Case Information
*1 Before RILEY, Chief Judge, [*] LOKEN and BENTON, Circuit Judges.
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LOKEN, Circuit Judge.
*2
Section 36(b) of the Investment Company Act (ICA) of 1940, 15 U.S.C. § 80a- 35(b), provides that an action may be brought “by a security holder of [a] registered investment company on behalf of such company, against [its] investment adviser . . . for breach of fiduciary duty in respect of [the] compensation [for services] or payments [of a material nature] paid by [the] registered investment company or by the security holders thereof to [its] investment adviser.” American Chemicals & Equipment 401(K) Retirement Plan (ACE) invested in six LifeTime Funds, which are mutual funds created by Principal Funds Incorporated (PFI). The LifeTime Funds are structured as target-date “funds of funds,” meaning each fund invests in a portfolio of other mutual funds designed to maximize performance for investors targeting a specific retirement date. ACE sued the LifeTime Funds’ investment adviser, Principal Management Corporation (PMC), for breach of its § 36(b) fiduciary duty to the LifeTime Funds, seeking to recover “unfair and excessive” fees. ACE explicitly disclaimed a challenge to the excessiveness of the adviser fees that the LifeTime Funds paid directly to PMC. Instead, ACE based its excessiveness challenge on “all or part of” the adviser fees paid to PMC by the funds in which the LifeTime Funds invest, fees which indirectly reduced the net asset values of the LifeTime Funds. The district court [1] entered judgment in favor of PMC, concluding that ACE lacks statutory standing under § 36(b) to challenge the fees in question. Reviewing this decision de novo , we affirm.
I.
A.
Responding to investment company mismanagement and abuse, Congress
enacted the ICA in 1940 “to impose controls and restrictions on the internal
management of investment companies.” Burks v. Lasker,
To curb perceived abuses,
[2]
including the charging of duplicative fees, the ICA
initially limited mutual funds to buying up to five percent of another mutual fund’s
shares. See 15 U.S.C. § 80a-12(d)(1) (1940). It also authorized the Securities and
Exchange Commission “to bring an action . . . alleging that a person serving or acting
[as an investment adviser] has been guilty . . . of gross misconduct or gross abuse of
trust in respect of any registered investment company.” § 80a-35 (1940). After World
War II, “investment companies enjoyed enormous growth.” Daily Income Fund, Inc.
v. Fox,
The 1970 amendments also extended § 12(d)(1)’s restrictions on funds of funds
investing to unregistered and foreign funds. See § 80a-12(d)(1)(A)-(B). Since 1970,
however, Congress and the SEC have concluded that carefully regulated fund-of-
*4
funds structures offer advantages to small investors. Using its general exemption
authority, § 80a-6(c), the SEC first allowed several large mutual fund complexes to
create “affiliated” funds of funds free from the percentage restrictions in § 12(d)(1).
See, e.g., Vanguard Special Tax-Advantaged Retirement Fund, Inc., Investment
Company Release No. 14361,
Experience persuaded the SEC that the public disclosures of affiliated funds of funds limited the investor’s ability to compare their management costs with other mutual funds by obscuring the indirect costs incurred from investing in other mutual funds. See Fund of Funds Investments, Proposed Rules, 68 Fed. Reg. 58,226, at 58,234 (Oct. 8, 2003). In 2006, the SEC promulgated a rule that requires funds of funds to disclose their “Acquired Fund Fees and Expenses,” or AFFE. The rule, which formed the basis of ACE’s Complaint, was “designed to provide investors with a better understanding of the actual costs of investing in a fund that invests in other funds.” Fund of Funds Investments, Final Rule, 71 Fed. Reg. 36,640, at 36,645 (June 27, 2006) (codified at 17 C.F.R. § 274.11). The AFFE reflects the underlying funds’ total expenses, including management fees, apportioned according to the percentage of shares that the fund of funds holds in the underlying funds and expressed as a percentage of the fund of funds’ total assets. The AFFE discloses indirect costs the fund of funds incurs, including management fees paid by the underlying funds. It does not disclose payments made by the fund of funds.
B. ACE holds shares in six LifeTime Funds, which are affiliated funds of funds that invest in twenty-or-so underlying funds under the § 80a-12(d)(1)(G) exemption. PMC is the investment adviser for both the LifeTime Funds and the *5 underlying funds. Each LifeTime Fund pays PMC a management fee of 3 basis points (0.03% of the LifeTime Funds’ total net assets) for its services to these funds of funds, which PMC pays to an affiliated sub-adviser, Principal Global Investors. PMC also calculates and discloses the AFFE for each LifeTime Fund in accordance with SEC disclosure requirements. In 2013, the AFFE of the six LifeTime Funds at issue ranged from 0.59% to 0.75% of the fund’s total net assets. The management fees that the underlying funds pay directly to PMC for its advice and services to those funds are reflected in the LifeTime Funds’ AFFE, weighted in accordance with the SEC’s disclosure formula.
Count I of ACE’s Complaint alleged that PMC breached its § 36(b) fiduciary
duty by charging fees for advisory services that “are unfair, excessive, and were not
negotiated at arm’s length in light of all the surrounding circumstances.” The
Complaint alleged that ACE “does not challenge” the 3-basis-point management fee
the LifeTime Funds pay directly to PMC. “Instead, [ACE] here challenges and seeks
recovery of part or all of a fee charged to investors in the LifeTime Funds” that PMC
calls the AFFE. As ACE’s Reply Brief described this convoluted claim on appeal,
for purposes of § 36(b) PMC received as “compensation” or “payments of a material
nature” the AFFE’s “revenue portion,” that is, “the proportional share of the overall
management fee that is attributable to PMC’s management of the assets in the
Underlying Fund owned by the LifeTime Funds.” To recover on this claim, ACE has
the burden to prove, based on consideration of all relevant procedural and substantive
factors, that the fee 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.” Jones,
Ruling on PMC’s motion for summary judgment, the district court held that ACE lacked a cause of action under § 36(b). As ACE was not challenging the 3- basis-point management fee the LifeTime Funds pay directly to PMC, and undisputed *6 evidence showed that the AFFE includes “fees charged by advisors to the Underlying Funds” and “does not reveal what shareholders in the LifeTime Funds pay” to PMC, the court concluded that ACE was in fact challenging fees paid by the underlying funds “at a level once removed from [ACE’s] security interest.” ACE admitted that it was not a security holder in the underlying funds, and § 36(b) “only allows security holders to challenge fees paid by the entity in which they have an interest.” Am. Chems. & Equip., Inc. 401(K) Ret. Plan v. Principal Mgmt. Corp., 2016 WL 7155791, (S.D. Iowa Feb 3, 2016).
The district court concluded that ACE lacked “statutory standing” under
§ 36(b) and dismissed the Complaint for lack of subject matter jurisdiction. The
Supreme Court has occasionally referred to “statutory standing” as “effectively
jurisdictional,” but “the absence of a valid (as opposed to arguable) cause of action
does not implicate subject-matter jurisdiction,
i.e.
, the court’s statutory or
constitutional power to adjudicate the case.” Lexmark Int’l, Inc. v. Static Control
Components, Inc., 134 S. Ct. 1377, 1387 n.4 (2014) (quotation and emphasis
omitted). “The question whether a federal statute creates a claim for relief is not
jurisdictional.” Nw. Airlines, Inc. v. Cty. of Kent, Mich.,
II.
A.
On appeal, ACE argues that the plain language of § 36(b) “authorizes
shareholders of a fund of funds to bring an action on behalf of the fund to challenge
excessive acquired fund fees that it pays to the investment adviser.” ACE is
admittedly a “security holder” in the LifeTime Funds, a “registered investment
company.” ACE has sued the LifeTime Funds’ investment adviser, PMC, for breach
of its § 36(b) fiduciary duty, and no party doubts that ACE falls within § 36(b)’s zone
*7
of protected interests. See Lexmark,
ACE has abandoned its claim in the Complaint and to the district court that the AFFE “represents payments made by LifeTime Fund shareholders to [PMC],” a claim the summary judgment record established is factually wrong. The AFFE is not “compensation for services.” It simply estimates the fund of funds’ costs of investing in other funds. Nor is the AFFE a “payment of a material nature” because no entity pays the AFFE. As ACE’s expert explained, the AFFE is “not even an actual fee. It’s a construct.” ACE now argues that a portion of the fees paid by the underlying funds to PMC were “compensation for services” or “payments of a material nature” (the operative words in § 36(b)) that were “paid by” the LifeTime Funds with respect to their investment in the underlying funds. [3] Though worded differently, the argument has the same factual flaw. Section 36(b) limits shareholder suits to breaches of fiduciary duty regarding compensation or payments paid by the mutual fund or its shareholders. Here, the acquired fund fees at issue were paid by the underlying funds, which are separate investment companies, not by the LifeTime Funds in which ACE was a shareholder. As with any enterprise, adviser fees and other costs reflected in the AFFE reduced the net asset value of the underlying fund paying the fees, which in turn reduced the value of the LifeTime Funds’ shareholdings in the underlying fund. But the mere reduction of an asset’s value does not mean that the reduction was paid by the asset’s investors. To take an example from the corporate world, an increase in a subsidiary’s operating expenses adversely affects the value of the parent corporation’s investment, but the increased expense is not paid by the parent corporation or its shareholders.
*8 ACE argues the district court erred in concluding that ACE has no valid claim under § 36(b) because the acquired fund fees at issue were paid only “indirectly” by the LifeTime Funds. ACE asserts, without citation to any authority, that the court’s direct payment requirement “does not exist in the language of the statute itself.” Of course, this assertion is patently wrong -- § 36(b) is expressly limited to claims regarding compensation or payments of a material nature paid by the LifeTime Funds or its shareholders.
ACE argues that the district court’s ruling “would allow excessive fees to be buried at the underlying fund level and render the fees immune from any challenge under § 36(b) where most or all of the underlying funds are held by the funds of funds.” But “parading that horrible” does not apply to this case because the record shows that unaffiliated investors hold varying percentages of the outstanding shares of the underlying funds. Indeed, PMC suggests that, because ACE is not seeking relief on behalf of all underlying funds’ shareholders, the relief ACE seeks as a LifeTime Funds shareholder would be contrary to SEC rules precluding preferential treatment of investors. See 17 C.F.R. § 270.18f-3(a)(1)(ii). In a different case, where the fund of funds in an affiliated fund of funds complex owned all the shares of the underlying funds, the disinterested directors of each fund would still have responsibility to rigorously review management fees, and the SEC would have authority to sue the investment adviser of any fund for breach of the § 36(b) fiduciary duty. In addition, Congress and to a great extent the SEC retain authority, repeatedly exercised in the past, to adjust the rules and exemptions governing fund of funds investment companies to protect individual mutual fund investors.
B. After filing the initial Complaint, ACE filed two substantively identical “anniversary” complaints reflecting the ICA’s one-year statute of limitations. The third case was stayed pending the district court’s summary judgment decision in the first two cases, which had been consolidated. When the district court granted summary judgment in the consolidated case, PMC moved for summary judgment in *9 the third, stayed case. In response, ACE abandoned its prior admission that it is not a shareholder of the underlying funds, a position taken to avoid adverse § 36(b) precedent rejecting the argument. See Curran v. Principal Mgmt. Corp., LLC, 2011 WL 223872 (S.D. Iowa Jan. 24, 2011). ACE now argued that “because the LifeTime Funds and the underlying funds in which they invest are not distinct companies, but are part of a single registered investment company,” it is a “security holder” in the only “registered investment company” that PMC manages, namely PFI, and therefore may assert this § 36(b) claim for PMC’s alleged breach of fiduciary duty.
The district court granted summary judgment in the third case “[f]or the reasons
articulated” in its prior order, without considering this new argument. ACE renews
this belated argument on appeal. Similar to a motion for reconsideration, ACE
introduced this argument only after the district court had granted summary judgment
in the consolidated case, and the district court did not address the new argument.
Accordingly, the issue was not preserved for appeal, see PFS Distrib. Co. v.
Raduechel,
on behalf of a fund in which it lacks an interest. Cf. Santomenno ex rel. John
Hancock Trust v. John Hancock Life Ins. Co.,
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Notes
[*] The Honorable William Jay Riley stepped down as Chief Judge of the United States Court of Appeals for the Eighth Circuit at the close of business on March 10, 2017. He has been succeeded by the Honorable Lavenski R. Smith.
[1] The Honorable John A. Jarvey, Chief Judge of the United States District Court for the Southern District of Iowa.
[2] See generally Sec. & Exch. Comm’n, Investment Trusts and Investment Companies, pt. I, ch. 1, H.R. Doc. No. 76-279 (1939).
[3] In other words, if the LifeTime Funds own twenty-five percent of an underlying fund and that underlying fund earned $100 in compensation for PMC, then PMC received $25 in compensation for managing the LifeTime Fund.