By John M. Jascob, J.D., LL.M.
Great-West Capital Management has again prevailed on claims that the investment adviser and an affiliate breached their fiduciary duties to retirement plan investors by charging excessive mutual fund fees in violation of Investment Company Act Section 36(b). Affirming the ruling below, a Tenth Circuit panel held that the plaintiffs failed to establish any of the Gartenberg factors for showing that the fees charged to the Great-West mutual funds were disproportionately and unreasonably large in relationship to the defendants’ services (Obeslo v. Great-West Life & Annuity Insurance Co., July 26, 2021, McHugh, C.).
Investment Company Act Section 36(b) imposes a fiduciary duty on investment advisers with respect to setting and collecting their fees and also paying affiliates from mutual fund assets. Section 36(b) also grants a private right of action to shareholders, who must show that the adviser’s compensation 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" (Jones v. Harris Assocs. L.P. (U.S. 2010). The Supreme Court has instructed courts to consider all relevant factors when making this determination, including the six factors articulated by the Second Circuit in Gartenberg v. Merrill Lynch Asset Management, Inc. (1982). No plaintiff has ever prevailed on a Section 36(b) claim since Congress enacted the statute in 1970.
In a consolidated shareholder derivative action, individuals who acquired shares of certain Great-West-advised funds through their retirement plans had alleged that both the advisory and administrative services fees charged to the funds were excessive under Section 36(b). After an 11-day bench trial, however, Judge Christine Arguello dismissed the suit, ruled that the plaintiffs failed to prove any of the Gartenberg factors. The plaintiffs also failed to establish that they suffered actual damages, with the court characterizing the theories underlying their expert witness’s damages analysis as being "fundamentally flawed." The court later sanctioned the plaintiffs’ counsel for recklessly pursuing the claims despite the red flags concerning their expert’s testimony, which left the plaintiffs with no plausible means of establishing actual damages or "the outer bounds of arm’s length bargaining."
Balancing test. On appeal, two basic patterns pervaded the plaintiffs’ arguments and tilted each factor in the defendants’ favor, the Tenth Circuit noted. First, the plaintiffs failed to carry their heavy burden under clear error review of demonstrating that the district court erred on enough issues to justify overturning its application of Gartenberg’s multifactor balancing test. The substantial deference afforded the district court’s factual conclusions doomed the plaintiffs’ effort because the record was so flush with support for the findings that the plaintiffs had little recourse beyond relitigating facts already decided below, the appeals court stated.
For example, the sixth Gartenberg factor is "the level of expertise, conscientiousness, independence, and information with which the board acts." The panel noted that the emphasis the Supreme Court placed on this factor in Jones, when coupled with its unique basis in the statutory text, suggests that it is the most important factor. Given that the defendants failed to challenge the district court’s finding that the fund board’s directors were independent and well-qualified, however, this factor already tilted in favor of the defendants. Moreover, the plaintiffs mischaracterized the critical inquiry, which is whether the board’s process for negotiating and reviewing investment-adviser compensation was robust. Among other things, the district court found that the board’s Section 15(c) process for annually reviewing and approving advisory compensation followed best practices recommended by industry authorities. The district court also found that the evidence made it clear that the directors closely scrutinized fees, resulting in numerous fee reductions.
Second, the plaintiffs failed to satisfy their burden under Section 36(b) of showing that the fees charged by Great-West were outside the range that arm’s-length bargaining would produce. The district court had agreed with the defendants’ analysis that their fees were within range of their peers, in part because the plaintiffs did not provide credible contradictory evidence during the bench trial. While the plaintiffs on appeal selectively cited outlying fees as proof of unreasonableness, they wrongly assumed that high fees are inherently disproportionate, the panel stated. The plaintiffs also ignored the district court’s findings that the defendants’ fees were below average when looking at other data sets.
The plaintiffs also criticized the use of generic fee comparisons over fund-specific fee comparisons, but this argument’s claim that fund-specific analysis should be the preferred methodology is not grounded in the law because the text of Section 36(b) does not require a separate analysis for each fund at issue, the panel reasoned. Finally, the plaintiffs’ redeployment of factual arguments rejected by the district court was merely an attempt to relitigate the facts in the appellate court, an approach that could not succeed or establish clear error.
The case is No. 20-1310.