NEW YORK, February 18, 2009 – Last week Milbank scored another victory for our client Capital Research and Management Company (“CRMC”) by obtaining the dismissal of a major securities action brought against CRMC and its wholly owned subsidiary American Funds Distributors (“AFD”). CRMC is the investment adviser to the American Funds family of funds, which is currently the second largest mutual fund family in the world. AFD is the distributor for these funds.
Plaintiff, a shareholder in the $100 billion EuroPacific Growth Fund (the “Fund” or “EUPAC”), brought the action in the United States District Court for the Central District of California challenging the Fund’s payment of post-sale Rule 12b-1 fees to broker dealers for servicing Fund shareholders. Judge Feess held oral argument on CRMC’s motion to dismiss on February 2nd, and last Wednesday issued his opinion dismissing the action. See Korland v. Capital Research and Management Co. et al., No. 08-cv-04020-GAF (RNBx).
Plaintiff claimed that the Rule 12b-1 fees paid by the EUPAC fund were improper and therefore per se excessive in violation of Sections 36(b) and 48(a) of the Investment Company Act of 1940 (“ICA”). Rule 12b-1, enacted by the SEC in 1980, provides a mechanism by which a mutual fund may use its assets to pay for activities primarily intended to result in the sale of fund shares. In response to this Rule, EUPAC, like many mutual funds, enacted a “Rule 12b-1 plan” which allowed the fund to use fund fees to pay for distribution, as well as for activities relating to post-sale shareholder services. Plaintiff alleged that this latter use – payments to broker-dealers for ongoing service advice rendered by individual financial consultants – was an activity which did not “result in the sale of fund shares” and was therefore per se illegal.
Milbank moved to dismiss the complaint, arguing that there is no such thing as a per se violation of Section 36(b) and that Plaintiff failed to state a claim under the six-factor Gartenberg test which governs mutual fund excessive fee actions. The complaint raised an issue which was very important for the entire mutual fund industry, and our motion papers highlighted for Judge Feess the 28-year history of Rule 12b-1, and the fact that the SEC had recognized that post-sale shareholder services encourages Fund shareholders to purchase new or additional fund shares.
In his written opinion, Judge Feess held that under applicable case law, it was insufficient under Section 36(b) for Plaintiff to plead that an expenditure under Rule 12b-1 was “per se” unlawful or unauthorized; “more must be alleged.” Judge Feess went on to state that the mere allegation “that fees are used for an improper purpose” is also not sufficient to state a Section 36(b) claim. Judge Feess explained that if Plaintiff chooses to replead, Plaintiff must plead detailed Gartenberg-style allegations. Lastly, Judge Feess held that there is no private right of action for controlling person liability under Section 48(a) of the ICA, and dismissed that claim with prejudice.
The Milbank litigation team consisted of partners James Benedict and Sean M. Murphy; associates C. Neil Gray, L. Anthony Pellegrino, Eric Fishman, Will Gross, Rachel Penski, Krista Smokowski, and Michael Weiner; case manager Jennifer Russo; and paralegal William Ziegelbauer.