On October 3, 2018, Judge Edgardo Ramos of the U.S. District Court for the Southern District of New York issued a decision that largely denied an investment adviser’s motion for summary judgment in an action filed against Calamos Advisers, LLC under Section 36(b) of the Investment Company Act of 1940. Like Section 36(b) complaints filed against BlackRock, T. Rowe Price, MetWest, Davis Advisors, and JP Morgan, the Calamos complaint was premised on allegations that the adviser provided substantially similar advisory services for a lower fee as subadviser to unaffiliated funds. Like other district court decisions, the Calamos decision is not binding precedent on any other court.
Courts typically 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 Calamos granted summary judgment with respect to two Gartenberg factors – economies of scale and fall-out benefits – but denied summary judgment with respect to the other Gartenberg factors. Notably, and in contrast to recent partial summary judgment decisions involving Hartford, Russell, and BlackRock, the court in Calamos denied summary judgment with respect to board process, leaving that issue for trial. The court also found that facts in dispute made trial appropriate with respect to nature and quality of services, comparative fees, and profitability.
Board process. The court held that because of factual disputes about potential deficiencies in the board’s process, the court would defer until trial whether substantial deference was owed to the board’s approval of the challenged fees.
- The court suggested that when a board compared advisory and subadvisory fees, the board’s failure to review differences in services and risks might indicate a deficiency in the board process. The court noted that although it was undisputed that the services and risks that the adviser undertook for the fund at issue differed from those for subadvised funds and other clients, the adviser had pointed to no evidence that the board had reviewed or considered those differences.
- The court held that where an adviser provided services under both an advisory contract and an administrative contract, a board’s review of those services in a “bundled fashion” could indicate “a lack of conscientiousness.” According to the court, Section 36(b) requires that transactions be considered separately and not aggregated, and that services be considered in the context of the specific fee paid for those services, rather than looking only at all services and the aggregate fee. The court held that a board’s failure to distinguish between services provided under the two contracts could be evidence of a potential deficiency in the board process.
- On the other hand, the court held that Section 36(b) does not require actual negotiation between the board and the adviser, and that the lack of evidence of a negotiation did not indicate any deficiency in the board process.
- The court held that the plaintiffs did not need to provide a range of fees that could be negotiated at arm’s length, above which the fee would be excessive as a matter of law.
- The court held that the plaintiffs’ comparison to fees the adviser charged to subadvisory and other clients was sufficient to withstand summary judgment, but at trial the plaintiffs would need to show that those comparisons were probative.
- The court rejected the adviser’s argument that differences in services and risks with respect to subadvisory clients made the comparisons to subadvisory fees not probative as a matter of law. The court held that whether those differences were material or de minimis was in dispute and therefore an issue for trial.
- The court held that the fact that the challenged advisory fee fell within the range charged by other investment advisers for similar funds did not insulate the adviser’s fees from review. The court held that comparison to peer funds’ fees was a factor, but not a dispositive factor.
Profitability. The plaintiffs challenged the adviser’s methodology for computing the adviser’s profitability attributable to the fund at issue and presented evidence with respect to alternate methodologies. The court held that in the absence of board deference, whether the adviser used an appropriate profitability methodology was an issue for trial, not summary judgment.
Nature and quality of services. The court held that fund performance was an important factor in evaluating the nature and quality of advisory services. The court held that because the fund’s performance was below average compared to peer funds, the nature and quality of the adviser’s services was an issue for trial and could not be resolved at summary judgment.
Economies of scale.
- The court held that the existence of economies of scale could not be inferred solely from operating expenses declining while assets grew, because other factors could cause costs to decline. The court held that to get past summary judgment with respect to economies of scale, a plaintiff must have evidence that the per-unit cost of performing fund transactions decreased as the number of transactions increased. Because the plaintiffs in Calamos pointed to no evidence of this, the court granted summary judgment with respect to economies of scale.
- The court held, however, that shrinking assets during the period at issue (beginning one year prior to the complaint’s filing) did not necessarily preclude the existence of economies of scale. The court held that it was possible for an adviser to continue to benefit from older economies of scale that it had not shared with the fund, even though assets had recently shrunk.
Fall-out benefits. The court rejected the plaintiffs’ contention that the adviser’s provision of similar services and strategies to other clients was a fall-out benefit – that is, “additional, non-fund sources of revenue accruing to [the adviser] as a result of its relationship with the Fund.” The court held that, as a matter of law, revenues from providing similar services to other clients do not fall within the definition of fall-out benefits. Accordingly, the court granted summary judgment with respect to fall-out benefits.
The court has scheduled a non-jury trial for November 19, 2018.
Calamos is the sixth case of the approximately 25 Section 36(b) cases filed since the Supreme Court decided Jones v. Harris in 2010 in which a court has denied summary judgment for the adviser in whole or in part and ordered the case to trial. The adviser won two of those cases after trial (AXA and Hartford), one was settled (Russell), and three remain pending (BlackRock, Great West, and now Calamos). In three instances, courts have granted summary judgment for the adviser rather than trying the case (JP Morgan, Harbor Capital, and New York Life). In one additional instance, a court granted summary judgment for the adviser based on the plaintiff’s lack of standing to bring the lawsuit (Principal). Motions for summary judgment are pending in two other cases (Davis and MetWest).
A copy of the decision is available here.