United States District Court, N.D. Illinois, Eastern Division
MEMORANDUM OPINION AND ORDER
JOAN H. LEFKOW, District Judge.
Plaintiff Terrence Zehrer, a shareholder of Harbor International Fund ("the Fund"), filed this action on behalf of the Fund under § 36(b) of the Investment Company Act, 15 U.S.C. § 80a-1 et seq. ("the ICA"). Zehrer alleges that the Fund's investment manager and advisor, Harbor Capital Advisors, Inc. ("Harbor Capital"), charged excessive advisory fees in breach of its fiduciary duty under § 36(b). Zehrer also named the Fund as a nominal defendant. Both Harbor Capital and the Fund have moved to dismiss the complaint. The Fund's motion to dismiss (dkt. 48) is granted and Harbor Capital's motion to dismiss (dkt. 43) is denied.
Zehrer holds shares in the Fund, which is one of 29 funds under the "Harbor Funds" umbrella. (Compl. ¶¶ 7-8.) Each of the 29 funds is overseen by the same eight-member Board of Trustees ("the Board"). ( Id. ¶ 32.)
The Fund opened in 2006 with approximately $15 billion of assets. ( Id. ¶ 8.) By October 31, 2013, it had grown to over $48 billion. ( Id. ) The Fund invests primarily in common and preferred stocks of foreign companies, including those in emerging markets. ( Id. ) An Investment Advisory Agreement dated July 2013 gives Harbor Capital oversight responsibility for the management of the Fund. ( Id. ¶¶ 8-9; dkt. 44, ex. 4.) Harbor Capital delegates the Fund's investment management to Northern Cross under a Sub-Advisory Agreement also dated July 2013. (Compl. ¶ 16; dkt. 44, ex. 5.) Harbor Capital is not liable for the investment decisions made by Northern Cross but maintains general oversight and supervisory responsibilities for the Fund, including those related to regulatory filings, legal support, and board meetings. (Compl. ¶¶ 16-17; dkt. 44, ex. 4 at 2.)
The Board approved the fees paid to Harbor Capital for its services under the Advisory Agreement. (Compl. ¶ 29.) Harbor Capital receives a fee of 0.75% for the first $12 billion of the Fund's assets under management and 0.65% for assets above $12 billion. ( Id. ¶ 19.) The Fund paid Harbor Capital over $225 million in advisory fees for the 2012 fiscal year. ( Id. ) Harbor Capital, in turn, paid Northern Cross approximately $125 million under the Sub-Advisory Agreement for its investment management services to the Fund. ( Id. ¶ 20.) Harbor Capital thus retained approximately $100 million of the fees paid by the Fund in 2012. ( Id. ) Zehrer alleges that this fee is excessive and a breach of Harbor Capital's statutory fiduciary duty under § 36(b) of the ICA. ( Id. ¶¶ 36-44.)
A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) challenges a complaint for failure to state a claim upon which relief may be granted. Fed.R.Civ.P. 12(b)(6). In ruling on a Rule 12(b)(6) motion, the court accepts as true all well-pleaded facts in the plaintiff's complaint and draws all reasonable inferences from those facts in the plaintiff's favor. Dixon v. Page, 291 F.3d 485, 486 (7th Cir. 2002). To survive a Rule 12(b)(6) motion, the complaint must not only provide the defendant with fair notice of a claim's basis but must also establish that the requested relief is plausible on its face. See Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009); Bell Atl. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). The allegations in the complaint must be "enough to raise a right of relief above the speculative level." Twombly, 550 U.S. at 555. At the same time, the plaintiff need not plead legal theories. Hatmaker v. Mem'l Med. Ctr., 619 F.3d 741, 743 (7th Cir. 2010); Johnson v. City Shelby, 574 U.S. ___, ___ S.Ct. ___, 2014 WL 5798626, at *1 (Nov. 10, 2014) (per curiam) ("Federal pleading rules call for a short and plain statement of the claim showing the pleader is entitled to relief'... they do not countenance dismissal of a complaint for imperfect statement of the legal theory supporting the claim asserted.").
A typical mutual fund is set up by an advisor who selects the fund's directors, manages its investments, and provides other services to the fund for a fee. See Jones v. Harris Assocs., L.P., 559 U.S. 335, 338, 130 S.Ct. 1418, 176 L.Ed.2d 265 (2010). Because of this relationship, "the fund often cannot, as a practical matter, sever its relationship with the adviser.'" Id. (quoting Burks v. Lasker, 441 U.S. 471, 481, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979)). In order to check the potential for abuse inherent in this structure, the ICA requires that investment companies, such as mutual funds, be governed by a board of trustees, at least 40 percent of whom may not be "interested persons" as defined by the ICA. 15 U.S.C. §§ 80a-2(19), 80a-10. The board is tasked with negotiating advisory fees with the investment advisor on behalf of the fund and is required to act in the shareholders' best interest. 15 U.S.C. §§ 80a-15(c), 80a-35(a). As a further protection against abuse, § 36(b) of the ICA imposes a fiduciary duty on investment advisors "with respect to the receipt of compensation for services...." 15 U.S.C. § 80a-35(b). The Securities and Exchange Commission or a fund shareholder may bring an action on behalf of the fund against the advisor for breach of this fiduciary duty with respect to compensation or payments. Id. The plaintiff bears the burden of establishing a breach of fiduciary duty. Id.
"[T]o face liability under § 36(b), an investment adviser must charge a fee that 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, 559 U.S. at 346. To determine if a fee meets this standard, courts look to all relevant factors, including those set forth in Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923 (2d Cir. 1982) and adopted by the Supreme Court in Jones. Id. at 344-46. The Gartenberg factors are, "(1) the nature and quality of the services provided to fund shareholders; (2) the profitability of the fund to the adviser-manager; (3) fall-out benefits; (4) economies of scale; (5) comparative fee structures; and (6) the independence and conscientiousness of the trustees." Am. Chem. & Equip., Inc. 401(k) Retirement Plan v. Principal Mgmt. Corp., No. 4:14-CV-00044, 2014 WL 5426908, at *4 (S.D. Iowa Sept. 10, 2014) (quoting Forsythe v. Sun Life Fin., Inc., 417 F.Supp.2d 100, 114 (D. Mass. 2006)).
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. Am. Chem., 2014 WL 5426908, at *4; see also Reso ex rel. Artisan Int'l Fund v. Artisan Partners Ltd. Partnership, No. 11-CV-873, 2011 WL 5826034, at **5-6 (E.D. Wisc. Nov. 18, 2011); In re Scudder Mut. Funds Fee Litig., No. 04 Civ. 1921, 2007 WL 2325862, at *18 (S.D.N.Y. Aug. 14, 2007) (citing In re Evergreen Mut. Funds Fee Litig., 423 F.Supp.2d 249, 258 (S.D.N.Y. Mar. 24, 2006)); Millenco, L.P. v. MEVC Advisors, Inc., No. CIV. 02-142, 2002 WL 31051604, at *3 (D. Del. Aug. 21, 2002). But "a § 36(b) complaint is not sufficient if it rests solely on general and conclusory legal assertions that the fees charged were excessive." Forsythe, 417 F.Supp.2d at 115. A plaintiff must allege sufficient facts to plausibly support an inference that the advisory fee is so disproportionately large as to bear no reasonable relationship to the services rendered in exchange for the fee. Am. Chem., 2014 WL 5426908, at **4-5 ("At the heart of a 36(b) claim is the relationship between the fees charged to the fund and the services rendered to the fund.") (citations omitted).
I. The Fund's Motion to Dismiss
The Fund argues that the language of § 36(b) precludes an action against the Fund as a nominal defendant. Section 36(b) of the ICA is neither a purely direct nor a purely derivative action: "[W]hile section 36(b) claims are not derivative for the purposes of Rule 23.1 of the Federal Rules of Civil Procedure, which requires pre-suit demand on the board of directors, they are derivative, in the general sense of the word, because they are asserted on behalf of all shareholders and result in no direct benefit to the individual plaintiff shareholders." In re Dreyfus Mut. Fund Fee Litig., 428 F.Supp.2d 357, 359 (W.D. Pa. 2006). Because § 36(b) straddles the line between direct and derivative, courts have looked to the language of the statute to resolve ...