Derivative Action Challenging Rule 12b-1 Fees Dismissed Based on Lack of Private Right of Action


The U.S. District Court for the Southern District of New York dismissed a shareholder derivative lawsuit challenging distribution fees paid pursuant to Rule 12b-1 under the Investment Company Act of 1940, as amended (the “1940 Act”). The plaintiff was a shareholder of two mutual funds (the “Funds”) that paid Rule 12b-1 fees to the Funds’ distributor (“Distributor”), which funneled the fees to broker-dealers who distributed the Fund shares. The plaintiff argued that the broker dealers were required to register under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) because they provided investment advice in exchange for 12b-1 payments, which as asset-based fees constituted “special compensation” under Section 202(a)(11)(C) of the Advisers Act.

The plaintiff claimed that through the payment of 12b-1 fees to broker-dealers who failed to register as investment advisers, the Distributor and the Fund trustees (the “Trustees”) breached their fiduciary duties owed to the Funds under Section 36(a) of the 1940 Act. The plaintiff also alleged that the Trustees breached an affirmative duty derived from Rule 38a-1 under the 1940 Act to ensure that the distribution fees were paid in accordance with the Advisers Act and other governing law. According to the plaintiff, these breaches rendered the agreement between the Funds and the Distributor unenforceable under Section 47(b) of the 1940 Act, which provides that contracts that violate provisions of the Act are void.

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