Defendants Win Leveraged Advisory Fees Case

Preferred Stock Proceeds Used in Calculation of Advisory Fees Not Fraud

By John M. Baker, Esq.

Federal Judge Debevoise of the District of New Jersey recently granted summary judgment to defendants in a case alleging that including preferred stock proceeds in the calculation of mutual fund advisory fees violates the defendants’ fiduciary duty under section 36 (b) of the Investment Company Act of 1940. Green v. Fund Asset Management, C.A. No. 97-3502 (DRD) (D.N.J. June 5, 2001).

The defendants leveraged the mutual funds by selling low-interest preferred stock, investing the proceeds in higher-interest municipal bonds. The advisory fees were based on net assets, that is, total assets less liabilities. Because the sale of preferred stock increases assets but does not increase liabilities, the leveraging technique increased advisory fees.

The plaintiff shareholders did not allege that the advisors’ compensation was excessive. Instead, plaintiffs alleged that taking into account the muni bonds purchased with the proceeds from sale of preferred stock in determining advisory fees creates an actual conflict of interest between the advisers and the funds; that the advisers’ supposed failure adequately to have disclosed this conflict to the funds or their common shareholders amounts to an actionable breach of fiduciary duty; and that the conflict itself is per se an actionable breach of fiduciary duty.

The court held that the fee calculation was adequately disclosed and that Congress did not intend unavoidable conflicts of interest to be per se breaches of fiduciary duty. The court also ruled that salary payments to defendant officers are insufficient to subject them to liability under section 36(b).

On a previous appeal of this case, the U.S. Court of Appeals for the Third Circuit ruled that section 36(b) of the 1940 Act does not preempt state law claims. However, because the plaintiffs’ only remaining claims are under state law, the district court dismissed the case for lack of federal jurisdiction. The court noted that plaintiffs may wish to file a new complaint alleging breach of fiduciary duty and deceit in a Maryland state court.

The court’s opinion is available online at

Copyright 2001, John M. Baker, Esq., Stradley, Ronon, Stevens & Young, LLP, 1220 19th Street, N.W., Suite 700, Washington, DC 20036 – (202) 822-9611- Fax (202) 822-0140 This article was originally posted to the FundLaw List, To subscribe to FundLaw, send a blank e-mail to

Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article.



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