Lynn M. Kennis Trust U/A DTD 10/02/2002 et al v. First Eagle Investment Management LLC

Filing 34

REPORT AND RECOMMENDATIONS- denying 15 MOTION to Dismiss for Failure to State a Claim. Please note that when filing Objections pursuant to Federal Rule of Civil Procedure 72(b)(2), briefing consists solely of the Objections (no longer than ten (10) pages) and the Response to the Objections (no longer than ten (10) pages). No further briefing shall be permitted with respect to objections without leave of the Court. Objections to R&R due by 10/26/2015. Signed by Judge Sherry R. Fallon on 10/8/2015. (lih)

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF DELAWARE
THE LYNN M. KENNIS TRUST U/A
DTD 10/02/2002, BY LYNN M. KENNIS.
AS TRUSTEE, and THE RONALD J.
KENNIS TRUST, BY RONALD J.
KENNIS AND DOLORES M. KENNIS
AS TRUSTEES,

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)
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)
)
)

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Plaintiffs,
v.
FIRST EAGLE INVESTMENT
MANAGEMENT, LLC,
Defendant.

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)
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)

Civil Action No. 14-585-SLR-SRF

REPORT AND RECOMMENDATION
I.

INTRODUCTION
Presently before the court in this action alleging violations of Section 3 6(b) of the

Investment Company Act of 1940 (the "Act"), 15 U.S.C. § 80a-35(b), is defendant First Eagle
Investment Management, LLC' s ("FEIM" or "defendant") motion to dismiss for failure to state a
claim pursuant to Federal Rule of Civil Procedure 12(b)(6). (D.I. 15) For the following reasons,
I recommend that the court deny the motion to dismiss.

II.

1

BACKGROUND 1

When considering a Rule 12(b)(6) motion to dismiss, the court must accept as true all factual
allegations in the complaint and view them in the light most favorable to the plaintiff. See
Newman v. Beard, 617 F.3d 775, 779 (3d Cir. 2010) ("We accept all factual allegations as true,
construe.the amended complaint in the light most favorable to [the plaintiff], and determine
whether, under any reasonable reading of the ... complaint, he may be entitled to relief."); see
also Umland v. Planco Fin. Servs., 542 F.3d 59, 64 (3d Cir. 2008). Consequently, the following

FEIM serves as investment adviser to the First Eagle Global Fund (the "Global Fund")
and the First Eagle Overseas Fund (the "Overseas Fund") (together, the "Funds") pursuant to an
Investment Advisory Contract dated December 16, 2010 (the "IAC"). (D.I. 1 at ifif 1-2, 27)
Each of the Funds is a mutual fund registered under the Act. (Id at if 18) Plaintiff, the Lynn M.
Kennis Trust U/A DTD 10/02/2002, is a shareholder in the Global Fund and has continuously
owned shares in the Global Fund since September 2012. (Id at if 15) Plaintiff, the Ronald J.
Kennis Trust (together with the Lynn M. Kennis Trust U/A DTD 10/02/2002, "plaintiffs"), is a
shareholder in the Overseas Fund and has continuously owned shares in the Overseas Fund since
May 2013. (Id at.if 16) A Board of Trustees (the "Board") oversees the Funds, and selects and
monitors the Funds' service providers. (Id at if 25)
The IAC provides that FEIM must offer certain investment advisory services to each
Fund, 2 including: (a) "regularly provid[ing] [each Fund] with investment research, advice and
supervision;" (b) "fumish[ing] continuously an investment program for [each Fund's] Portfolio;"
and (c) "recommend[ing] what securities shall be purchased for each of the Funds, what portfolio
securities shall be sold by each Fund, and what portion of each Fund's assets shall be held
uninvested." (Id at if 28) The Funds' most recent prospectus, dated March 1, 2014 (the
"Prospectus"), provides additional information about the investment advisory services provided
by FEIM to the Funds and indicates that both Funds invest primarily in equity securities, with
substantial investments in the equity securities of foreign companies. (Id at ifif 29-30)

background information is drawn from plaintiffs' complaint dated May 7, 2014, and does not
constitute findings of fact. (D.I. 1)
2
The same team of FEIM portfolio managers, analysts, research associates, and traders (the
"Global Value Team") provides investment advisory services to both Funds. (D.I. 1 at if 34)
FEIM employs the same approach in selecting investments for both Funds. (Id at 'if 33)
2

In exchange for the investment advisory services provided by FEIM, the IAC requires
each Fund to pay FEIM an annual fee calculated as a percentage of the Fund's assets under
management ("AUM"). (Id at if 39) The rate for each Fund is 0.75% of the AUM. (Id at if 40)
During fiscal year 2013, the Global Fund and the Overseas Fund paid $306 million and $97
million in investment advisory fees, respectively. (Id at iii! 41-42)
FEIM provides substantially the same investment advisory services to other clients,
including a mutual fund named the Mercer Global Low Volatility Equity Fund (the "Subadvised
Fund"), which was organized and sponsored by Mercer Investment Management, Inc.
("Mercer"), a financial institution independent of FEIM. 3 (Id at ifil 43-45, 52-53) Mercer serves
as the Subadvised Fund's investment adviser and receives investment advisory fees from the
Subadvised Fund. (Id at if 49) Mercer supcontracts with FEIM to provide investment advisory
services to the Subadvised Fund in exchange for an undisclosed fee, which is paid by Mercer.

(Id at iii! 50-51, 63) The Subadvised Fund's most recent prospectus indicates that FEIM
employs the same or substantially the same investment strategies on behalf of the Suabdvised
Fund as it does on behalf of the Funds. (Id at iii! 54-58)
Publicly available information regarding Mercer's fee arrangements with subadvisers for
other equity mutual funds suggests that the fees paid by the Subadvised Fund are significantly
lower than the fees paid by the Funds for substantially the same investment advisory services.

(Id at iii! 64-70) Additional services provided by FEIM to the Funds beyond the investment
advisory services are governed by separate contracts for separate compensation, and do not affect
the fees paid to FEIM under the IAC. (Id at iii! 71-74)

3

The same Global Value Team that manages the Funds also manages the Subadvised Fund's
investment portfolio, and uses substantially the same investment strategies in providing
investment advisory services to the Subadvised Fund as it does to the Funds. (D.I. 1 at ifil 59-60)

3

The Prospectus identifies eight individuals who are officers of the Funds, and who also
serve as officers of six other mutual funds managed by FEIM and its affiliates. (Id at ,-r,-r 75-76)
The Funds' officers are employed by FEIM and devote a majority of their time providing
services to other clients of FEIM. (Id at ,-r 77) The complaint alleges that the officers' annual
compensation allocable to their services as officers of the Funds is disproportionate to their level
of service in connection with the Funds. (Id at ,-r,-r 78-79)
Between 2009 and the present, the Funds' AUM has grown and, correspondingly, the
amount of investment advisory fees paid by the Funds has increased. (Id at ,-r,-r 80-83) However,
the increase in investment advisory fees paid to FEIM by each Fund was not accompanied by a
proportionate increase in the level of services provided by FEIM to the Funds, and FEIM
realized economies of scale as the Funds' AUM increased without passing on those benefits to
the Funds. (Id at ,-r,-r 84-85, 90) Specifically, the Funds' investment advisory fee schedules do
not include any breakpoints to reduce the Funds' fee rate as the AUM increased. (Id at ,-r,-r 8689)
Pursuant to the terms of the IAC, the Board must approve the investment advisory fees
paid by the Funds on an annual basis. (Id at ,-r,-r 91-92) Plaintiffs allege that the Board has
approved the IAC each year without independently assessing the amount of investment advisory
fees paid by the Funds or effectively representing the interests of the Funds' shareholders,
instead relying on information prepared by FEIM. (Id at ,-r,-r 93, 96-103) In contrast, plaintiffs
contend that FEIM' s fees for providing investment advisory services to the Subadvised Fund are
the product of an arm's length negotiating process between Mercer and FEIM. (Id at ,-r,-r 104-08)
According to plaintiffs, the investment advisory fees paid from the Funds' assets directly reduce
the value of the Funds' investment portfolio. (Id at ,-r,-r 109-11)

4

Plaintiffs have brought this twO'' count complaint, alleging that the investment advisory
fees charged by FEIM are excessive and violate FEIM' s fiduciary duty owed to the Funds under
Section 36(b) of the Act. Specifically, plaintiffs allege that FEIM breached a fiduciary duty
under Section 36(b) by charging investment advisory fees to the Funds "that are so
disproportionately large that they bear no reasonable relationship to the value of the services
provided by Defendant and could not have been the product of arm's-length bargaining." (Id. at

ifif 116, 124) The first count of the complaint asserts that FEIM breached its fiduciary duty as it
relates to the Global Fund, and the second count alleges the same as to the Overseas Fund.

III.

LEGAL STANDARD
Rule 12(b)(6) permits a party to move to dismiss a complaint for failure to state a claim

upon which relief can be granted. Fed. R. Civ. P. 12(b)(6). When considering a Rule 12(b)(6)
motion to dismiss, the court must accept as true all factual allegations in the complaint and view
them in the light most favorable to the plaintiff. Umland v. Planco Fin. Servs., 542 F.3d 59, 64
(3d Cir. 2008).
To state a claim upon which relief can be granted pursuant to Rule 12(b)(6), a complaint
must contain a "short and plain statement of the claim showing that the pleader is entitled to
relief." Fed. R. Civ. P. 8(a)(2). Although detailed factual allegations are not required, the
complaint must set forth sufficient factual matter, accepted as true, to "state a claim to relief that
is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007); see also Ashcroft

v. Iqbal, 556 U.S. 662, 663 (2009). A claim is facially plausible when the factual allegations
allow the court to draw the reasonable inference that the defendant is liable for the misconduct
alleged. Iqbal, 556 U.S. at 663; Twombly, 550 U.S. at 555-56.

5

When determining whether dismissal is appropriate, the court must conduct a three-step
analysis. 4 See Santiago v. Warminster Twp., 629 F.3d 121, 130 (3d Cir. 2010). First, the court
must identify the elements of the claim. Iqbal, 556 U.S. at 675. Second, the court must identify
and reject conclusory allegations. Id at 678. Third, the court should assume the veracity of the
well-pleaded factual allegations identified under the first prong of the analysis, and determine
whether they are sufficiently alleged to state a claim for relief. Id; see also Malleus v. George,
641 F.3d 560, 563 (3d Cir. 2011). The third prong presents a context-specific inquiry that
"draw[s] on [the court's] experience and common sense." Id at 663-64; see also Fowler v.

UPMC Shadyside, 578 F.3d 203, 210 (3d Cir. 2009). As the Supreme Court instructed in Iqbal,
"where the well-pleaded facts do not permit the court to infer more than the mere possibility of
misconduct, the complaint has alleged - but it has not 'show[n]' - 'that the pleader is entitled to
relief."' Iqbal, 556 U.S. at 679 (quoting Fed. R. Civ. P. 8(a)(2)).

IV.

DISCUSSION
Section 36(b) of the Act creates a fiduciary duty in a mutual fund's investment adviser

"with respect to the receipt of compensation for services." 15 U.S.C. § 80a-35(b). To state a
claim for breach of fiduciary duty under§ 36(b), a plaintiff "must meet no more rigorous a
burden than that found in Federal Rule of Civil Procedure 8(a)." Am. Chems. & Equip., Inc.

401 (k) Ret. Plan v. Principal Global Investors, LLC, 2014 WL 5426908, at *3 (S.D. Iowa Sept.
10, 2014) (quotingAmron v. Morgan Stanley Inv. Advisors, Inc., 464 F.3d 338, 343 (2d Cir.
2006)). The plaintiff bears the burden of establishing a breach of fiduciary duty. 15 U.S.C. §

4

Although Iqbal describes the analysis as a "two-pronged approach," the Supreme Court
observed that it is often necessary to "begin by taking note of the elements a plaintiff must plead
to state a claim." 556 U.S. at 675, 679. For this reason, the Third Circuit has adopted a threepronged approach. See Santiago v. Warminster Twp., 629 F.3d 121, 130 n.7 (3d Cir. 2010);
Malleus v. George, 641F.3d560, 563 (3d Cir. 2011).
6

80a-35(b)(l); see also Green v. Fund Asset Mgmt., L.P., 286 F.3d 682, 685 (3d Cir. 2002).
To state a claim under§ 36(b), a plaintiff must plead facts demonstrating "the
relationship between the fees charged to the fund and the services rendered to the fund." Am.
Chems., 2014 WL 5426908, at *5; see also Migdal v. Rowe Price-Fleming Int'!, Inc., 248 F.3d

321, 327 (4th Cir. 2001). Specifically, a plaintiff must plead sufficient facts to show that the fee
charged, in the context of all of the surrounding facts and circumstances, 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." Gartenberg v. Merrill Lynch Asset
Mgmt., Inc., 694 F.2d 923, 928 (2d Cir. 1982) (internal citations omitted); see also Jones v.
Harris Assocs. L.P., 559 U.S. 335, 344 (2010).

"[A] § 36(b) complaint is not sufficient if it

rests solely on general and conclusory legal assertions that the fees charged were excessive."
Forsythe v. Sun Life Fin., Inc., 417 F. Supp. 2d 100, 115 (D. Mass. 2006).

In Jones v. Harris Associates L.P., the Supreme Court identified a series ,of factors
adopted by the Second Circuit in Gartenberg that are useful in assessing claims brought under §
36(b). See Jones, 559 U.S. at 344-45 n.5. The Gartenberg factors include, but are not limited to:
"(l) the nature and quality of the services provided to the fund and shareholders; (2) the
profitability of the fund to the adviser; (3) any 'fall-out financial benefits,' those collateral
benefits that accrue to the adviser because of its relationship with the mutual fund; (4)
comparative fee structure ... ; and (5) the independence, expertise, care, and conscientiousness of
the board in evaluating adviser compensation." Id (citing Gartenberg, 694 F .2d at 929-32). The
Supreme Court also discussed economies of scale. Id at 344. However, "[b]ecause a claim
under§ 36(b) need only meet the liberal pleading standards set forth in Rule 8, it is not necessary
for a plaintiff to make a conclusive showing of each Gartenberg factor to survive a motion to

7

dismiss." Zehrer v. Harbor Capital Advisors, Inc., 2014 WL 6478054, at *2 (N.D. Ill. Nov. 18,
2014). As this court has noted, "the Gartenberg decision ... is helpful only after the complete
evidentiary record has been established." Millenco L.P. v. MEVC Advisors, Inc., C.A. No. 02142-JJF, 2002 WL 31051604, at *3 n.3 (D. Del. Aug. 21, 2002) (noting that the Third Circuit has
not established a specific standard for evaluating excessive fees under § 36(b)).
In their complaint, plaintiffs have relied on three of the Gartenberg factors: (1) the
adequacy of the fee comparisons; (2) economies of scale; and (3) the independence of the Board.
(D.I. 16 at 10-20) FEIM moves to dismiss on the basis that plaintiffs have failed to plausibly
allege that the advisory fees it receives are so disproportionately large that they bear no
reasonable relationship to the services rendered to the Funds based on the foregoing factors. In
its review of the pending motion, the court must deny the motion to dismiss even if plaintiffs
failed to allege the existence of certain Gartenberg factors if the complaint, taken as a whole,
alleges facts demonstrating a plausible claim for relief under§ 36(b). See In re Blackrock
Mutual Funds Advisory Fee Litig., 2015 WL 1418848, at *4 (D.N.J. Mar. 25, 2015) (quoting
Kasilag, et al. v. Hartford Inv. Fin. Servs., LLC, 2012 WL 6568476 (D.N.J. Dec. 17, 2012)).

A.

Adequacy of Fee Comparisons

In support of its motion to dismiss, FEIM contends that the complaint fails to plead any
facts indicating that the investment advisory fees paid by the Funds are disproportionately large
in comparison to the advisory fees paid by other clients ofFEIM. (D.I. 16 at 10-11) According
to FEIM, the comparisons drawn in plaintiffs' complaint rely on data that is not based on
advisory or sub-advisory fees charged by FEIM, but is instead based on fees charged by other
managers for providing sub-advisory services to other Mercer equity funds. (Id. at 11-13)
Moreover, FEIM alleges that the investment mandate of the Subadvised Fund is not comparable

8

to the investment mandate of the Overseas Fund because the Overseas Fund cannot include a
large allocation to U.S. equity investments. (Id at 13-14) FEIM alleges that the complaint's
treatment of the Global Fund and the Overseas Fund as interchangeable investment strategies
illustrates the fatal deficiencies in the complaint at this stage of the proceedings. (Id at 14-15)
In response, plaintiffs contend that the disparity between advisory fees charged to the
Funds and the Subadvised Fund supports a plausible inference that the advisory fees charged to
the Funds are disproportionate to the services provided, and fall outside the range of what could
be negotiated at arm's length. (D.I. 21 at 15-16) Plaintiffs allege that the data reflected in the
complaint's charts passes muster at this stage of the proceedings because the advisory fees
received by FEIM on the open market for substantially the same services are not publicly
disclosed. (Id at 16-19)
Contrary to FEIM' s contentions, the complaint in the present matter contains more than
conclusory allegations regarding the allegedly excessive nature of the advisory fees.
Specifically, the complaint alleges that FEIM charges the Funds 75 basis points of each Fund's
AUM, whereas it charges Mercer between 38 and 50 basis points of the Subadvised Fund's
AUM to provide substantially the same investment advisory services. (D.I. 1 at~~ 40, 66)
Plaintiffs base their estimate of the Subadvised Fund's fees on publicly available information
regarding Mercer's fee arrangements with other captive mutual funds, including fee
arrangements with twelve different subadvisers for five separate equity mutual funds. (Id at ~
64) According to the calculations set forth in the complaint, application of the lower rates to the
Global Fund and the Overseas Fund would save the Funds up to $183 million and $55 million in
annual fees, respectively. (Id

at~~

68-69) FEIM's challenges to the factual underpinnings of

these allegations cannot be resolved by the court prior to the conclusion of fact discovery.

9

Similarly, the court cannot make factual findings regarding FEIM' s contention that the
Overseas Fund is not sufficiently comparable to the Subadvised Fund at this stage of the
proceedings. See In re Blackrock Mut. Funds Advisory Fee Litig., 2015 WL 1418848, at *5
(D.N.J. Mar. 27, 2015) (finding that "the disagreements over the degree of relevancy of a fee
comparison should not be decided at the pleadings stage"). This is particularly true where, as
here, FEIM relies on evidence outside the pleadings in support of its argument regarding the
distinctions between the Overseas Fund and the Subadvised Fund. 5 Although the Supreme Court
has cautioned that "courts should not rely too heavily on comparisons with fees charged to
mutual funds by other advisers," Jones, 559 U.S. at 350-51, Jones is distinguishable from the
facts of the present case because it was decided on summary judgment, after discovery had
concluded.
The complaint further alleges that the higher fees paid by the Funds pursuant to the IAC
"are not justified by any additional services provided to the Funds by [FEIM] or its affiliates."

(Id at if 70) Plaintiffs contend that, "like the Funds' IAC, the subadvisory agreement requires
FEIM to 'conduct an ongoing program of investment, evaluation and, if appropriate, sale and
reinvestment' of the Subadvised Fund's assets, including 'purchas[ing], hold[ing] and sell[ing]
investments' and 'monitor[ing] such investments on an ongoing basis."' (Id. at ,-r 53) Plaintiffs
refer to the Subadvised Fund's prospectus to draw a comparison between the investment
strategies of the Funds and the Subadvised Fund, further illustrating the similarities in services

5

The court declines to consider the Morningstar documents attached to FEIM' s motion to
dismiss at this stage of the proceedings. See Federal Rule of Evidence 201(b)(2) (court may only
take judicial notice of "a fact that is not subject to reasonable dispute because it ... can be
accurately and readily determined from sources whose accuracy cannot reasonably be
questioned."). The documents explicitly state that "[t]he information contained herein ... is not
warranted to be accurate, complete or timely," indicating that they are subject to reasonable
dispute and are not capable of accurate and ready determination. (D .I. 17 at Exs. B & C)
10

provided to the Funds and the Subadvised Fund. (Id at ifif 54-58) Plaintiffs have alleged facts in
relationship to both the fee charged and the services provided, unlike the circumstances set forth
in Migdal. 248 F.3d at 327 ("[P]laintiffs did not address in any way the relationship between the
fees that the advisers received and the services which they provided in return.").
Similar allegations were found to be sufficient under the Rule 12(b)(6) standard in

Goodman v. J.P. Morgan Inv. Mgmt., Inc., 2015 WL 965665, at *4 (S.D. Ohio Mar. 4, 2015).
As in Goodman, "[p]laintiffs have pled a notable disparity in the fees obtained for servicing the .
. . funds with which they are involved and the subadvised funds, while concurrently pleading that
the services provided to and resources involved in all of the funds are substantially the same."

Id at *5 (noting that, as in the case at bar, the "prospectus disclosures and involvement by the
same portfolio managers and investment professionals support the similarity [of the]
allegations."). Although FEIM disputes whether the comparison with the Subadvised Fund is
relevant, and questions whether important distinctions between the Global Fund and the
Overseas Fund may be overlooked in the complaint, the ultimate weight of the comparisons is
not before the court. Taking the factual allegations of the complaint as true, plaintiffs'
comparison of the Subadvised Fund to the Funds is sufficient to withstand a Rule l 2(b)(6)
motion to dismiss. Am. Chems., 2014 WL 5426908 at *6.

FEIM' s attempt to distinguish Goodman based on the identification of specific fees
received by the defendant as a subadvisor to the subadvised funds in the Goodman complaint is
unavailing. (D .I. 30 at 1) The parties do not dispute that the specific fee rate charged to the
Subadvised Fund is not publicly disclosed, and would therefore only be made known during the
discovery process. (D.I. 28 at 1; D.I. 1 at if 63) Moreover, courts have recognized that "[i]t is
not necessary, and is often impossible, for § 36(b) plaintiffs to file suit with the fee data that

11

relates to the entire damages period." See Am. Chem., 2014 WL 5426908, at *1 n.1 (noting that
plaintiff filed complaint to preserve its claim for damages in the year between plaintiffs original
filing and its second complaint filed after publicly available information was updated).
Therefore, plaintiffs' allegations regarding the disparity in basis points between the advisory fee
rates charged to the Funds and the Subadvised Fund are sufficient to state a claim, and the
veracity of those allegations, along with the specific fee rate charged to the Subadvised Fund, are
appropriately the subject of discovery.
Moreover, FEIM's reliance on the Fourth Circuit's decision in Migdal is not compelling
because the case is not factually analogous to the circumstances presently before the court. In

Migdal, the Fourth Circuit granted the defendant's motion to dismiss after concluding that the
complaint did not sufficiently address the relationship between the fees received and the services
provided, as the complaint contained insufficient facts regarding the services rendered. Migdal,
248 F.3d at 327. As previously discussed, the complaint in the instant case sufficiently addresses
the relationship between the fees received and services rendered.
Taken as a whole, plaintiffs' complaint pleads sufficient facts regarding the fees paid to
FEIM and their relationship to the services rendered to present a plausible claim that the fees are
disproportionately large. See Goodman, 2015 WL 965665, at *5. In light of the foregoing, I
recommend that the court deny FEIM' s motion to dismiss.

B.

Economies of Scale

FEIM further alleges that the complaint fails to include specific factual allegations
showing that the Funds achieved economies of scale, or that FEIM did not adequately share
economies of.scale with the Funds' investors. (D.I. 16 at 15-18) According to FEIM, the
increase in size of the Funds does not automatically suggest that FEIM breached a fiduciary duty

12

to the Funds relating to its receipt of compensation. (Id at 18) In response, plaintiffs note that
the substantial increase in fees charged to the Funds, without a corresponding change in the level
of services provided, is sufficient at this stage of the proceedings to suggest that the fees are
excessive. (D.I. 21 at 21-22)
Allegations regarding economies of scale do not constitute an independent cause of
action under§ 36(b). See Am. Chems., 2014 WL 5426908, at *6. Instead, they are considered as
one factor under Gartenberg to determine whether an investment adviser breached its fiduciary
duty by charging excessive fees. Id The complaint in the instant action alleges that the Funds'
assets more than doubled between 2009 and 2013. (D.I. 1 at ifif 80, 82) As a result of the
increase in AUM, the investment advisory fees paid by the Funds also increased exponentially.

(Id at ifif 81, 83) The complaint states that the increase in investment advisory fees paid by the
Funds was not accompanied by a proportionate increase in services or costs incurred by FEIM.

(Id at if. 84) The Funds' investment advisory fee schedules did not include any breakpoints to
reduce ·the Funds' fee rate as AUM increased and ensure that the benefits of economies of scale
would accrue to investors. (Id at ifif 86-90)
The allegations in the complaint, taken as true at this stage of the proceedings, are
sufficient to establish that FEIM did not adequately share the benefits of economies of scale with
the Funds. Plaintiffs' allegations regarding economies of scale support their claim that the fees
are disproportionate to the services rendered and are not the product of arm's length bargaining.

See In re Blackrock Mut. Funds Advisory Fee LUig., 2015 WL 1418848, at *7 (D.N.J. Mar. 27,
2015) (denying motion to dismiss while allowing for an inference that "the adviser's 'breakpoints
did not give shareholders meaningful benefits from the economies of scale enjoyed by the
Funds'"); Reso ex rel. Artisan Int'! Fund v. Artisan Partners Ltd. P 'ship, 2011 WL 5826034, at

13

. *9 (E.D. Wis. Nov. 18, 2011) (denying motion to dismiss due to allegations relating to the
economies of scale factor of Gartenberg); Sins v. Janus Cap. Mgmt., LLC, 2006 WL 3746130, at
*3 (D. Colo. Dec. 15, 2006) (allegations regarding increase in assets without fee breakpoints
could show disproportionality); In re Goldman Sachs Mut. Funds Fee Litig., 2006 WL 126772,
at *9 n.24 (S.D.N.Y. Jan. 17, 2006) (allegations that significant increase in fees over time,
without corresponding change in quality of services rendered, is sufficient to meet the pleading
requirements of Gartenberg).
Unlike the facts set forth in In re Scudder Mutual Funds Fee Litigation, 2007 WL
2325862, at *16 (S.D.N.Y. Aug. 14, 2007), the .complaint in the present case specifically
identifies the amount of the increase in AUM, the corresponding amount of the fee increase with
no additional services provided, and the lack of breakpoints in the fee schedules to reduce the
advisory fees. The facts of In re Scudder are distinguishable from the facts of the case at bar
because the allegations regarding economies of scale in In re Scudder pertained to funds in
which the named plaintiffs did not own shares, or they involved time periods outside of the
statute oflimitations. Id Moreover, FEIM's reliance on In re Salomon Smith Barney Mut. Fund
Fees Litig., 528 F. Supp. 2d 332, 338-39 (S.D.N.Y. 2007) is unavailing because plaintiffs'
complaint in the present matter contains allegations regarding the costs. (D.I. 1 at~~ 84-85)

C.

Sufficiency of Board's Fee Approval Process

FEIM next contends that the complaint's allegations regarding the lack of
conscientiousness and independence of the Board do not give rise to an inference that the Funds'
fees are disproportionately large in relation to the services rendered. (D.I. 16 at 18) According
to FEIM, allegations that Board members' service is a part-time job, and the Board oversees
multiple other mutual funds, do not sufficiently challenge the Board's independence. (Id at 18-

14

19) Moreover, FEIM alleges that the Board's receipt and review of information prepared by an
adviser does not impair the independence of the Board. (Id. at 19)
In response, plaintiffs allege that the Board's approval should be given little deference
because the approval process used by the Board was deficient, as it was neither competitive nor
conducted at arm's length. (D.I. 21 at 21-22) Specifically, plaintiffs argue that the Board did not
solicit proposals from other investment advisers, and did not negotiate a "most favored nation"
provision into the IAC. (Id. at 29-30) Plaintiffs contend that FEIM's comparisons to peer
groups do not support dismissal because the fees in the comparison may not be the product of
negotiations conducted at arm's length, and fact discovery is needed to resolve this issue. (Id. at
23-24)
The _complaint in the case at bar alleges that the Board approves the IAC each year
without independently assessing the advisory fees paid by the Funds, and Board members are
generally part-time employees who oversee a number of other FEIM-managed mutual funds as
well. (D.I. 1 at~~ 93-95) The complaint indicates that the Board relies on information prepared
by FEIM and does not consider information or analyses regarding the interests of the Funds or
their shareholders. (Id.

at~~

96-97) Moreover, the complaint asserts that the Board improperly

failed to negotiate more favorable terms for the shareholders in the IAC, solicit proposals from
other advisers, or require that the fee rates paid by each Fund be at least as favorable as the
lowest rate other clients pay FEIM for substantially the same investment advisory services. (Id.
at~~

99-101)
"As the statutory text indicates, Section 36(b) is sharply focused on the question of

whether the fees themselves were excessive, and not on the status of the directors who approved
them." Migdal, 248 F.3d at 328 (noting that other sections of the Act address the independence

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of the funds' directors). Typically, "[a]llegations about the status of directors with whom fee
negotiations took place relate too tangentially to the simple question of whether the investment
advisers received excess compensation for the services they rendered." Id at 329. For these
reasons, the court should generally defer to the outcome of a board's negotiating process
regarding investment-adviser compensation. See Jones, 559 U.S. at 35.1 (citing Burks v. Lasker,
441 U.S. 471, 484 (1979)). The court must not second-guess the Board's decision simply
because the court might have weighed the relevant factors differently, as "the Act does not
require courts to engage in a precise calculation of fees representative of arm's-length
bargaining." Id (internal citations omitted).
Although the complaint's allegations regarding the Board's fee approval process are
insufficient, standing alone, to state a claim upon which relief can be granted, when viewed in
conjunction with the other disputed Gartenberg factors, the allegations in the complaint are
sufficient to withstand FEIM' s motion to dismiss. See In re Blackrock Mut. Funds Advisory Fee

Litig., 2015 WL 1418848, at *8 (D.N.J. Mar. 27, 2015); Gartenbergv. Merrill Lynch Asset
Mgmt., Inc., 694 F.2d 923, 928 (2d Cir. 1982) ("[T]he test is essentially whether the fee schedule
represents a charge within the range of what would have been negotiated at arm's-length in the
light of all of the surrounding circumstances."). Some courts have recognized membership on
the boards of several funds as a prevailing practice in the mutual fund industry, as opposed to a
sign of the directors' lack of conscientiousness. See Migdal, 248 F.3d at 330 (citing Olesh v.

Dreyfus Corp., 1994 WL 780179 (E.D.N.Y. Aug. 15, 1994)). Moreover, allegations that the
Board relied solely on information provided by FEIM do not wholly support plaintiffs' position,
as the statute itself provides that "[i]t shall be the duty of the directors ... to request and
evaluate, and the duty of an investment adviser to such company to furnish, such information as

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may reasonably be necessary to evaluate the terms of any contract whereby a person undertakes
regularly to serve or act as investment adviser of such company." 15 U.S.C. § 80a-15(c).
· However, other courts have concluded that a complaint which pleads that the directors oversee
numerous mutual funds, rely on information prepared solely by the defendant, and fail to
consider information reflecting the interests of the funds or the shareholders, is sufficient to
withstand a motion to dismiss. See Goodman, 2015 WL 965665, at *3-4; se.e also Zehrer v.

Harbor Capital Advisors, Inc., 2014 WL 6478054, at *2-3 (N.D. Ill. Nov. 18, 2014) ("Because a
claim under§ 36(b) need only meet the liberal pleading standards set forth in Rule 8, it is not
necessary for a plaintiff to make a conclusive showing of each Gartenberg factor to survive a
motion to dismiss.").
The complaint contains sufficiently specific factual allegations to meet Rule 8's liberal
pleading standard at this stage of the proceedings. In view of the foregoing, I recommend that
the court deny FEIM' s motion to dismiss.

V.

CONCLUSION
For the foregoing reasons, I recommend that the court deny FEIM' s motion to dismiss.

(D.I. 15)
This Report and Recommendation is filed pursuant to 28 U.S.C. § 636(b)(l)(B), Fed. R.
Civ. P. 72(b)(l), and D. Del. LR 72.1. The parties may serve and file specific written objections
within fourteen (14) days after being served with a copy of this Report and Recommendation.
Fed. R. Civ. P. 72(b)(2). The objections and responses to the objections are limited to ten (10)
pages each. The failure of a party to object to legal conclusions may result in the loss of the right
to de novo review in the District Court. See Sincavage v. Barnhart, 171 F. App'x 924, 925 n.1
(3d Cir. 2006); Henderson v. Carlson, 812 F.2d 874, 878-79 (3d Cir. 1987).

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The parties are directed to the court's Standing Order For Objections Filed Under Fed. R.
Civ. P. 72, dated October 9, 2013, a copy of which is available on the court's website,
http://www.ded.uscourts.gov.

Dated: October 8, 2015

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