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(Article from Registered Funds Alert, February 2015)

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The mutual fund industry has seen a recent spate of claims that investment advisers charged excessive fees by virtue of delegating substantially all of their duties to sub-advisers while retaining much of the advisory fees. Plaintiffs in Curd v. SEI Investments Management Corporation recently filed an amended complaint which, in addition to the sub-adviser delegation claim, also includes a novel allegation in the context of excessive fee litigation. The amended complaint alleges that SEI violated the fiduciary duties inherent in Rule 12d1-1[1] of the 1940 Act by investing fund assets in affiliated money market funds and not waiving or reimbursing the fees charged by the money market funds, resulting in “double-charging” of fees.

Accordingly, the complaint alleges that the board violated Section 36(b) of the 1940 Act by failing to conduct a conscientious review of the double-charged fees. Fund managers investing fund assets in money market funds (particularly affiliated money market funds) without waiving or reimbursing the fees charged by such money market funds should consider the potential risk of a similar shareholder derivative claim. In particular, boards should consider whether the fees charged at the investing fund level are for services that are in addition to, rather than duplicative of, services provided to the underlying funds. In addition, boards may wish to consider including disclosure regarding such review in publicly filed documents (such as shareholder reports describing the board considerations in connection with the annual contract renewal process), so that the consideration is available as an argument in a summary judgment motion rather than only available in proceedings that occur after discovery has commenced (which would be the case if, for example, the board’s considerations were only described in the minutes of a board meeting).

[1] While Rule 12d1-1 does not explicitly require such fees to be reimbursed or waived, plaintiffs rely on language in the Rule’s proposing release that states: “to the extent advisory services are being performed by another person, such as the adviser to an acquired money market fund, [the Section 36(b)] fiduciary duty would require an acquiring fund’s adviser to reduce its fee by the amount that represents compensation for the services performed by the other person.” However, the Rule’s adopting release also states: “A fund could pay duplicative fees if an adviser invests a fund’s cash in a money market fund (which itself pays an advisory fee) without reducing its advisory fee by an amount it was compensated to manage the cash. Fund directors have fiduciary duties, which obligate them to protect funds from being overcharged for services provided to the fund, regardless of any special findings we might require.”