In a decision unsealed on July 2, 2019, the federal district court in Manhattan granted summary judgment in favor of a mutual fund’s investment adviser in a lawsuit filed pursuant to Section 36(b) of the Investment Company Act of 1940. The complaint was filed against Davis Selected Advisers, L.P. (the “Adviser”) and alleged that the Adviser charged the Davis New York Venture Fund (the “Fund”) excessive advisory fees. The complaint was premised on a “subadvisory fee comparison theory,” in which a plaintiff compares the fee an adviser charges a proprietary mutual fund to the fee charged for allegedly similar services when the adviser acts as a subadviser to an otherwise unaffiliated fund. The decision is the second time a district court has granted summary judgment to an investment adviser in a Section 36(b) lawsuit premised on a subadvisory fee comparison.
The court’s analysis in the new decision started with board process, and concluded that the board’s decision to approve the Fund’s advisory fee was entitled to substantial deference. The court rejected the plaintiffs’ argument that evidence that the board had “deep ties to the financial services industry,” “did not attempt to negotiate a lower advisory fee,” and “did not inquire” about certain issues raised a dispute of material fact with respect to board process. The court held that “the 1940 Act does not impose a duty on a board to negotiate assertively,” and that the fact that a board “could have negotiated more aggressively does not provide a basis for a rational finding that the [b]oard’s review process was less than robust.” With respect to the board’s diligence, the court observed that the board had “issued a questionnaire” to the Adviser and requested additional information, was “advised by independent counsel,” and “reviewed reports by third parties such as Lipper and Morningstar.” The court held that, in the absence of evidence of specific deficiencies, this demonstrated sufficient process.
The court then considered three factors that, according to the plaintiffs, showed that the advisory fee was excessive: a comparison of the Fund’s fee to certain fees the Adviser charged for providing subadvisory fees to other funds; the Fund’s allegedly subpar investment performance; and the profitability of the Fund to the Adviser. The court concluded that the plaintiffs’ evidence with respect to these three factors did not raise a dispute of material fact with respect to whether the advisory fee violated Section 36(b) and that the plaintiffs were therefore not entitled to a trial.
With respect to comparative fees, the court concluded that the Fund’s fees fell within the range that could have been negotiated at arm’s length. The court noted that two other mutual funds had, in the past, fired their investment advisers and then hired the Adviser to replace them. The court noted, moreover, that the independent boards of those two funds had agreed to pay the Adviser higher advisory fees than the Fund’s current advisory fee. The court held that the fees that those independent boards had agreed to pay in the absence of a prior relationship with the Adviser were unrebutted evidence of the range of fees that could have been negotiated at arm’s length. The court concluded that the plaintiffs’ proffered comparison to lower subadvisory fees showed only that lower fees were also within the range that could be negotiated, assuming for the sake of argument that the advisory and subadvisory services were the same and the comparison apt, but were not probative as to the upper end of the range in light of the evidence of what the boards of the two other mutual funds had been willing to pay.
The court held that the Fund’s performance did “not strongly favor liability.” The court concluded that although the plaintiffs “proffered sufficient facts” to show that Fund performance “was below standard to at least some degree,” the plaintiffs’ evidence did not suggest that the poor performance “was particularly dramatic or unusual.” The court concluded that the performance evidence was insufficient to raise a dispute of material fact about whether the advisory fee was excessive.
The court also held that plaintiffs failed to show that the Fund’s profitability to the Adviser was “out of proportion to the services rendered.” The court concluded that the fact that the Adviser could still have made a profit if it had charged a lower fee was “insufficient to support a breach of fiduciary duty” under Section 36(b).
Last year, a federal court in Columbus, Ohio, granted summary judgment to another adviser in a lawsuit premised on a similar theory; that decision is currently on appeal. Lawsuits brought under a similar theory against two other advisers were tried in November and December of last year in New Jersey and in Los Angeles; the courts in both cases have yet to issue their decisions. Another court in the federal district court in Manhattan dismissed a similar complaint on the pleadings. And a similar lawsuit against another adviser is in the discovery phase in the federal district court in Baltimore.
A copy of the new decision is available here.