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Court Allows Claim for Excessive 12b-1 Fees to Go Forward

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  • Baker, John
    Federal Judge Denise Cote, who sits in Manhattan, has refused to dismiss a shareholder claim for excessive fees paid under a 12b-1 plan by a mutual fund that
    Message 1 of 1 , Sep 2, 2004
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      Federal Judge Denise Cote, who sits in Manhattan, has refused to dismiss a shareholder claim for excessive fees paid under a 12b-1 plan by a mutual fund that was closed to new investors. Pfeiffer v. Bjurman, Barry & Associates, No. 03 Civ. 9741 (DLC) (S.D.N.Y. Aug. 26, 2004). Rule 12b-1 allows a mutual fund that meets certain conditions to use a percentage of its assets to engage in activities that are primarily intended to result in the sale of its shares.

      The defendant mutual fund, a small cap growth fund, was closed to new investors but continued to make payments of up to 0.25% of the its average daily net assets under its 12b-1 plan. The plaintiff alleged that the fund's investment adviser breached its fiduciary duties under Section 36(b) of the Investment Company Act of 1940 by (1) continuing to charge the fund for marketing and distribution expenses after the fund closed to new investors, and (2) charging the fund for marketing, distribution, service, administrative and other expenses in proportion to the fund's assets rather than the services rendered (i.e., because of capital appreciation, the fund's 12b-1 expenses actually went up after it was closed to new investors). The defendants argued that, because the plan capped 12b-1 fees at 0.25% of average daily net assets, the fees were per se reasonable.

      The court ruled, on a motion to dismiss prior to taking discovery, that the plaintiff had met its burden of alleging that the investment adviser violated its fiduciary duty by receiving excessive promotion, distribution and servicing fees. (Claims for administrative, transfer agent, and "other" expenses, which were paid by the fund directly to a third-party service provider that was not a party to the lawsuit, were dismissed.) The court rejected the proposition that fees within the 0.25% cap were per se reasonable, saying that should the plaintiff succeed in showing that the fees were excessive when measured against the services rendered, the defendants will not be able to defeat that showing by arguing that they could have charged even more. The court warned that the plaintiff can recover only if it can demonstrate that the fees were so disproportionately large that they bore no reasonable relationship to the services actually provided and could not have been the product of an arm's length negotiation.

      The court's opinion provides little practical guidance to funds in determining the extent to which they can pay 12b-1 fees after the fund has been closed to new investors; presumably Judge Cote thought it better to wait until a factual record has been developed before making a more specific ruling. Her willingness to let the suit go forward at this stage, and her flat rejection of the proposition that fees within the plan's cap are per se reasonable, are likely to spur further litigation over the short term. The opinion is available online at


      John M. Baker <JMB@...>
      Stradley, Ronon, Stevens & Young, LLP http://www.stradley.com
      1220 19th Street, N.W., Suite 600, Washington, DC 20036
      (202) 419-8413 Fax (202) 822-0140
      FundLaw Listowner http://groups.yahoo.com/group/fundlaw
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