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Court Finds for Defendant Investment Adviser in Section 36(b) Excessive-Fee Case

On August 5, 2019, the U.S. District Court for the Central District of California found for the defendant, Metropolitan West Asset Management, LLC (MetWest), following a bench trial in an excessive fee case brought under Section 36(b) of the Investment Company Act of 1940 by a shareholder of the MetWest Total Return Bond Fund. The plaintiff’s claim centered on a comparison between the fees charged by MetWest in its role as investment adviser to the fund versus the sub-advisory fees charged by MetWest in serving as a sub-adviser to unaffiliated funds. Specifically at issue in the trial were four of the Gartenberg factors: comparative fees, profitability, economies of scale and the independence of the independent directors and the care and conscientiousness with which they performed their duties—i.e., whether the board’s approval of the advisory fee deserved substantial deference by the court. The court had previously granted the defendant’s motion for summary judgment with respect to fall-out benefits and the nature and quality of services provided.

The court’s findings regarding the Gartenberg factors at issue were as follows:

  • Deference Owed to the Board’s Approval of the Advisory Fee. The court afforded the board’s decision to approve the fund’s advisory fee substantial deference on the basis of, among other things, the board’s “sufficiently robust” 15(c) process. The plaintiff failed to persuade the court that the board’s process was deficient simply because MetWest neither delineated the services it provided to sub-advised funds on a sub-advised-fund-by-sub-advised-fund basis nor provided the sub-advisory agreements to the board. In addition, the court concluded that the board’s failure to negotiate a fee reduction did not prevent a finding that deference was owed. In this regard, the court concurred with the defendant’s assertion that “it was not the Board’s duty to negotiate the best deal possible, but instead to use its reasonable judgment in deciding whether to approve a fee once it had all relevant information.”
  • Comparative Fees. The court concluded that the services MetWest provided to the fund were significantly different from the services it provided to the sub-advised funds, noting, among other things, MetWest’s responsibilities in calculating the fund’s net asset value, satisfying redemption requests, providing compliance-related services, preparing public filings, assisting the board in fulfilling its duties and overseeing third-party service providers. The court also concluded that MetWest assumed substantial risks as adviser to the fund, which risks MetWest did not face–at least not to the same extent–when serving as sub-adviser. The risks cited by the court included reputational, financial, litigation and business risks, as well as cybersecurity risks, the threat of losing personnel essential to client relations, asset flight risk and risks associated with the fund’s regulatory filings.
  • Economies of Scale. The court did not believe that the plaintiff proved the existence of economies of scale, finding that the plaintiff’s expert witness was not persuasive. Moreover, the court concluded that, even if the evidence showed that MetWest experienced some economies of scale, the evidence was insufficient to find that MetWest failed to share those economies of scale with the fund. The court determined that the fund benefited from MetWest’s reinvestments in its organization—including through the addition of new employees, improving technology systems and increasing compensation for retention purposes. The court also noted the plaintiff’s failure to cite any case law requiring that the realization of economies of scale result in the addition of fee reductions or breakpoints in the advisory fee schedule. The court further cited evidence that MetWest priced the fund to scale at the outset.
  • Profitability. In finding that the plaintiff failed to prove that the profitability factor leaned in his favor, the court noted that MetWest’s profit margins over the relevant period “generally rested below the median of reported profit margins that other asset managers comparable to MetWest received.”

The court found in favor of MetWest and ordered the dismissal of the plaintiff’s action in its entirety, on the merits and with prejudice. The case is Kennis v. Metropolitan West Asset Management, LLC, Case No. 2:15-cv-08162 (C.D. Cal. July 9, 2019).

© 2020 Vedder PriceNational Law Review, Volume IX, Number 246

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About this Author

Nathaniel Segal, Investment Attorney, Vedder Price Law Firm
Associate

Nathaniel Segal is an Associate at Vedder Price and a member of the Investment Services group. He focuses his practice on investment companies and investment advisers in connection with the organization and operation of investment products and services, including traditional mutual funds, closed-end investment companies (including interval funds and listed closed-end funds), variable insurance products and registered hedge funds, as well as mutual funds utilizing complex hedging and absolute return strategies. Mr. Segal has experience in conducting transactional due...

(312) 609 7747
Jacob Tiedt, Vedder Price, investment services attorney
Shareholder

Jacob C. Tiedt is a Shareholder at Vedder Price and a member of the Investment Services group.

Mr. Tiedt’s practice includes the representation of registered mutual funds, closed-end funds and exchange-traded funds; private funds; investment advisers; and other financial institutions on a broad range of regulatory, governance and compliance matters. Mr. Tiedt regularly counsels clients on matters relating to SEC registration, disclosure and compliance; shareholder solicitation; NYSE, Nasdaq and FINRA regulation; corporate governance; and board administration. Mr. Tiedt has a broad range of experience advising clients on complex matters relating to product design and extraordinary transactions, including fund mergers and reorganizations; fund adoption transactions; closed-end fund IPOs, secondary offerings and preferred share transactions; and closed-end fund conversions, rights offerings and repurchase offers.

312-609-7697
Legal, Business, John Marten, Investment Attorney, Vedder Price Law FIrm
Shareholder

John S. Marten, a Shareholder in the Chicago office of Vedder Price, has substantial experience representing clients in the investment management industry.

As a member of the firm’s Investment Services group, Mr. Marten counsels clients on a wide variety of matters involving the application of the federal securities laws to investment companies, investment advisers and broker-dealers. He has significant experience counseling investment company clients with respect to new products and was recently involved in the creation of two mutual funds...

(312) 609 7753