Securities Law Updates | New Judicial Opinions
April 22, 2009
Eighth Circuit Reinstates Fund Advisory Fee Action Against Ameriprise Financial
John E. Gallus v. Ameriprise Financial
No. 07-2945, U.S. Court of Appeals for the Eighth Circuit, 4/8/2009
In this suit over mutual fund fees, the U.S. Court of Appeals for the Eighth Circuit has reversed a district court’s dismissal of a suit claiming violation of fiduciary duty of fund advisers under Section 36(b) of the Investment Company Act of 1940 (“ICA”). Plaintiffs led by John E. Gallus, shareholders of eleven mutual funds, claimed that fund manager and adviser Ameriprise Financial, Inc. (“Ameriprise”) breached its statutory fiduciary duty by misleading them during the negotiation and demanding excessive fees. Citing Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923 (2d Cir. 1982), the U.S. District Court for the District of Minnesota granted defendant Ameriprise’s motion for summary judgment. On appeal, the Eighth Circuit held that the district court erred in holding that no Section 36(b) violation occurred simply because defendant's fee passed muster under the standard laid down in Gartenberg. According to the Eighth Circuit, although the district court properly applied the Gartenberg factors for the limited purpose of determining whether the fees constituted a breach of fiduciary duty, it erred in rejecting a comparison between the fees defendant charged its institutional clients and its mutual funds clients. Further, the district court should have determined whether defendant purposefully omitted, disguised or obfuscated information regarding fees charged different types of clients in its presentations to the board of directors representing plaintiffs.
This appeal required the Eighth Circuit to examine the scope of the fiduciary duty imposed on advisers of mutual funds by § 36(b) of the ICA, 15 U.S.C. § 80a-35(b).
The plaintiffs are shareholders of eleven mutual funds (“the Funds”) that are registered investment companies under the ICA. The Funds are managed and distributed by affiliates of the defendants (collectively, “Ameriprise”). The plaintiffs filed this lawsuit on June 9, 2004, alleging that Ameriprise had breached its fiduciary duty under § 36(b) of the ICA.
Sec 36(b) of the ICA states in part: “For the purposes of this subsection, the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser. An action may be brought under this subsection by the Commission, or by a security holder of such registered investment company on behalf of such company, against such investment adviser . . .”
The fees paid to Ameriprise for advising the Funds are negotiated each year by the Funds’ board of directors (the “Board”), whose primary responsibility is to represent the plaintiffs and other shareholders during the fee negotiation. According to the plaintiffs, Ameriprise breached its statutory fiduciary duty by misleading the Board during the negotiation and demanding excessive fees.
The Eighth Circuit summarized the plaintiffs-appellants’ arguments into three claims: (1) the fee negotiation was inherently flawed because it was based not on Ameriprise’s costs and profits but on external factors—namely the fee agreements of similar mutual funds in the market; (2) Ameriprise provided comparable advisory services to institutional, non-fiduciary clients at substantially lower fees than it charged the plaintiffs, to whom it owed a fiduciary duty; and (3) Ameriprise misled the Board about its arrangements with non-fiduciary clients to prevent the Board from questioning the higher fees demanded by Ameriprise.
The district court granted defendants’ motion for summary judgment. The district court based its decision on an analysis of the factors set out in Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923 (2d Cir. 1982).
In ordering reversal, the Eighth Circuit noted the ruling laid down in Gartenberg. In Gartenberg, the Second Circuit analyzed § 36(b) and created the framework that has served as the starting point for interpreting a fund adviser’s fiduciary duty.
According to the Eighth Circuit, the plaintiffs in Gartenberg argued that, because of their fund’s exponential growth, the adviser’s fee had become so disproportionately large that it constituted a breach of fiduciary duty. After reviewing what the Second Circuit called the “tortuous legislative history” of § 36(b), the Second Circuit concluded that the purpose of the provision was to mitigate the competitive deficiencies of the mutual fund industry. Opinion, p. 8, citing Gartenberg, 694 F.2d at 928-29. Accordingly, the Second Circuit in Gartenberg held that the relevant test for a fee is whether it “represents a charge within the range of what would have been negotiated at arm’s-length in light of all the surrounding circumstances.” Id. at 928.
The Eighth Circuit also examined the Seventh Circuit’s ruling in Jones v. Harris Associates, 527 F.3d 627 (7th Cir. 2008), which according to the Eighth Circuit, eschewed the Gartenberg approach. Jones rejected the proposition that courts should evaluate the reasonableness of an adviser’s fee, holding that “(a) fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation.” Id., p. 9, citing Jones at 632. The Seventh Circuit based its conclusion on two fundamental premises: the plain meaning of the word “fiduciary” and a rejection of the economic assumptions inherent in Gartenberg. According to the Seventh Circuit, the plain meaning of “fiduciary” is a requirement of “candor in negotiation, and honesty in performance” and nothing in the obscure legislative history of § 36(b) alters that conclusion. Id. at 632-33.
After a review of the cases, legislative history, and academic work surrounding § 36(b), the Eighth Circuit concluded that the Gartenberg factors provide a useful framework for resolving claims of excessive fees, notwithstanding the substantial changes in the mutual fund industry that have occurred in the intervening years. The Eighth Circuit explained that The Eighth Circuit explained that the proper approach to § 36(b) is one that looks to both the adviser’s conduct during negotiation and the end result. Id., p. 12, citing In re Mutual Funds Investment Litigation, 590 F. Supp. 2d 741, 760 (D. Md. 2008).
Here, the Eighth Circuit found that the district court erred in holding that no § 36(b) violation occurred simply because Ameriprise’s fee passed muster under the Gartenberg standard. According to the Eighth Circuit, although the district court properly applied the Gartenberg factors for the limited purpose of determining whether the fee itself constituted a breach of fiduciary duty, it erred in rejecting a comparison between the fees charged to Ameriprise’s institutional clients and its mutual fund clients.
In part, the Eighth Circuit added, the district court based its decision on dicta from Gartenberg that refused to compare the adviser’s fees for fundamentally different investment vehicles—money market mutual funds and equity pension funds. The district court should have considered the argument for comparing mutual fund advisory fees with the fees charged to institutional accounts because the investment advice may have been essentially the same for both accounts.
Likewise, the district court should not have engaged in so limited a scope of review. Ameriprise’s conduct must be evaluated independent from the result of the negotiation. The district court concluded that Ameriprise did not breach its fiduciary duty in one way (by setting a fee that was exorbitant relative to that of other advisers), but it should have also considered other possible violations of § 36(b)said the Eighth Circuit. Specifically, the district court should have determined whether Ameriprise purposefully omitted, disguised, or obfuscated information that it presented to the Board about the fee discrepancy between different types of clients. The Eighth Circuit noted that the record indicated that there are material questions of fact on this issue.
On the basis of the foregoing, the Eighth Circuit reversed the district court’s judgment, and remanded the case for further proceedings consistent with its decision.
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