Plaintiffs are shareholders in two mutual funds, the Harbor International Fund (HIF) and the Harbor High Yield Bond Fund (HBF) (the Funds). Their claims are derivative in nature and center on the fees charged by Harbor to manage the Funds.
As succinctly explained in Jones v. Harris Assocs. L.P., 559 U.S. 335, 338, 130 S. Ct. 1418, 1422 (2010) (citation omitted),
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. The following arrangements are typical. A separate entity called an investment adviser creates the mutual fund, which may have no employees of its own. The adviser selects the fund's directors, manages the fund's investments, and provides other services. Because of the relationship between a mutual fund and its investment adviser, the fund often cannot, as a practical matter sever its relationship with the adviser. Therefore, 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.
The ICA created protections for shareholders of mutual funds, in part, by imposing a fiduciary duty on a fund's adviser with respect to the compensation it receives. Id. at 338-39.
HIF and HBF are part of the Harbor Funds, an investment company registered under and subject to the ICA. As described above, Harbor created the Funds and acts as the investment adviser for both pursuant to investment advisory agreements (IAAs).
Harbor has retained subadvisers for both HIF and HBF, creating what it calls a "manager of managers" structure. (PSOF ¶ 20.) Northern Cross, LLC (Northern Cross) is the subadviser for HIF, and Shenkman Capital Management (Shenkman) is the subadviser for HBF. (Id. ¶ 21.) The subadvisers make "the day-to-day investment decisions" for their Funds, albeit contractually subject to Harbor's oversight. (See 2013 HIF IAA ¶ 4; 2013 HBF IAA ¶ 4.)6
Despite the breadth of duties performed by the subadvisers, Harbor asserts that it retains a number of responsibilities under the IAAs including, among others, "establishing, and [ ] recommending changes to, the investment policies strategies and guidelines for each Fund," and "overseeing the subadviser to each Fund, including recommending for Board consideration the selection, termination and replacement of subadvisers." (Dkt. 173 at 26.) Plaintiffs do not dispute that the services provided by Harbor are consistent with the IAAs and of at least "reasonably good quality." (Dkt. 167-17, Deposition of Richard W. Kopke (Kopke Dep.) at 132:6-11.)
Plaintiffs object to the amount of fees the Funds pay to Harbor. For its services, Harbor receives a management fee from the Funds based on the average daily net asset value of each Fund. Harbor pays the subadviser's fees from the fees it receives from the Funds. The fee agreement for HIF includes "breakpoints," which decrease the percentage fee that Harbor collects as the levels of assets under management increase. Some of the breakpoints are included in the IAAs; others are the result of contractual fee waivers. The breakpoints are marginal, i.e., the fee reduction applies to all assets above the breakpoint. The theory behind the inclusion of breakpoints is that economies of scale should benefit the Fund rather than Harbor. The management fee, with breakpoints, paid by HIF is summarized in the table: | 0.75% (75 basis points (bps))
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HBF, on the other hand, pays a flat rate (0.60% or 60 bps) under its IAA, which has been reduced to 0.56% (56 bps) as a result of a contractual fee waiver. Like Harbor's fee arrangement with HIF, the fees of the subadviser for HBF are structured in tiers but the rates are lower than those paid by HIF. For example, Northern Cross's fee ranges from 0.55% on the first $1 billion under management down to 0.30% for assets under management over $36 billion, while Shenkman's fee starts at 0.40% on the first $25 million under management and decreases to 0.30% for assets under management over $100 million. (See 2013 HIF Subadviser IAA, Schedule A; 2013 HBF Subadviser IAA, Schedule A.) The tables below summarize Harbor's gross advisory fee and the subadviser fee for each Fund in 2011, 2012, 2013, and 2014. (Harbor retained approximately 45 percent of HIF's fee each year and 46-47 percent of HBF's fee, which amounts would include other services as well as its profits.)
V. Board Approval of the Fees The Board of Trustees of the Funds (the Board) is responsible for overseeing the affairs of the Trust. Harbor's IAAs with the Funds are reviewed and approved by the Board every year. (PSOF ¶ 12.) The subadviser IAAs are also Board-approved. (Id. ¶ 36.)
Between 2012 and 2015, at least six Trustees comprised the Board. Only one trustee was an "interested person" as the term is defined in § 2(a)(19) of the ICA. See 15 U.S.C. § 80a-2(a)(19); (PSOF ¶ 31). Plaintiffs do not contest the qualifications of the Board's members, nor do they dispute that the Board meets the statutory requirements regarding how many of its members must be disinterested persons. (Id.) The Board has independent counsel from the investment management practice of Dechert LLP, a "nationally recognized ... leader in advising mutual fund boards." (Id. ¶ 35.) In particular, Dechert advises the independent trustees regarding the legal standards applicable to, and what information should be considered in connection with, the annual review and approval of the IAAs required by the ICA (also known as the "15(c) review" for the section of the ICA containing the requirement). (Id. ¶ 37.)
The Board meets twice quarterly, typically holding three-hour telephonic meetings, followed a week-to-ten days later by in-person meetings that typically last two days. (Id. ¶ 33.)The IAAs and subadviser IAAs are discussed and approved at the Board's February meeting. (Id. ¶ 36.) The February telephone meeting is used to give the independent trustees an opportunity to convene with representatives from Dechert and preview the questions and issues that the independent trustees plan to discuss at the in-person meeting. (Id. ¶ 62.) There is some dispute between the parties regarding the Board's preparation and diligence. Harbor's lead independent trustee, Rodger Smith, testified that "it's a very interactive group. Everybody talks. Everybody owns the responsibility." (Dkt. 167-5, Deposition of Rodger Smith (Smith Dep.) at 153:9-11.) Likewise, another independent trustee, Raymond Ball, testified, "I was told Harbor is known as a board that is very active and gets very involved and you don't miss board meetings and you come prepared and do your homework...." (Dkt. 167, Deposition of Raymond J. Ball (Ball Dep.) at 64:18-65:1.) Plaintiffs point to evidence that thousands of pages are posted shortly before the telephonic meeting, and at the meetings some trustees concede that they have not read them page by page. (Dkt. 225, Plaintiffs' Amended Response to DSOF ¶¶ 62, 63(a).)
In advance of the 15(c) review meeting in February, Dechert makes a written request to Harbor for information pertinent to what are known as Gartenberg factors (so named for the case that first elucidated them, Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923 (2d Cir. 1982)), as well as any other matters relevant to the trustees' 15(c) review process. (PSOF ¶ 38.) In response to the request, Harbor provides a large amount of information for the Board to review, including information about the nature and quality of the various services provided by Harbor and the subadvisers, including investment, administrative, and oversight services. (Id. ¶ 40.) Much of these "nature and quality" materials are prepared by Harbor and the subadvisers (see, e.g., id. ¶ 41), but there are also reports from independent financial services firms, Lipper, Inc., and Morningstar. (Id. ¶ 42.)
The Lipper reports evaluate the comparative fees paid by similar funds to their advisers and compare the Funds' performance for the previous year against benchmarks and competitors. (See id. ¶¶ 42-44, 45-46, 48.) It also reports the profits Harbor realizes from the Funds. (Id. ¶ 50.) Harbor's profits are reported to the Board in two ways: a gross profitability analysis on a...
