Circuit for further proceedings in accordance with the Supreme Court’s decision in Harris Associates.  The Eighth Circuit, in turn, remanded Gallus I to the district court which reinstated its order granting summary judgment to the defendants.  The district court found that such a holding was “appropriate,” given the Supreme Court’s decision in Harris Associates which “adopted the Gartenberg framework and reasoning” that the district court had used in granting summary judgment, and dismissed the action with prejudice.  The plaintiffs appealed the district court’s decision on remand.  (For a more detailed discussion of the prior decisions in this case, see the April 14, 2009 Financial Services Alert, the April 6, 2010 Financial Services Alert and the December 21, 2010 Financial Services Alert.) 

The Eighth Circuit’s Application of Harris Associates.  The Eighth Circuit determined that the plaintiffs failed to meet their burden of raising a genuine issue of material fact that the fee charged was “so disproportionately large that it bore no reasonable relationship to the services rendered and could not have been the product of arm’s length bargaining.”  As to the plaintiff’s assertion that lower fees charged the adviser’s other institutional clients was evidence of excessive fund advisory fees, the Eighth Circuit allowed that while such a disparity is likely relevant to whether fund fees “fall within the arm’s length range,” the plaintiffs had failed to set forth the additional evidence required to survive a motion for summary judgment.  Turning to the plaintiff’s arguments based on fund board deliberations and the information about its institutional client fee arrangements provided by the adviser, the Eighth Circuit observed that under Harris Associates “a process-based failure alone does not constitute an independent violation of §36(b).”  On this basis, the Eighth Circuit held that the plaintiffs’ allegations that the fund board was not informed of all relevant information could not itself make out a Section 36(b) claim.  The Eighth Circuit held that “a deficient process” could not provide the plaintiffs with the additional evidence they needed to survive a summary judgment motion given Harris Associates’ focus on whether the fee levels themselves are “outside the arm’s length range.”

The Eighth Circuit noted, however, that “[t]he fee negotiation process remains critically important, as it allows the court to determine the amount of deference to give the board’s decision to approve the fee.”  The Eighth Circuit determined that while the fund board considered the relevant factors and its process could “fairly be described as robust,” the board’s judgment was entitled to less deference “than would have been the case had [the adviser] been candid about the fees it charged its clients” and had the board not focused so heavily on a comparison between the fees charged by the funds’ adviser and those charged by other advisers, such a comparison having been identified as problematic in Harris Associates because other advisers’ fees might not themselves have been the result of arm’s‑length negotiation.  The Eighth Circuit concluded that in its initial review, the district court had subjected the fee arrangements to sufficient scrutiny under the standard set forth in Harris Associates.  Having found that the plaintiffs had failed to meet their evidentiary burden for surviving a summary judgment motion, the Eighth Circuit affirmed the district court’s dismissal of the complaint with prejudice.