Sixth Circuit Issues Section 36(b) Ruling Affirming Grant of Summary Judgment To Mutual Fund Investment Adviser

Key Takeaways

• Sixth Circuit Court of Appeals reaffirms that comparison of advisory fees to subadvisory fees is “inapt” under Jones v. Harris Assocs., relying on undisputed evidence of differences in services and risks.
• Sixth Circuit also holds that no other Gartenberg factor supports a trial on plaintiff’s claim, rejecting plaintiff’s arguments on economies of scale and trustee conscientiousness

On March 30, 2020, the U.S. Court of Appeals for the Sixth Circuit affirmed the district court’s grant of summary judgment to the investment adviser in Goodman v. J.P. Morgan Investment Management Company^.1  Applying a de novo standard of review, the Court held that plaintiffs had failed to show that the fees charged to five mutual funds advised by J.P. Morgan (the JPMorgan Core Bond Fund, the JPMorgan High Yield Fund, JPMorgan Mid Cap Value Fund, the JPMorgan Large Cap Growth Fund, and the JPMorgan Value Advantage Fund) (collectively, the “Funds”) were excessive.  In particular, this decision is an important addition to a recent line of cases recognizing the differences between the services provided and risks incurred in serving as an adviser to a mutual fund as opposed to serving as a subadviser.

Section 36(b) imposes a fiduciary duty on an investment adviser to a mutual fund “with respect to the receipt of compensation,” and gives mutual fund shareholders a private right of action to enforce that duty.  The statute expressly assigns to any such plaintiff the burden of proof, and subsequent case law makes clear that a breach may be shown only where the fee charged 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.”²   

Plaintiffs, shareholders in the Funds, alleged that J.P. Morgan Investment Management Company (“JPMIM”) charged “excessive” advisory fees in violation of its fiduciary duty under Section 36(b).  Following fact and expert discovery, the district court entered a full grant of summary judgment to JPMIM.  The district court concluded that evidence demonstrating that the Funds performed better than, and their fees were in line with, other similar mutual funds was not dispositive, but was “telling regarding whether the fees are excessive.”  The district court also rejected Plaintiffs’ core contention that the “arm’s-length bargaining range” was comprised of the fees that other funds paid JPMIM to act as subadviser to those funds, instead concluding that “even assuming arguendo that some of the services provided as adviser and as subadviser are ‘substantially’ the same, Defendants have presented uncontroverted evidence that the risk undertaken and scale of services are different.”  Giving this comparison the weight it merits, the district court concluded that “the comparisons in this instance are not materially similar and cannot create a genuine issue of material fact.”  The district court similarly found that the other Gartenberg factors did not support Plaintiffs’ claims.

On appeal, the Sixth Circuit affirmed the district court’s ruling.  The Sixth Circuit held that although Plaintiffs urged a comparison of the advisory fees charged to the Funds to subadvisory fees that JPMIM charged to other mutual funds, “this comparison serves only to show that [the adviser] charges different fees for dissimilar services with dissimilar risks and responsibilities.”  The Sixth Circuit noted that the adviser “put forth clear evidence that the responsibilities [it] has as adviser to the Funds are different from those it has as subadviser to the Subadvised Funds, as are the associated risks.”  Accordingly, the Sixth Circuit “agree[d] with the district court that the comparison between the Funds and Subadvised Funds is inapt.”  

The Sixth Circuit acknowledge JPMIM’s argument that the comparative fee and nature and quality of services Gartenberg factors alone warranted summary judgment.³   The Court noted that the Seventh Circuit had held those factors to be dispositive in granting summary judgment on remand from the Supreme Court’s Jones decision,⁴  and agreed with the importance of those factors.  However, the Sixth Circuit held that “per the instruction of the Supreme Court in [Jones] that all relevant factors must be considered, we find these two factors are not dispositive standing alone.”  The Court then proceeded to consider the remaining Gartenberg factors.  

Turning to economies of scale, the Court noted that “whether economies of scale could have been shared at a higher level is not the issue.”  Rather, “whether the board could have agreed to those levels after engaging in good faith negotiations is the issue.”  The Court observed that JPMIM did share profits with the Funds in the form of fee waivers, and rejected Plaintiffs’ expert’s testimony that profits should have been shared differently. 

Finally, the Court addressed the care and conscientiousness of the Funds’ Board of Trustees.  The Court held that even though the Board may not have received all the information that Plaintiffs contended they should have received, the Board “still engaged in a thoughtful review process that considered substantial information” about the Funds.  

The Goodman decision is an important recognition of the differences in serving as an adviser and a subadviser to a mutual fund.  Its reasoning builds on a number of recent opinions, including the post-trial opinion issued in Chill v. Calamos Advisors LLC⁵ that contains the most comprehensive rejection of plaintiffs’ contention that a mutual fund’s advisory fees should be limited to fees charged to institutional or subadvised accounts, instead ruling that such a comparison is “inapt” within the meaning of Jones because managing a mutual fund entails greater services and risks than subadvising other accounts.  

Collectively, these decisions should spell the end of the argument advanced by the plaintiffs’ bar that fees charged to other types of client accounts, such as institutional or subadvisory accounts, necessarily form the upper boundary of the fee that can be charged to a mutual fund following the same strategy.  

Footnotes

¹  ___ F.3d ____, 2020 WL 1502451 (6th Cir. Mar. 30, 2020).   

² Jones v. Harris Associates, L.P., 559 U.S. 335, 346 (2009). 

³  The Court considered Plaintiffs’ profitability arguments as part of its consideration of the comparative fees and nature and quality of services Gartenberg factors.

⁴ Jones v. Harris Assocs. L.P., 611 F. App’x 359 (7th Cir. 2015).  

⁵ 417 F. Supp.3d 208 (S.D.N.Y. 2019).