Skip to Search
Skip to Main Content
Main Content


News & Publications


Godfrey & Kahn Updates


Press Room


Investment Management - Legal and Regulatory Update

October 16, 2009

Excessive Fee Legal Developments

Jones v. Harris Update
Oral arguments before the U.S. Supreme Court are scheduled for November 2, 2009 in the Jones v. Harris excessive advisory fee case. In the Jones case, the Seventh Circuit rejected the long-standing "reasonableness" standard for determining excessive fees under Section 36(b) of the Investment Company Act. This "reasonableness" standard was established by the Second Circuit in Gartenberg v. Merrill Lynch Asset Management, Inc. (1982).

Under Gartenberg, to be guilty of a violation of Section 36(b), an 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. In applying this standard, a court will consider the fairness of the advisory fee and the process used by directors in approving the advisory agreement. The court in Jones, however, rejected the Gartenberg standard, concluding that Section 36(b) does not impose a "reasonableness" standard on advisory fees. Instead, the court concluded that Section 36(b) imposes a common law fiduciary duty on advisers with respect to the receipt of advisory fees. Therefore, the role of the courts when faced with a claim under Section 36(b) is to determine whether the adviser properly discharged its fiduciary duties by "mak[ing] full disclosure" and "play[ing] no tricks."

The Supreme Court's decision to grant certiorari in the Jones case was likely made to resolve the split between the Second Circuit's standard established in Gartenberg and the Seventh Circuit's approach in Jones. The Supreme Court's decision could change the standard by which excessive fee cases are reviewed. Numerous amicus curiae briefs have been filed in the Jones case, including a brief filed by the Investment Company Institute (ICI) in favor of the Gartenberg standard.

Until the Supreme Court's decision is published, we recommend that boards continue to review advisory contracts using a robust Section 15(c) process that evaluates, among other items, the factors set forth in Gartenberg and to document this process in the required shareholder report disclosures..

Source: Jones, et. al. v. Harris Associates L.P., 537 F. 3d 788 (7th Cir. 2008), appeal docketed, No. 07-1624 (U.S. November 3, 2008)

American Funds Trial Update
A shareholder suit against American Funds, the adviser, Capital Research and Management Company, and the principal underwriter, American Funds Distributors, Inc., went to trial in July. The suit alleged that the defendants breached their fiduciary duties under Section 36(b) of the Investment Company Act in connection with excessive advisory fees, Rule 12b-1 fees and servicing fees charged to eight funds from 2004 to 2007. The plaintiffs argued that these excessive fees violated the "reasonableness" standard established in Gartenberg. In the court's statement of intended decision published on September 16, 2009, which sets forth the intended resolution of the case, the court indicated that the plaintiffs did not proffer sufficient evidence to establish that the fees at issue could not have been the product of arm's length bargaining.

Source: In re American Funds Fee Litigation, Statement of Intended Decision, CV 04-05598, U.S. District Court, Central District of California (September 16, 2009)

Portfolio Reporting Rule for Money Market Funds
The SEC has adopted temporary Rule 30b1-6T under the Investment Company Act to require money market funds to report weekly portfolio holdings and valuation information to the SEC under certain circumstances. The required information is substantially similar to the information formerly required for money market funds participating in the Treasury Department's Temporary Guarantee Program, which expired on September 18, 2009. Only a money market fund with a market-based NAV below $.9975 is required to report under the temporary rule, and it must continue to report its portfolio schedule as of the last business day of the week until its market-based NAV at the end of the week is $.9975 or greater. Information provided to the SEC under Rule 30b1-6T will be confidential and non-public, to the extent permitted by law.|

The SEC has noted that this temporary rule was adopted because of the importance of money market fund portfolio information. The SEC is considering a permanent reporting regime for money market fund portfolio information as part of the money market fund reform proposing release published in June 2009.

Source: SEC Interim Final Temporary Rule, Release No. IC-28903 (available September 18, 2009)
Effective Date: September 18, 2009 through September 17, 2010
Money Market Fund Reform: SEC Proposed Rule, Release No. IC-28807 (available June 30, 2009)
Effective Date: TBD
Comment period ended September 8, 2009

Board Oversight of Fund Compliance
The Independent Directors Council (IDC) recently published a comprehensive task force report addressing board oversight of fund compliance. The IDC created a task force to explore how funds have developed and implemented their compliance programs, including considerations relating to the role of the CCO. The report highlights the task force's findings in the following areas: (i) compliance program goals; (ii) the role of the CCO; (iii) the role of fund management in compliance; (iv) fund board practices with respect to the evaluation of a fund's compliance program and its CCO; and (v) defining a strong compliance program.

The report discusses the pros and cons of an individual serving as both the fund and adviser's CCO or only as the fund CCO. It reviews ways in which the board can review the effectiveness of the CCO, including the reporting relationship, and considerations with respect to CCO compensation. The report notes that despite the variation in industry practices, successful programs have certain characteristics, such as a strong "tone at the top," a collaborative CCO, risk-based compliance, transparency and appropriate resources.

Source: The task force report is available through the ICI's website at (available September 9, 2009).

DOL Bulletin Regarding Delivery of Summary Prospectus
The U.S. Department of Labor (DOL) has issued a field assistance bulletin confirming that the delivery of a summary prospectus by a plan fiduciary or designee to plan participants and beneficiaries satisfies the prospectus delivery requirements of the ERISA § 404(c) regulations. These regulations require, among other things, that a plan participant or beneficiary be provided, or have the opportunity to obtain, sufficient information to make informed decisions with regard to investment alternatives available under the plan. When those investment alternatives involve a mutual fund, the regulations require the plan fiduciary or designee to furnish a copy of the fund's most recent prospectus. Delivery of a summary prospectus to plan participants and beneficiaries, both automatically and upon request, will satisfy the ERISA prospectus delivery requirements under Section 404(c), which limits liability to plan fiduciaries for participant-directed plans. This DOL guidance only applies to defined contribution plans covered under Title I of ERISA.

Source: Robert J. Doyle, Delivery of a Summary Prospectus in an ERISA §404(c) Plan, U.S. Department of Labor, Field Assistance Bulletin 2009-003 (September 8, 2009)

Proposed Rules to Curtail "Pay to Play" Practices
The SEC has proposed rules to curtail potential "pay to play" practices by advisers seeking to manage money for state and local government clients (e.g., public pension plans, 529 plans and 403(b) plans) by prohibiting advisers from making contributions to government officials who are in a position to influence the award of advisory business.

The proposed rule would make it unlawful for an adviser to receive compensation for providing advisory services to a government entity for a two-year period after the adviser or any of its covered associates makes a political contribution to an official of the government entity. "Covered associates" of an adviser include any general partner, managing member, executive officer, employee who solicits a government entity and any political action committee (PAC) controlled by the adviser or any of the above persons. A de minimis exception is included in the proposed rule for contributions totaling $250 or less to any one candidate, per election, made by a covered associate to an official for whom the covered associate was entitled to vote at the time of the contribution.

The proposed rule would also prohibit advisers, subject to certain exceptions, from paying a third party, such as a solicitor, finder or pension consultant, to solicit a government entity for advisory services on behalf of the adviser. In addition, the proposed rule would prohibit an adviser and its covered associates from coordinating, or soliciting any person or PAC to make, any contribution to an official of a government entity to which the adviser is providing or seeking to provide advisory services or any payment to a political party of a state or locality where the adviser is providing or seeking to provide advisory services to a government entity. Finally, an adviser and its covered associates would be prohibited from indirect violations of the rule (e.g., facilitating contributions through third parties).

An adviser to a covered investment pool in which a government entity invests or is solicited to invest (which includes mutual funds, hedge funds and other collective investment pools) will be treated as though the adviser were providing or seeking to provide advisory services to the government entity and will be subject to the prohibitions set forth in the proposed rule.

The ICI has submitted a comment letter to the SEC recommending that the applicability of the proposed rules to registered investment companies be reconsidered. However, if the SEC determines to adopt the rules as proposed, the ICI has recommended significant changes to the proposed rules to alleviate certain of the costs and burdens it perceives the proposed rules will place on registered investment companies.

Sources: SEC Proposed Rule, Release No. IA-2910 (available August 3, 2009); Comment Letter Submitted by Karrie McMillan, Investment Company Institute (October 6, 2009)
Compliance Date: TBD
Comments due by October 6, 2009

Proposed Amendments to Enhance Compensation and Corporate Governance Disclosure
The SEC has proposed amendments to enhance the compensation and corporate governance disclosures of public companies, including investment companies, in proxy and information statements and registration statements. The SEC's proposal has two categories of amendments specifically relating investment company disclosures: (1) enhanced director and nominee disclosure and (2) new disclosure about the structure of fund boards and the board's role in the risk management process.

With respect to the first category, the proposed amendments would amend disclosures in fund proxy statements and information statements where action is to be taken with respect to the election of directors. Funds would also be required to include expanded disclosures in their SAIs. Specifically, the proposed amendments would require disclosure detailing for each director and nominee the particular experience, qualifications, attributes or skills that qualify that person to serve as a director of the fund and as a member of any board committee. In addition, the proposed amendments require disclosure of any directorships held by each director and nominee at any time during the past five years at public companies, as well as lengthening the time during which disclosure of relevant legal proceedings is required from five to ten years. In its comment letter submitted to the SEC, the IDC objected to the proposed disclosure requirements that are subjective in nature, specifically disclosure describing the "qualifications," "attributes" or "skills" of the director or nominee.

With respect to the second category, the proposed amendments would amend disclosures in fund proxy and information statements and fund SAIs regarding the structure of fund boards, specifically providing disclosure of whether the board chair is an "interested person" of the fund, as that term is defined in the Investment Company Act, and if the board chair is an interested person, disclosing whether the fund has a lead independent director and what specific role the lead independent director plays in the leadership of the fund. In addition, the proposed amendments require disclosure about the board's role in the fund's risk management process. In separate comment letters submitted to the SEC, both the ICI and the IDC objected to the proposed disclosure requirement relating to the role of the board in the risk management process based on the argument that the proposal improperly implies that fund boards should have a hands-on role in a fund's day-to-day risk management function.

Sources: SEC Proposed Rule, Release Nos. 33-9052, 34-60280 and IC-28817 (available July 10, 2009); Comment Letter Submitted by Amy B.R. Lancelotta, Independent Directors Council (September 15, 2009); Comment Letter Submitted by Karrie McMillan, Investment Company Institute (September 15, 2009)
Compliance Date: TBD
Comment period ended September 15, 2009

Proposed Proxy Rule Amendments to Facilitate Shareholder Director Nominations
The SEC is proposing changes to the federal proxy rules that would facilitate shareholders' ability to nominate and elect directors. The SEC has proposed a new rule (Rule 14a-11) under the Exchange Act that would require companies, including investment companies, to include disclosures about shareholder nominees for directors in a company's proxy materials, under certain circumstances, so long as the shareholders meet certain eligibility requirements. Proposed Rule 14a-11 would not be available if state law or a company's governing documents prohibited shareholders from nominating directors.

Under proposed Rule 14a-11, eligible shareholders may propose up to 25% of a company's board, or one nominee, whichever is greater. The nominating shareholder must provide and file with the SEC a notice on new Schedule 14N to the company of the shareholder's intent to require the company to include the shareholder's proxy materials. The notice must meet certain disclosure requirements. Shareholder eligibility would be based on a minimum ownership threshold, which would be tiered according to company size. An investment company would not be able to exclude a shareholder nominee if, as of the date of the notice, the shareholder has beneficially owned for at least one continuous year: (i) at least 1% of the company's voting securities for registered investment companies with net assets of $700 million or more; (ii) at least 3% of the company's voting securities for registered investment companies with net assets of $75 million or more, but less than $700 million; and (iii) at least 5% of the company's voting securities for registered investment companies with net assets of less than $75 million. Shareholders may aggregate their holdings to meet these ownership thresholds.

In its rule proposal, the SEC has also included amendments to Rule 14a-8(i)(8) under the Exchange Act that would require companies, including investment companies, to include in their proxy materials, under certain circumstances, shareholder proposals that would amend, or that seek to amend, a company's governing documents regarding nomination procedures or disclosures related to shareholder nominations. To be eligible, a shareholder must have held at least $2,000 in market value or 1% of the company's outstanding shares for at least one year prior to submitting a proposal.

In its comment letter submitted to the SEC, the ICI recommends that the SEC's proposal exclude investment companies for a variety of reasons, including that the proposal does not account for the significant differences in governance models between public operating companies and investment companies. The ICI voiced strong opposition to the proposal to create a federally mandated right and process for shareholders to nominate directors on a company's proxy statement under proposed Rule 14a-11. The ICI comment letter generally supports the proposed amendments to Rule 14a-8, but recommends revisions to certain shareholder eligibility and disclosure requirements.

The SEC has stated that it will not vote on a final rule proposal until after January 1, 2010.

Sources: SEC Proposed Rule, Release Nos. 33-9046, 34-60089 and IC-28765 (available June 10, 2009); Comment Letter Submitted by Paul Schott Stevens, Investment Company Institute (August 17, 2009)
Compliance Date: TBD
Comment period ended August 17, 2009

Proposed Amendments to the Investment Adviser Custody Rule
The SEC has proposed amendments to the investment adviser custody rule, Rule 206(4)-2 under the Investment Advisers Act, with the stated intention of improving protection for advisory clients and clarifying the current rule. The proposed amendments would require all registered advisers with custody of client assets to engage an independent public accountant to conduct an annual surprise examination regardless of whether a qualified custodian provides statements directly to clients. The independent public accountant performing the surprise examination would verify all client funds and securities for which an adviser has custody, including those funds and securities that are not maintained by a qualified custodian, such as certain privately offered securities and mutual fund shares. No exemption has been proposed for advisers that have custody of client assets only by virtue of their ability to deduct fees from the custodian.

Advisers would be required to enter into a written agreement with the independent public accountant conducting the surprise examination to ensure certain reporting requirements are fulfilled. In particular, the independent public accountant must submit a Form ADV-E accompanied by a certificate to the SEC within 120 days of the time chosen for the surprise examination stating the nature and extent of the examination.

The definition of "custody" would be expanded to provide that an adviser has custody of client securities or funds that are directly or indirectly held by a "related person" in connection with advisory services provided to its clients. A "related person" is any person controlling or controlled by the adviser or under common control with the adviser.

Advisers that do not use an independent qualified custodian (i.e., the adviser or a related person serves as a qualified custodian for client securities and funds) would be required to obtain an internal control report (Type II SAS 70 Report) from an independent public accountant registered with the PCAOB at least once a year and would be required to have their surprise examination by an independent public accountant registered with the PCAOB.

Source: SEC Proposed Rule, Release No. IA-2876 (available May 20, 2009)
Compliance Date: TBD
Comment period ended July 28, 2009

Identity Theft Prevention Programs - Implementation of the Red Flags Rule
The Federal Trade Commission (FTC) and other regulatory agencies have adopted regulations, known as the "red flag rules," as part of the Fair and Accurate Credit Transactions Act of 2003. The red flag rules are applicable to financial institutions, including investment companies, that offer "transaction accounts," which are accounts that permit the account holder to make payments or transfers to third parties through check writing, wire transfers or other similar means. The red flag rules require financial institutions to establish an identity theft prevention program designed to detect, prevent and mitigate identity theft in connection with the opening of a covered account or an existing covered account. "Covered accounts" include accounts maintained primarily for personal, family or household purposes that involve or are designed to permit multiple payments or transactions, and any other accounts that pose a reasonably foreseeable risk to shareholders or to the safety and soundness of the investment company from identity theft.

The identity theft prevention program must include reasonable policies and procedures to identify relevant red flags and incorporate them into the program, detect red flags, respond appropriately to any red flags that are detected, and ensure the program is updated periodically. The identity theft prevention program may be combined with an AML/CIP program.

The rule requires financial institutions to obtain approval of the initial identity theft prevention program from the board of directors or a committee of the board. The board, a board committee or a designated employee must also be involved in the oversight, development, implementation and administration of the program, including training staff and review of annual compliance reports.

Because most investment companies engage a transfer agent to process new customer applications, open new accounts and maintain customer accounts, an investment company that holds transaction accounts should review its transfer agent agreement to see if the agreement needs to be amended to require the transfer agent to have policies and procedures to detect relevant red flags and either report the red flags to the investment company or take appropriate steps to prevent or mitigate identity theft. An investment company should also request a copy of the transfer agent's identity theft prevention program.

After multiple compliance date extensions by the FTC, financial institutions will be required to comply with the red flag rules on November 1, 2009.

Source: Identity Theft Red Flags and Address Discrepancies under the Fair and Accurate Credit Transactions Act of 2003, Final Rule, 72 Fed. Reg. 63718 (November 9, 2007)
Compliance Date: November 1, 2009

Privacy Law Developments

Massachusetts Standards for the Protection of Personal Information

The Massachusetts Office of Consumer Affairs & Business Regulation has issued regulations imposing standards that require any person, including an investment company or investment adviser, who receives, maintains, processes or otherwise has access to "personal information" about Massachusetts residents to develop a comprehensive, written information security program. "Personal information" is defined to include a Massachusetts resident's first name and last name or first initial and last name in combination with any one or more of the following: (i) social security number; (ii) driver's license number or state-issued identification number; or (iii) financial account number. The standards provide that the safeguards for protection of personal information contained in the program must be consistent with the safeguards for protection of personal information set forth in any state or federal regulations by which the person who receives, maintains, processes or otherwise has access to such information may be regulated. The standards also provide that a person must take reasonable steps to select and retain third party service providers that are capable of maintaining appropriate security measures to protect such personal information consistent with the Massachusetts regulations and any applicable federal regulations. The data encryption requirements set forth in the standards are to be implemented only to the extent technically feasible.

Since being issued last fall, the regulations have been significantly revised in response to strong industry opposition, particularly by the ICI. The ICI has noted that the standards now imposed by the Massachusetts regulations resemble, for the most part, the proposed amendments to Regulation S-P that require investment companies and investment advisers to develop, implement and maintain comprehensive information security programs. A hearing, in which the ICI participated, on the proposed revisions to the standards was held on September 22, 2009.

The compliance date is March 1, 2010.

Sources: 201 CMR 17.00: Standards for the Protection of Personal Information of Residents of the Commonwealth; Frequently Asked Questions Regarding 201 CMR 17.00 (available at; ICI Memorandum No. 23720 (August 17, 2009) (available at
Compliance Date: March 1, 2010
Regulation S-P Amendments: SEC Proposed Rule, Release Nos. 34-57427 and IC-28178 (available March 4, 2008)
Compliance Date: TBD
Comment Period Ended May 12, 2008

Regulation S-AM: Limitations on Affiliate Marketing
The SEC has adopted Regulation S-AM under the Fair Credit Reporting Act and the Fair and Accurate Credit Transactions Act of 2003, which required the SEC and other federal agencies to adopt rules implementing limitations on a person's use of certain information received from an affiliate to solicit a consumer for marketing purposes, unless the consumer has been given notice and a reasonable opportunity and a reasonable and simple method to opt out of such solicitations.

Regulation S-AM allows a consumer, in certain situations, to block affiliates of a covered firm from soliciting the consumer based on certain eligibility information (e.g., financial information) received from the person. Persons subject to Regulation S-AM include brokers, dealers, investment companies, investment advisers, transfer agents and municipal securities dealers registered with the SEC. Regulation S-AM does not prohibit the sharing of information with another entity. However, Regulation S-AM does prohibit a person from using eligibility information received from an affiliate to make marketing solicitations to consumers unless certain criteria are met.

Notice and opt out provisions can be combined with other required disclosures, such as initial or annual privacy notices required by Regulation S-P. In addition, Regulation S-AM has a number of exceptions to the notice and opt out requirements (e.g., when an affiliate making a marketing solicitation has a previous business relationship with the consumer or provides marketing materials in response to a communication initiated by the consumer).

The ICI has requested the compliance date be delayed until June 1, 2010, to permit a more orderly implementation of the regulation.

Source: SEC Final Rule, Release Nos. 34-60423, IC-28842 and IA-2911 (available August 4, 2009)
Effective Date: September 10, 2009
Compliance Date: January 1, 2010

Media Contact 

If you have a media request or need an attorney with particular knowledge for comment, please contact Kyle Mondy, Marketing & Communications Manager, at 414.287.9481 or


Subscribe today to receive firm newsletters and blogs, client updates, seminar announcements, and more according to your preferences and areas of interest.

Recent News

Please wait while we gather your results.

Recent Updates

Please wait while we gather your results.

Disclaimer and Legal Notices

Copyright © 2019 Godfrey & Kahn, S.C.

Attorneys at Law - All rights reserved.


Client Login