Other Types of Advisory Fees Not Relevant to Mutual Fund Fees, Says Court
It was only three sentences long, but fund lawyers have been buzzing over the July 17 order in the American Century mutual fund fee case. In it, the court stated that the level of management fees paid by pension funds and other institutional clients to American Century had no bearing on whether American Century’s mutual funds paid excessive management fees.
Specifically, the U.S. District Court for the Western District of Missouri ruled that the plaintiffs in the case were precluded from presenting any evidence relating to American Century’s management of non-mutual fund accounts. Such evidence, said the court, "is irrelevant to Plaintiffs’ claims involving mutual fund fees under Section 36(b) of the Investment Company Act."
The plaintiffs had alleged that American Century charged lower management fees to institutional clients than it did to its retail mutual funds, and had sought to establish that each of the funds’ fees was "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," the standard set under Gartenberg v. Merrill Lynch Asset Management for determining whether a fund adviser has breached its fiduciary duty with respect to the receipt of compensation by the fund. The Gartenberg court had identified "competitive fee structures" as one of the factors relevant to such a determination.
On June 22, American Century filed a motion to prevent the plaintiffs from introducing evidence about the fund company’s management of sub-advised and institutional accounts on the grounds that such evidence was irrelevant to a claim involving mutual fund fees under ICA Section 36(b). The fund company argued that evidence of "comparative fee structures" should be limited to fees charged to an "appropriate universe" of similar mutual funds. Management fees for different types of investment products, it said, "are irrelevant." To bolster its argument, American Century cited a number of court decisions in which institutional management fees were not allowed to be used as a basis for assessing mutual fund fees under Section 36(b). For example, in the 2002 case of Strougo v. BEA Associates, the court flatly stated that "relevant comparison must be to other mutual funds, not to non-mutual fund institutional clients."
On July 7, the plaintiff filed an opposing memoranda, asserting that the non-fund fee evidence was, in fact, highly relevant.
Here, plaintiffs appeared to have made two missteps. First, they argued that the cases cited by American Century in support of its view that non-fund fee evidence should be excluded were factually distinguishable, since they applied only to money market mutual funds. In contrast, said plaintiffs, the American Century funds at issue were growth equity funds. "The reason for distinguishing money market funds from other types of funds is that significantly more time is spent in processing redemptions in the money market setting," said the plaintiffs. The three cases cited by American Century in its motion to dismiss the non-fund evidence, they said, "are simply not applicable" to the American Century funds at issue, "because money market accounts are very different from long-term equity mutual funds."
But the Strougo case did deal with an equity mutual fund. In its response, American Century cited a number of additional fee cases that involved funds other than money market mutual funds.
Second, plaintiffs did not discuss the SEC’s June 2004 rulemaking requiring funds to disclose whether or not their boards considered information about other, non-fund management fees, when deliberating about the level of the fund manager’s fees. That rulemaking amended Form N-1A to require funds to disclose whether their board, in approving the advisory contract, relied upon comparisons of the services to be rendered and the amounts to be paid under the contract with those under other advisory contracts, including contracts with other funds or with other types of clients, such as pension funds.
In any event, on July 17, the court ruled in favor of the defendants. On July 31, just a week before trial, plaintiffs agreed to dismiss the care.
"The case was the first legal test of plaintiffs’ new legal theories challenging the level of mutual fund fees." said Milbank Tweed partner James Benedict, who represented American Century, in a statement. "The plaintiffs failed miserably. Hopefully, the result here will send a loud and clear message to the plaintiffs bar."
FundDemocracy founder Mercer Bullard called the court’s decision to exclude non-fund fees "a stunning ruling." Bullard noted that the plaintiffs did not raise the issue of the SEC’s rulemaking, which he said explicitly acknowledged the significance of non-fund fees. The SEC rule "clearly says ‘this is relevant,’" he said. "You think that would be the main argument you would make if you wanted to win that element."
And, he added, even the Investment Company Institute "conceded that those two things can be compared." In November 2003, the ICI released a report comparing the management fees paid by mutual funds and pension funds. The report concluded that the expenses borne by mutual funds for portfolio management are roughly the same as the expenses incurred by public pension plans for external management of their portfolios. The ICI, said Bullard, is "on record as recognizing the relevance of those fees."
Added Bullard: "It is incredible to me that in the wake of those two factors you could have that ruling."
The suit had been filed by plaintiffs lawyer Guy Burns, who a few years back represented the Florida State Board of Administration in its unsuccessful lawsuit against Alliance Capital. The Florida board had asserted that Alliance Capital hadn’t done its homework before investing SBA in Enron.
Burns did not respond to a request for comment.