On March 30, 2010, the U.S. Supreme Court considered the question of what a mutual fund shareholder must prove in order to show that a mutual fund investment adviser breached the “fiduciary duty with respect to the receipt of compensation for services” that is imposed by §36(b) of the Investment Company Act of 1940.
The case originated when shareholders in three different mutual funds managed by respondent Harris Associates L. P., an investment adviser, filed a complaint alleging that Harris Associates had violated §36(b) by charging fees that were “disproportionate to the services rendered” and “not within the range of what would have been negotiated at arm’s length in light of all the surrounding circumstances.”
After discussing the history of the Investment Company Act, the mutual fund industry and the split in legal analysis on the topic, the Supreme Court concluded that the standard adopted in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F. 2d 923 (CA2 1982) was correct in its basic formulation of what §36(b) requires: to face liability under §36(b), an investment adviser must charge 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.
Thus, a party claiming that an investment adviser has received compensation in an amount that violates the fiduciary duty dicated by §36(b) must prove that the fee is outside the range that arm’s-length bargaining would produce. The battle over the appropriate factors to consider will be fought on a case by case basis. The starting point should always be the Investment Advisers Act, which provides that scrutiny of investment adviser compensation by a fully informed mutual fund board is the “cornerstone of the . . . effort to control conflicts of interest within mutual funds. The board’s procedure in coming to a determination of the fee arrangement is paramount, followed by the substance of their decision.
If you would like to discuss this further, contact Jeffrey Wittenberg at 877-352-2010.