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From Securities Regulation Daily, October 29, 2015

Adviser delegated responsibilities to subadvisors, but kept too much profit

By Rodney F. Tonkovic, J.D.

A complaint adequately alleged that an advisory fee was excessive. According to the district court's unpublished opinion, while certain factors weighed in favor of the advisor, the nature and quality of services provided, the profitability to the adviser of managing the funds, and economies of scale weighed in favor of the plaintiffs (Redus-Tarchis v. New York Life Investment Management LLC, October 28, 2015, Walls, W.).

Background. The plaintiffs brought this action for breach of fiduciary duty under the Advisers Act on behalf of four mutual funds against their adviser, New York Life Investment Management LLC. NYLIM subcontracted with investment subadvisers that performed essentially all of the advisory services required by the funds and paid another subcontractor to provide administrative services. In 2014, NYLIM charged the funds $427,242,000 in management fees, of which it retained a "mark-up" of approximately $200,650,000 after the payment of subadvisory and administrative fees.

The complaint alleged that NYLIM’s management fees were disproportionate to the services actually rendered to the funds, pointing to the large “mark-up” between the fees NYLIM charged to the funds and the subcontractor fees. Also, since the funds' performance in 2014 was poor, the investors argued that the mark-up was disproportionate to the low quality of the investment management services NYLIM provided. The complaint also asserted that NYLIM did not share economies of scale with the funds and that the funds' board did not negotiate the management fees charged by NYLIM in an arms-length transaction.

The Gartenberg factors. The court analyzed the complaint using the Second Circuit's Gartenberg factors and found that two factors weighed in favor of NYLIM, but three weighed in favor of the investors. The court first addressed the allegation that NYLIM delegated "substantially all" of its duties to subadvisers, while retaining nearly half of the charged fees. While NYLIM maintained that the subadvisory agreements required it to retain substantial responsibility, the court considered this to be a merits argument more appropriate at the summary judgment stage. The issue of the nature and quality of NYLIM's services accordingly weighed in favor of the plaintiffs. The court similarly determined that NYLIM's services did not justify its fees.

The court then found that the economies of scale weighed in favor of the investors. According to the court, the complaint made specific allegations that NYLIM's costs did not grow at the same rate as the funds' assets under management, leading to a larger profit. This was sufficient to withstand a motion to dismiss.

Finally, the court gave considerable weight to the fact that the independent board approved NYLIM's management fees. The plaintiffs maintained that the board members, who only served part-time, failed to devote the time and attention necessary to independently assess the fees. The court disagreed, stating that directors may serve on other boards, or keep other employment, without compromising their independence. Additionally, while the board received information about compensation and subadviser contracts directly from NYLIM , it also engaged third parties to provide further information. Also, since the complaint made no allegations regarding fall-out benefits, which are collateral benefits accruing to the adviser due to its relationship with a fund, this factor favored NYLIM.

In conclusion, the court denied NYLIM's motion to dismiss the complaint. According to the court, taking the complaint as a whole, the investors adequately alleged a combination of facts that supported an inference that the adviser's fees, given all of the surrounding facts and circumstances, were disproportionately large to the services rendered.

The case is No. 14-7991.

Attorneys: Arnold Carl Lakind (Szaferman, Lakind, Blumstein & Blader, P.C.) for Cynthia Ann Redus-Tarchis. Liza M. Walsh (Connell Foley LLP) for New York Life Investment Management, LLC.

Companies: Cynthia Ann Redus-Tarchis; New York Life Investment Management, LLC

MainStory: TopStory InvestmentAdvisers NewJerseyNews

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