Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 04 C 8305-Charles P. Kocoras, Judge.
The opinion of the court was delivered by: Easterbrook, Chief Judge.
ARGUED SEPTEMBER 10, 2007
Before EASTERBROOK, Chief Judge, and KANNE and EVANS, Circuit Judges.
Harris Associates advises the Oakmark complex of mutual funds. These open-end funds (an open-end fund is one that buys back its shares at current asset value) have grown in recent years because their net returns have exceeded the market average, and the investment adviser's compensation has grown apace. Plaintiffs, who own shares in several of the Oakmark funds, contend that the fees are too high and thus violate §36(b) of the Investment Company Act of 1940, 15 U.S.C. §80a--35(b), a provision added in 1970. The district court concluded that Harris Associates had not violated the Act and granted summary judgment in its favor. 2007 U.S. Dist. LEXIS 13352 (N.D. Ill. Feb. 27, 2007).
Plaintiffs rely on several sections of the Act in addition to §36(b), and we can make short work of these. The Act requires at least 40% of a mutual fund's trustees to be disinterested in the adviser, see 15 U.S.C. §80a--10(a), and obliges the fund to reveal the financial links between its trustees and the adviser, see 15 U.S.C. §80a--33(b). Compensation for the adviser is controlled by a majority of the disinterested trustees. 15 U.S.C. §80a--15(c). Plaintiffs say that the Oakmark funds have violated all of these rules. Because none of the funds is a party to this suit, an order directing the funds to comply is not available as relief. Plaintiffs say that the court could require Harris to return the compensation it has received, but such a penalty would be disproportionate to the wrong. That's not the only problem: although §36(b) creates a private right of action, the other sections we have mentioned do not. We need not decide whether a private right of action should be implied, see Alexander v. Sandoval, 532 U.S. 275 (2001), or whether a sensible remedy could be devised, as there has been no violation of §10(a) or §15(c).
Victor Morgenstern is among the funds' trustees. Until the end of 2000, when he retired, Morgenstern was a partner of Harris Associates and counted among the funds' "interested" trustees. Since his retirement, Morgenstern has been treated as a disinterested trustee and has voted at the special meetings that deal with the adviser's compensation. Plaintiffs insist that Morgenstern does not meet the statutory standards because Harris Associates bought out his partnership with a stream of payments that can be deferred if Harris does not satisfy performance benchmarks in a given year. This makes the payments a form of profit sharing, plaintiffs contend, and because profit-sharing agreements are treated as "securities" under 15 U.S.C. §80a--2(a)(36), Morgenstern owns securities in Harris Associates and is not disinterested. 15 U.S.C. §80a--2(a)(19)(B)(iii). More-over, plaintiffs continue, the Oakmark funds did not disclose these facts to the public and so are out of compliance with 15 U.S.C. §80a--33(b).
Harris Associates contends that payments fixed in amount are not "profit sharing" in the statutory sense just because the time of payment is uncertain. Let us assume (again without deciding) that Morgenstern held a "security" under the Act because he was exposed to the risk of business reverses at his old firm. Failure to disclose Morgenstern's post-retirement payments from Harris Associates might support an order directing the funds to correct their annual reports and other official disclosure documents but would not justify any relief against Harris Associates. To get anywhere, even with a private right of action, plaintiffs would have to show the sort of violation that knocks out any valid contract between Harris Associates and the funds. Only a violation of the 40%-independence rule or the approval-by-a-majority-of-disinterested-trustees rule could do that. Yet most of the funds' trustees are disinterested even if Morgenstern is treated as interested.
During the time covered by the suit, the funds had nine or ten trustees, at least seven of whom are independent even if we count Morgenstern as interested. That's comfortably over the statutory requirement that 40% of trustees be disinterested. And as the disinterested trustees unanimously approved the contracts with Harris Associates, it makes no difference how Morgenstern is classified. Plaintiffs ask us to suppose that Morgenstern possessed some Svengali-like sway over the other trustees, so that his presence in the room was enough to spoil their decisions. But in 2000 and before, when Morgenstern had been treated as interested, the disinterested trustees met in his absence and approved Harris's compensation. More: although the disinterested directors initially meet separately, the whole board ultimately discusses and votes on the contract. 15 U.S.C. §80a--15(a)(2). Interested directors are not silenced. So it is impossible to see how Morgenstern's role from 2001 through 2004 can be treated as poisoning the deliberations.
Now for the main event: plaintiffs' contention that the adviser's fees are excessive. They rely on §36(b), which provides:
For the purposes of this subsection, the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser. An action may be brought under this subsection by the Commission, or by a security holder of such registered investment company on behalf of such company, against such investment adviser . . . . With respect to any such action the following provisions shall apply:
(1) It shall not be necessary to allege or prove that any defendant engaged in personal misconduct, and the plaintiff shall have the burden of proving a breach of fiduciary duty.
(2) In any such action approval by the board of directors of such investment company of such compensation or payments, or of contracts or other arrangements providing for such compensation or payments, and ratification or approval of such compensation or payments, or of contracts or other arrangements providing for such compensation or payments, by the shareholders of such investment company, shall be given such consideration by the court as is deemed appropriate under all the circumstances. . . .
The district court followed Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982), and concluded that Harris Associates must prevail because its fees are ordinary. Gartenberg articulated two variations on a theme:
[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 ...