Following a full bench trial, a court has ruled in favor of the defense in a case under section 36(b) of the Investment Company Act of 1940. Sivolella v. AXA Equitable Life Insurance Co., No. 3:11-cv-4194 (D.N.J. Aug. 25, 2016). The trial was the first in several years under section 36(b). Section 36(b) provides that the investment adviser of a registered investment company has a fiduciary duty with respect to the receipt of compensation for services, and it provides shareholders with a derivative right of action against a fund adviser that receives excessive compensation.
The ruling is a solid defense win in almost every respect. The quality of the experts seems to have been a key factor in the judge’s determination. Each of the plaintiffs’ experts had issues that caused the judge to give his testimony little weight, while the defendants’ experts were all found to be credible. Indeed, the court even found that the plaintiffs’ experts failed to show actual damages, which would have prevented a recovery even if plaintiffs had proved a breach of fiduciary duty.
The plaintiffs relied heavily on the argument that the fund adviser delegated substantially all of its duties to sub-advisers, but retained substantial fees that were disproportionate to the work it actually performed. The court found that while the language of the advisory and sub-advisory contracts suggests that the sub-advisers perform a majority of the investment management services, testimony demonstrated that the adviser performs a number of services beyond those expressly outlined in the contracts. The court found that these duties are far more extensive than plaintiffs’ contention, and that they warrant compensation through a fee.
The court also found that the funds’ board is sufficiently diverse and independent, and the procedures it followed demonstrate that the board robustly reviewed the adviser’s compensation. The court noted that the fact that the adviser’s CEO acts as chairman of the funds’ board presents a transparency issue, but it found that the board acts professionally and independently to counteract this issue. The court also found, however, that the filing of the lawsuit brought about positive changes to the board’s composition and process, which it noted is at odds with its conclusion that plaintiffs failed to meet their burden to demonstrate that defendants breached their fiduciary duty.
The plaintiffs have the right to appeal to the U.S. Court of Appeals for the Third Circuit. However, the court’s judgment is grounded heavily in the facts found by the court, which may make an appeal a less attractive option for the plaintiffs. It remains to be seen what effect the court’s opinion will have on other cases alleging that fund advisers that use sub-advisers retain excessive compensation.
I have placed the court’s 159-page opinion on the FundLaw website (free registration with Yahoo Groups may be required), and it can be accessed at
https://groups.yahoo.com/neo/groups/FundLaw/files/SivolellavAXAEquitableLifeInsCo.pdf