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Court Refuses To Dismisses Amended 36(b) Complaint

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  • Baker, John
    A federal judge in New Jersey has refused to dismiss a complaint under Section 36(b) of the Investment Company Act of 1940 alleging excessive investment
    Message 1 of 1 , Dec 17, 2012
      A federal judge in New Jersey has refused to dismiss a complaint under Section 36(b) of the Investment Company Act of 1940 alleging excessive investment advisory fees. Kasilag v. Hartford Investment Financial Services, No. 1:11-cv-01083 (D.N.J. Dec. 17, 2012). The court previously dismissed the case, with leave to amend, as conclusory and unsupported, and the plaintiffs responded with a second amended complaint setting out their allegations in much more detail. I have placed copies of the opinion and the second amended complaint on the FundLaw website, although I did not include the expert's declaration attached as an exhibit, as the court did not rely on it.

      According to the complaint, the defendant fund adviser pays sub-advisers to perform substantially all of the investment management services that it provides to the funds at a fraction of the fee it charges for such services. The complaint alleged that the management fees the defendant charges its funds are, on average, three times (and sometimes more than five times) the amount it pays its sub-advisers for substantially the same services. The complaint supported the allegation with a table comparing the language in the sub-adviser contracts with the similar language in the fund adviser's agreements. The defendant argued that it provides the funds with extensive administrative and investment management services that are not delegated to the sub-advisers, but the court ruled that this is a merits argument that is more appropriate at summary judgment.

      The court also addressed several other issues, including the complaint's allegations that the funds' board of directors has not acted conscientiously in approving the fund adviser's agreements. The plaintiffs supported this allegation with claims that the board members are responsible for overseeing all 85 mutual funds in the complex, a task that precludes them from assessing each fund individually; that truly independent directors would not have approved the management fees in light of the adviser's minimal services, economies of scale, profitability, and exorbitant fees; that the fund adviser was the subject of an SEC cease and desist proceeding regarding improper use of fund assets; and that a comparison to the far lower fees charged by Vanguard for similar services is evidence that the board should have known that the adviser's fees were excessive. The court ruled that, while these allegations are certainly not dispositive, when taken together they create an inference that the board of directors may not have adequately considered important facts when approving the management fees, and the directors' approval requires somewhat less deference than it would have had they diligently performed their watchdog role.

      The court did dismiss, without prejudice, the plaintiffs' claims for excessive Rule 12b-1 fees. The plaintiffs alleged that both Class A and Class B shareholders faced excessive 12b-1 fees. The Class A allegations were sparse and conclusory. The court ruled that the plaintiffs lack Article III standing (notwithstanding the existence of statutory standing) to challenge distribution fees charged to Class B shares because none of the plaintiffs own shares in this class.

      The detailed complaint in this case is likely to be a model to future 36(b) plaintiffs who seek at least to avoid dismissal before their case even reaches discovery. However, defendants will closely examine the court's ruling on Article III standing to see to what extent it can apply to other situations and serve to narrow plaintiffs' claims.

      There seems to be a problem with links, and anything appearing after a link, appearing properly on the FundLaw website. If you are reading this on the web, click on the Files link to the left and scroll down to "Kasilag". (Free registration with Yahoo Groups may be necessary to access the documents.) For email readers, you should be able to access the court's opinion and the second amended complaint (again, with Yahoo Groups registration) at the links below.



      John M. Baker
      Stradley Ronon Stevens & Young, LLP http://www.stradley.com
      1250 Connecticut Avenue, NW, Suite 500
      Washington, DC 20036
      202.822.0140 fax
      FundLaw Listowner http://groups.yahoo.com/group/FundLaw/
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