Court Decision Compares Asset Manager Advisory and Subadvisory Fees

A shareholder in the MetWest Total Return Bond Fund sued Metropolitan West Asset Management, LLC for violation of Section 36(b) of the Investment Company Act of 1940 (ICA).

The plaintiff alleges that MetWest breached its fiduciary duty to the Fund in violation of Section 36(b) because it receives investment advisory fees that are “so disproportionately large that they bear no reasonable relationship to the value of the services provided by Defendant and could not have been the product of arms-length bargaining.” The plaintiff alleges MetWest charged much higher fees to manage the fund than it does for the substantially similar subadvisory work it conducts on third-party funds.

Previously, U.S. District Judge George H. Wu of the U.S. District Court for the Central District of California denied Metropolitan West’s motions for dismissal and summary judgment.

In a tentative finding, which has since been approved, Wu notes that MetWest launched the fund amid a competitive landscape, initially charging a management fee of 55 basis points (bps) set as a percentage of the fund’s assets under management (AUM). MetWest originally set that advisory fee (with some level of reimbursement to the Fund if total expenses exceeded 65 bps) because that rate was at or below the median of the funds that MetWest expected to compete against, and the 55 bps fee would continue to constitute a below median fee if the fund ultimately grew.

Starting in 2000 and after the increase of institutional investors in the fund, MetWest lowered its advisory fee to 35 bps and the Independent Trustees approved that rate. According to the decision, the advisory fee includes payment for MetWest’s management of the portfolio and for providing the personnel and resources to sponsor and manage a compliant fund, but with certain third parties providing additional specified services More than 80 investment professionals are involved in managing the fund’s portfolio.

With the fund’s management completely externalized, MetWest supplies the fund with officers and employees to operate the fund. Certain departments at MetWest provide the administrative and operational services necessary to operate the fund.

Under a separate document dated July 29, 2015, MetWest and the MetWest Funds entered into a “Supplemental Administration Agreement.” The fund’s board approved the agreement in 2015 and in 2017. That agreement covered the following services: general supervision of administration services, including but not limited to ongoing due diligence; reviewing and assisting in the preparation of certain regulatory filings; coordinating outside services for vendors and contractors and the audit of the fund’s financial statements; coordinating, preparing, and reviewing quarterly Board materials; supplemental compliance testing, consulting, and reporting; and reviewing tax work. The agreement allows MetWest to receive up to $650,000 each year in exchange for performing administrative services set forth in the agreement for all the MetWest Funds. However, Wu notes that as of trial, MetWest had not ever sought or received any fees from the MetWest Funds authorized by the Supplemental Administration Agreement.

Third-party service providers receive separate payments directly from the fund that are not included in the 35 bps advisory fee.

The court document then explains that MetWest serves as a “subadviser” to certain third-party mutual funds. As presented at trial, MetWest’s initial subadviser’s fee to the Subadvised Funds ranged from 15 bps to 35 bps. The sponsoring advisers for those funds in turn would add their own fees which ranged from 12 bps to 125 bps resulting in total charges of between 30 bps to 160 bps, with the average/mean rate being 58.4 bps and the median being 47 bps. While MetWest’s advisory fee for the Total Return Bond Fund is higher than all of the subadvisory fee rates it charged the Subadvised Funds (except for one fund, where it was the same), MetWest’s fee for the fund was considerably lower than combined total of the advisory and subadvisory fees charged as to each of the Subadvised Funds, except for one.

The plaintiff argues that the Board’s process failed the fund because the Board: (1) did not seek or discuss a reduction in fees; (2) failed to sufficiently analyze economies of scale, costs, and profits; (3) failed to consider services that MetWest performs for both the Fund and the Subadvised Funds; and (4) erroneously relied on captive fund fee comparisons. In response, the defendant argues that the plaintiff has provided no evidence that the Independent Trustees failed to consider any relevant factor in approving the 35 bps advisory fee. Wu concluded that the Board’s 15(c) process was sufficiently robust.

“Only after a robust 15(c) process and with sufficient information provided, the Independent Trustees found the differences between MetWest’s advisory fees charged to the Fund and those it charged the Subadvised Funds to be justified in light of differences in services provided and the risks involved,” Wu wrote in his decision. He concluded that the Board’s determination in this regard deserves substantial deference based on the evidence presented at trial.

“The Court concludes that the services that MetWest provides to the Fund for its 35 bps fee are significantly different than the services it provides to the Subadvised Funds for the subadvisory fee,” Wu wrote. “Considering and weighing all the evidence presented at trial, the Court concludes that MetWest provides substantially different services and takes on substantially different risks in exchange for the 35 bps fee charged to the Fund versus the subadvisory fees charged to the Subadvised Funds.”

In a statement to PLANADVISER, a spokesperson from TCW, manager of the MetWest fund families, said: “We are very pleased with the court’s ruling and are proud of the MetWest Total Return Bond Fund’s long-term track record of delivering shareholders outstanding risk-adjusted performance for median-or-below fees.”

Rob Skinner, a partner at Ropes & Gray, which represented MetWest said: “We are thrilled with the court’s decision. In many ways, it is the decision the mutual fund industry has been waiting for: a thorough dismantling of the core theory pushed by the plaintiffs’ bar that recognizes key truths about how the industry works as supported by the evidence MetWest presented at trial.”

“Throughout the decision, the court rightly recognized important market realities of today’s mutual fund industry, including the stiff competition among fund advisers to attract investor assets,” Ropes & Gray Partner Amy Roy said. “We are pleased with Judge Wu’s decision and we expect it to have a broader impact on plaintiffs’ efforts to compare advisory and subadvisory fees going forward.”