12(b)-1 ruling eases fund firms', B-Ds' worries - for now

JUL 13, 2011
Mutual fund companies breathed a sigh of relief last week when a judge dismissed a case that could have forced funds to pay back years' worth of 12(b)-1 fees, creating more pressure on broker-dealers to register as investment advisers. In Bradley C. Smith v. OppenheimerFunds Distributor Inc., the plaintiffs alleged that brokers are being paid for investment advice by receiving 12(b)-1 payments and thus need to be registered as investment advisers. Specifically, the plaintiffs argued that because 12(b)-1 payments are asset-based fees, they are technically “special compensation” under the Investment Advisers Act of 1940. The case was heard before Judge Leonard B. Sand in the U.S. District Court in the Southern District of New York. “The case alleged that by paying 12(b)-1 fees to broker-dealers who were not registered as investment advisers, the funds and the fund trustees breached the fiduciary standard,” said William K. Dodds, chairman of the securities litigation practice at Dechert LLP and the lead attorney on the case representing OppenheimerFunds. In his decision, Mr. Sand dismissed the suit, stating that the plaintiffs didn't have “private rights to action” under the statutes that they cited. In other words, as private investors, the plaintiffs didn't have the right to sue the funds on behalf of shareholders based on the sections of the Investment Advisers Act that they invoked in their argument. This was the last of three cases brought by Milberg LLP against fund companies on this issue. The firm also has filed suit against Eaton Vance Distributors Inc. and Franklin Templeton Distributors Inc. Both cases were dismissed, but the decisions have been appealed. Mr. Dodds said that he expects the plaintiffs to appeal the OppenheimerFunds decision, too. Xenia Kobylarz, a spokeswoman at Milberg, declined to comment. Because Mr. Sand didn't rule on the merits of the case, it is possible that the litigants still might come away with a victory in court. In fact, if any of the decisions are reversed, it could make all fund companies that pay 12(b)-1 fees vulnerable to similar lawsuits and force them to pay back billions of dollars in 12(b)-1 fees, Mr. Dodds said. “A different outcome on any of these cases [could] encourage similar litigation,” he said. “It not only would represent a tremendous financial burden on funds, but it also would undermine the entire 12(b)-1 system and in some respects make mutual funds the watchdog for broker-dealers.” A victory for the plaintiffs could put more pressure on broker-dealers to dually register as investment advisers, even though brokers weren't the defendants, Mr. Dodds said. The court's decision comes as the Securities and Exchange Commission is looking to establish a universal fiduciary standard for all brokers, as well as revamp 12(b)-1 fees. Although a change in 12(b)-1 fees wouldn't affect the cases on appeal, “depending on what happens with 12(b)-1, it could affect whether there is a basis for a case going forward,” Mr. Dodds said. E-mail Jessica Toonkel at [email protected].

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