Sivolella v. AXA Equitable Life Ins. Co., Civil Action No.: 11-cv-4194 (PGS)(DEA)

• Decision Date: 25 August 2016
• Docket Number: Civil Action No.: 11-cv-4194 (PGS)(DEA)
• Parties: MARY ANN SIVOLELLA, GLENN D. SANFORD, BRIAN A. SANCHEZ, et al. Plaintiffs, v. AXA EQUITABLE LIFE INSURANCE COMPANY, et al. Defendants. GLENN D. SANFORD, et al. Plaintiffs, v. AXA EQUITABLE LIFE INSURANCE COMPANY, et al. Defendants.
• Court: U.S. District Court — District of New Jersey

MARY ANN SIVOLELLA, GLENN D. SANFORD, BRIAN A. SANCHEZ, et al. Plaintiffs,
v.
AXA EQUITABLE LIFE INSURANCE COMPANY, et al. Defendants.

GLENN D. SANFORD, et al. Plaintiffs,
v.
AXA EQUITABLE LIFE INSURANCE COMPANY, et al. Defendants.

Civil Action No.: 11-cv-4194 (PGS)(DEA)

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY

August 25, 2016

OPINION

This case arises under § 36(b) of the Investment Company Act of 1940, 15 U.S.C. § 8a-35(b) ("ICA" or "36(b)"). Plaintiffs bring this consolidated, derivative¹ action on behalf of mutual fund investors who are contract holders to variable annuity products with Defendants AXA Equitable Insurance Company ("AXA") and AXA Equitable Funds Management Group, LLC ("FMG").

The Court conducted a 25-day, non-jury trial beginning on January 6, 2016 and

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concluding on February 25, 2016. Findings of Fact and Conclusions of Law were thereafter submitted. ECF Nos. 247, 248, 275, 276, 279, 290, 283, 284, 285. Closing arguments were heard on June 1, 2016.

Plaintiffs allege that the Board of Trustees (the "Board") for the EQ Advisors Trust ("EQAT" or the "Fund"), a mutual fund complex, breached its fiduciary duty by approving service contracts that charged excessive management and administrative fees. The thrust of the trial focused on Plaintiffs' claim that FMG charged investors exorbitant fees for mutual fund investment and administrative duties, and then delegated those same duties to sub-advisers and sub-administrators for nominal fees. Plaintiffs allege: (a) FMG's fees were so disproportionally high when compared to the fees of sub-advisers and sub-administrators, and therefore some, if not all, of FMG's fees should be reimbursed to the mutual fund rather than enriching FMG; (b) the allegedly independent Board breached its fiduciary duty by authorizing such disproportionate fees; and (c) FMG manipulated the Board meeting materials and duped the Board by providing misleading and unreliable materials in the fee approval process. In sum, Plaintiffs contend that FMG's compensation under the investment management and administrative agreements "could not have been the product of arm's-length bargaining." ECF No. 276, Plaintiffs' Response to Defendants' Proposed Findings of Fact ("PRDFOF"), ¶ 3.

Pursuant to FED. R. CIV. P. 52(a), and after careful consideration of the entire record in this case and the applicable law, the Court concludes that Plaintiffs have failed to meet their burden to demonstrate that Defendants breached their fiduciary duty in violation of § 36(b) of the ICA or have shown any actual damages. At odds with that conclusion is that the filing of the lawsuit, as opposed to the substance of the proofs, has been the impetus to improve the quality of

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the Board's decision-making, facilitating enhancements to the Board materials and changes in the Board's composition.

Legal Standard

A. Statutory Cause of Action

By way of background, Congress enacted the ICA because it understood that mutual fund products were different from stock of an individual company. Generally, "[a] mutual fund is a pool of assets, consisting primarily of [a] portfolio [of] securities, and belonging to the individual investors holding shares in the fund." Burks v. Lasker, 441 U.S. 471, 480, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979) (citing Tennenbaum v. Zeller, 552 F.2d 402, 405 (2d Cir. 1977)). A mutual fund is often created by an investment adviser who selects the fund's board of trustees, manages its investments, provides administrative services and markets the funds in exchange for fees paid out of the assets of the fund. Jones v. Harris, L.P., 559 U.S. 335, 338, 130 S.Ct. 1418, 176 L.Ed.2d 265 (2010); see also Burks, 441 U.S. at 480, 99 S.Ct. at 1838.

Obviously, the investment adviser has superior control over the Board of Trustees than the individual investors do, like the Plaintiffs in this case, a teacher (Sivolella) and a police officer (Sanchez). As such, "the forces of arm's length bargaining do not work in the mutual fund industry in the same manner as they do in other sectors of the American economy." Jones, 559 U.S. at 338, 130 S.Ct. at 1422 (internal citation omitted). As a result, the relationship between a fund and its investment adviser is considered to be "fraught with potential conflicts of interest . . ." Id. at 339 (citing Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 536-38, 104 S.Ct. 831, 78 L.Ed.2d 645 (1984)).

Congress adopted the ICA "because of its concern with the potential for abuse inherent in the structure of investment companies." Jones, 559 U.S. at 339. Hence, the Act declared its purpose:

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to mitigate and, so far as is feasible, to eliminate the conditions enumerated in this section which adversely affect the national public interest and the interest of investors.

15 U.S.C. §80a-1. When initially enacted, the ICA imposed a "scheme that regulates most transactions between investment companies and their advisers." Daily Income Fund, 464 U.S. at 536 (citing 15 U.S.C. §80a-17). It limited the number of persons affiliated with the adviser who may serve on the mutual fund's board of directors (15 U.S.C. § 80a-10), and required that fees for investment advice and other services be governed by a written contract that the mutual fund's board must approve (15 U.S.C. § 80a-15(c)). Daily Income Fund, 464 U.S. at 536-37. Under the ICA's original scheme, a shareholder seeking to challenge an investment adviser's fee under state law was required to demonstrate "common-law standards of corporate waste, under which an unreasonable or unfair fee might be approved unless the court deemed it 'unconscionable' or 'shocking,'" and "security holders challenging adviser fees under the [ICA] itself had been required to prove gross abuse of trust." Jones, 559 U.S. at 340 (quoting Daily Income Fund, 464 U.S. at 540, n.12)).

In response to the growth of mutual funds in the 1950s and 1960s, Congress amended the Act in 1970 to bolster the protections afforded to mutual funds and their shareholders. Jones, 559 U.S. at 339; see also Daily Income Fund, 464 U.S. at 537-38. The amendment "required that no more than 60 percent of a fund's directors be 'persons who are interested persons,' e.g., that they have no interest in or affiliation with the investment adviser." Jones, at 339-40 (quoting 15 U.S.C. § 80a-10(a); § 80a-2(a)(19)). This "was designed to place the unaffiliated directors in the role of 'independent watchdogs.'" Burks, 441 U.S. at 484 (quoting Tannenbaum, 552 F.2d at 406). In serving as "independent watchdogs," unaffiliated directors are to ensure that "mutual funds . . . operate in the interest of all classes of their securities holders, rather than for

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the benefit of investment advisers, directors, or other special groups." Tannenbaum, 552 F.2d at 406.

The amendment also added Section 36(b), which imposes a "fiduciary duty" on investment advisers and their affiliates, "aiming to give shareholders a stronger remedy . . . to bring actions to challenge a fee that was not 'reasonable'. . ." Jones, 559 U.S. at 340; see also Daily Income Fund, 464 U.S. at 538. Section 36(b) states that "investment company advisers owe shareholders in investment companies a fiduciary duty with respect to determining and receiving their advisory fees." Green v. Fund Asset Management, L.P. 286 F.3d 682, 685 (3d Cir. 2002) (citing 15 U.S.C. § 80a-35(b)).

Furthermore, the Act allows for a private cause of action for breach of this fiduciary duty by shareholders in an investment company, "provided that they own shares at the time the action is initiated and continue to own shares throughout the pendency of the litigation." Redus-Tarchis v. New York Life Insurance Management LLC, 2015 WL 6525894 at * 4 (D.N.J. Oct. 28, 2015) (citing Santomenno ex rel. John Hancock Trust v. John Hancock Life Ins. Co. (USA), 677 F.3d 178, 182-83 (3d Cir. 2012)).

The Act imposes additional statutory requirements when bringing an action for breach of fiduciary duty under Section 36(b). Specifically, Congress: (a) limited the period of damages so that "[n]o award of damages shall be recoverable to any period prior to one year before the action was instituted"; (b) directed that the amount of any award be limited "to the actual damages resulting from the breach of fiduciary duty"; (c) required that "[n]o such action shall be brought or maintained against any person other than the recipient of such compensation or payments," i.e. the defendant must be either an investment adviser or an affiliated person to the investment adviser. 15 U.S.C. § 80a-35(b)(3); see also In re Salomon Smith Barney Mut. Fund

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Fees Litigation, 441 F. Supp. 2d 579, 598-99 (S.D.N.Y. 2006). Finally, the Act provides that the board of directors' approval of compensation, payments, or contracts "shall be given such consideration by the court as is deemed appropriate under all the circumstances." 15 U.S.C. § 80a-35(b)(2).

However, the "fiduciary duty imposed by § 36(b) is significantly more circumscribed than common law fiduciary duty doctrines . . . [T]he plaintiff has the burden of proving a breach of fiduciary duty [under § 36(b)] in contrast with the common law rule that requires a fiduciary to justify its conduct." Green, 286 F.3d 682 at 685 (internal citations omitted).

B. Case Law

In addition to the Act's statutorily imposed requirements, there are primarily two cases that explain the standard for determining whether a breach of fiduciary duty occurred: Jones, supra, and Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923 (2d Cir. 1982). Both Jones and Gartenberg teach that Section 36(b) liability requires proof that "the adviser-manager [to] 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 arms-length bargaining." Gartenberg, 694 F.2d at 928. To determine whether a disproportionate fee was approved or a breach of...