Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 1 of 15

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1 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 1 of 15 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK JOAN PIRUNDINI, Plaintiff, v. J.P. MORGAN INVESTMENT MANAGEMENT INC., No. 1:17-cv GBD Defendant. REPLY MEMORANDUM OF LAW IN FURTHER SUPPORT OF DEFENDANT S MOTION TO DISMISS THE COMPLAINT Mark Holland Valerie A. Haggans Charles A. Brown Elizabeth S. David GOODWIN PROCTER LLP The New York Times Building 620 Eighth Avenue New York, NY Tel: (212) Fax: (212) Michael K. Isenman (admitted pro hac vice) GOODWIN PROCTER LLP 901 New York Ave NW Washington, DC Tel: (202) Fax: (202) Attorneys for Defendant J.P. Morgan Investment Management Inc. Dated: August 29, 2017

2 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 2 of 15 TABLE OF CONTENTS INTRODUCTION...1 ARGUMENT...2 I. THE OPPOSITION FAILS TO ARTICULATE A RANGE OF ARM S LENGTH BARGAINING....2 II. III. A. Comparison to the Long-Only Fund B. Comparison to Bloomberg Large-Cap Blend Fund Category C. Comparison to the Subadvised Fund... 4 RECITATION OF THE GARTENBERG FACTORS DOES NOT SUFFICE TO STATE A CLAIM....5 A. Economies of Scale B. Quality of Services C. Profitability D. Fall-Out Benefits E. Board Process... 9 THE LONG/SHORT FUND S FEE SATISFIES THE JONES STANDARD....9 CONCLUSION...10 i

3 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 3 of 15 TABLE OF AUTHORITIES Page(s) Cases Ashcroft v. Iqbal, 556 U.S. 662 (2009)... passim In re Blackrock Mutual Funds Advisory Fee Litig., No. 14 Civ. 1165, 2015 WL (D.N.J. Mar. 27, 2015)...7 Jones v. Harris Assocs., L.P., 559 U.S. 335 (2010)... passim Jones v. Harris Assocs., L.P., 611 F. App x 359 (7th Cir. 2015) , 9 Kalish v. Franklin Advisers, Inc., 742 F. Supp (S.D.N.Y. 1990)...6 Krinsk v. Fund Asset Mgmt., Inc., 715 F. Supp. 472 (S.D.N.Y. 1988) Laboy v. Bd. Of Trs. Of Bldg. Serv. 32 BJ SRSP, No. 11 Civ. 5127, 2012 WL (S.D.N.Y. Aug. 7, 2012)...10 Paskowitz v. Prospect Capital Mgmt. L.P., 232 F. Supp. 3d 498, 502 (S.D.N.Y. 2017)... passim SEC v. Daifotis, 874 F. Supp. 2d 870 (N.D. Cal. 2012)...10 Statutes and Rules Section 36(b), 15 U.S.C. 80a-35(b)...2, 6 Other Authorities S. Rep. No (1969), reprinted in 1970 U.S.C.C.A.N ii

4 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 4 of 15 INTRODUCTION The Supreme Court has made clear that to state a claim under Section 36(b), a complaint must allege facts that plausibly show that a challenged fee is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm s length bargaining. Jones v. Harris Assocs., L.P., 559 U.S. 335, 344 (2010); see Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). Plaintiff s Memorandum of Law in Opposition to Defendant s Motion to Dismiss (the Opposition or Opp. ) nowhere so much as mentions this standard, let alone explains how the Complaint meets it. And for good reason. The facts alleged in the Complaint actually demonstrate that the Long/Short Fund s 1 advisory fee is well within the range of fees that could result from arm s length bargaining (and is, in fact, relatively inexpensive). The Opposition does not dispute that: JPMIM s advisory fee for the Long/Short Fund is lower than 80% of its peer funds with a similar strategy; JPMIM charges the Long/Short Fund only 20% more than it charges Pacific Life, the investment adviser of the Subadvised Fund, for subadvisory services; and JPMIM charges the Long/Short Fund an advisory fee that is 26% less than the advisory fee that Pacific Life charges investors who invest in the Subadvised Fund. The Opposition also does not dispute that, unlike the Long-Only Fund, the Long/Short Fund engages in short transactions. Nor does it dispute that the Long/Short Fund holds almost twice as many securities positions as, and trades securities more often than, the Long-Only Fund. Rather than try to explain how the Complaint meets the Jones standard, the Opposition formulaically recites the Gartenberg factors as if they constituted the elements of a Section 1 Except as otherwise noted, capitalized terms have the same meaning as in JPMIM s Memorandum of Law in Support of Defendant s Motion to Dismiss the Complaint (the Motion or Mot. ). 1

5 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 5 of 15 36(b) claim. Opp. at 12. They do not. The Gartenberg factors are no substitute for the legal standard set forth in Jones and do not excuse Ms. Pirundini from her legal obligation to plead facts sufficient to plausibly show that the challenged fee falls outside the range that arm s length bargaining could produce. Thus, even though the Section 36(b) complaint in the Prospect Capital case included allegations regarding all six Gartenberg factors, Judge Stanton concluded that from the facts pleaded one cannot plausibly infer that defendants fees do not bear a reasonable relationship to the services rendered, or fall outside the range that arm s length bargaining could produce. Paskowitz v. Prospect Capital Mgmt. L.P. ( Prospect Capital ), 232 F. Supp. 3d 498, 502 (S.D.N.Y. 2017). The Supreme Court has also made clear that, in resolving a motion to dismiss, mere conclusory statements are not entitled to the assumption of truth. Iqbal, 556 U.S. at Many allegations relied upon in the Opposition are not facts, but mere conclusions. Once stripped of those conclusions, the Complaint s remaining allegations are, as in Prospect Capital, insufficient to plead a violation of Section 36(b). 2 ARGUMENT I. THE OPPOSITION FAILS TO ARTICULATE A RANGE OF ARM S LENGTH BARGAINING. To plead that a fee could not have been the product of arm s length bargaining, a Section 36(b) plaintiff must plead sufficient facts to establish the range of arm s length bargained fees. The Complaint fails to do so. The Opposition points to three different comparisons made in the Complaint. But none of those comparisons even remotely suggests that the Long/Short Fund s fee falls close to, let alone outside, the outer bounds of arm s length bargaining. Jones 2 Plaintiff attempts to distinguish Prospect Capital on the ground that the fund involved there was a business development company ( BDC ). Opp. at 1-2. A BDC, like a mutual fund, is a registered investment company, and both are subject to Section 36(b) s fiduciary duty standard. See 15 U.S.C. 80a-35(b). 2

6 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 6 of 15 v. Harris Assocs., L.P., 611 F. App x 359, 360 (7th Cir. 2015) ( Jones II ) on remand from 559 U.S. 335 (2010). A. Comparison to the Long-Only Fund The Opposition first compares the Long/Short Fund s advisory fee to the advisory fee JPMIM charges to the Long-Only Fund. The Complaint s own allegations, however, rebut any suggestion that the two funds are comparable. The Opposition does not dispute that the Complaint itself establishes: The Long/Short Fund but not the Long-Only Fund engages in short transactions. The Complaint itself characterizes this as a major... difference between the two funds. Compl. 89(d). Short selling is an uncommon strategy for mutual funds that, as the Long/Short Fund s prospectus discloses, involves added complexity and special risks. David Decl. Ex. B, at 87; see Compl. 63. The Long/Short Fund also holds positions in almost twice as many securities as the Long-Only Fund. Compl. Ex. A, at 2. The Long/Short Fund trades securities much more often than the Long-Only Fund, as reflected in its higher portfolio turnover ratio. Compl. Ex. A, at 2. The Supreme Court directed in Jones that [i]f the services rendered are sufficiently different that a comparison is not probative, then courts must reject such a comparison. 559 U.S. at 350. The Opposition s contention that the Long/Short Fund and Long-Only Fund are similar but only if one looks at the Long/Short Fund minus the Fund s short positions (Opp. at 5) does nothing to bridge these fundamental differences between the funds. The contention that the fee JPMIM charges the Long-Only Fund is a probative comparison to what fee might be 3

7 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 7 of 15 negotiated at arm s length to manage a fund that also engages in a short selling strategy is exactly the type of conclusory allegation that the Supreme Court has ruled is not entitled to the assumption of truth. Iqbal, 556 U.S. at 679. B. Comparison to Bloomberg Large Cap Blend Fund Category The Opposition incorrectly states that JPMIM does not specifically address the [Bloomberg] benchmark. Opp. at 18. The [Bloomberg] benchmark is a comparison to a list of 291 Large Cap Blend Mutual Funds that Plaintiff selected from Bloomberg Finance L.P. Compl , Ex. C1. In fact, JPMIM addressed this exact issue in its Motion: it explained that the Complaint s list of Bloomberg funds could not establish an appropriate benchmark because the Complaint did not allege that those funds engaged in short transactions and therefore were comparable to the Long/Short Fund. Mot. at 13. The Opposition has no response to this point. The contention that 291 funds selected from a Bloomberg terminal must be deemed comparable to the Long/Short Fund because they make similar long investments, while ignoring whether they make short investments is another merely conclusory statement, and therefore not entitled to the assumption of truth. Iqbal, 556 U.S. at 679. And, when compared to other mutual funds that do use similar short-selling strategies, the Long/Short Fund s fee is lower than 80% of its peers. Mot. at C. Comparison to the Subadvised Fund The Opposition does not dispute that the Subadvised Fund s investment adviser, Pacific Life, charges that fund a total advisory fee of 0.98%, whereas JPMIM charges the Long/Short Fund a total advisory fee of 0.72%. Nor does the Opposition dispute that an investor would pay less to invest in the Long/Short Fund than to invest in the Subadvised Fund. Instead, the Opposition myopically focuses on the 0.60% that JPMIM charges Pacific Life to provide 4

8 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 8 of 15 subadvisory services. 3 Even if it were appropriate to compare the 0.60% subadvisory fee to the 0.72% advisory fee, the existence of a single lower fee does not render a challenged fee excessive. 4 A single data point does not establish a range of arm s length bargaining and certainly does not say anything about the outer bounds of arm s length bargaining. And the Opposition does not dispute or even address the Supreme Court s statement in Jones that Section 36(b) does not require fee parity. The fact that JPMIM charges 0.72% to serve as an investment adviser but only 0.60% to serve as a subadviser does not plausibly suggest that the Long/Short Fund s fee is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm s length bargaining. Jones, 559 U.S. at 344. II. RECITATION OF THE GARTENBERG FACTORS DOES NOT SUFFICE TO STATE A CLAIM. The Opposition fails to show why any of the three comparisons in the Complaint suggest that the Long/Short Fund s fee falls outside the range of arm s length bargained fees. For this reason alone, the Complaint fails to plead a violation of Section 36(b) under Jones. The Opposition nevertheless goes on to discuss other Gartenberg factors, 5 without explaining how any of them demonstrate that the Long/Short Fund s advisory fee falls outside the range of 3 The Opposition incorrectly states that the Subadvised Fund retained JPMIM. Opp. at 5. In fact, Pacific Life retained JPMIM. See Mot. at 6. The Opposition also cannot make up its mind about what services JPMIM provides to the investment adviser of the Subadvised Fund. On the one hand, the Opposition contends that the services provided to the Long/Short Fund and to the investment adviser of the Subadvised Fund are the same. Opp. at 16. On the other hand, the Opposition contends that JPMIM provides more services to the investment adviser of the Subadvised Fund than JPMIM provides to the Long/Short Fund. Opp. at The Opposition commits a mathematical error when it says that the fee that JPMIM charged the [investment adviser of the] Subadvised Fund was... 33% less than what it charged the [Long/Short] Fund. Opp. at 6. The Long/Short Fund s fee after waivers was 0.72%, and the fee JPMIM charged the Subadvised Fund s investment adviser was 0.60%. A 0.60% fee is 20% less, not 33% less, than a 0.72% fee. Elsewhere on page 16 the Opposition gets the math right, and acknowledges that the difference is only 20%. 5 The Jones court listed the Gartenberg factors in a footnote (559 U.S. at 345 n.5) but, contrary to Plaintiff s contention (Opp. at 12), never adopted those factors as elements of a claim or otherwise. Instead the court rejected a categorical rule and explained that the Act requires consideration of all relevant factors. 559 U.S. at

9 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 9 of 15 arm s-length bargaining. A. Economies of Scale The Complaint alleges that because the Long/Short Fund does not include any breakpoints in its fee schedule, JPMIM necessarily failed to share any economies of scale with shareholders. Yet the Opposition does not and cannot cite to any authority requiring mutual fund fees to include breakpoints. Nor does it dispute that economies of scale can be shared in a variety of other ways. See Mot. at Faced with undisputed facts coming directly from the Complaint that, during the last few years, the Long/Short Fund s assets have decreased and that the Long/Short Fund s advisory fee has actually declined by 28%, from 1.00% to 0.72%, the Opposition now says that it is JPMIM s burden to show that it has sufficiently shared economies of scale. Opp. at That assertion is incorrect as matter of law. Section 36(b) states that the plaintiff shall have the burden of proving a breach of fiduciary duty. 15 U.S.C. 80a-35(b)(1). Further, Plaintiff seeks to impose a requirement with respect to economies of scale that does not exist. Section 36(b) does not require an investment adviser to turn over all the benefits from economies of scale to a fund. Rather, a court must evaluate whether the benefits from any economies of scale were shared. Prospect Capital, 232 F. Supp. 3d at 507. In Prospect Capital, Judge Stanton found the complaint s allegations about economies of scale to be inadequate because there was at least some sharing of economies of scale with shareholders. Id. 6 The Complaint s allegations, including that the challenged fee declined 28%, do not come close to 6 See also Kalish v. Franklin Advisers, Inc., 742 F. Supp. 1222, 1239 (S.D.N.Y. 1990), aff d 928 F.2d 590 (2d Cir. 1991) (if adviser has realized economies of scale, then the question becomes whether the fund has permitted shareholders to participate, at least in part, in the economies of scale ) (emphasis added); S. Rep. No (1969), reprinted in 1970 U.S.C.C.A.N. 4897, 4901 (Section 36(b) recognizes that investors should share equitably... in the economies available as a result of the growth... of mutual funds ) (emphasis added). 6

10 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 10 of 15 pleading facts showing that JPMIM failed to share any economies of scale with shareholders. 7 The Opposition also argues that the Long/Short Fund grew rapidly between 2006 and 2016, increasing from $69.2 million to $9.86 billion in AUM. Opp. at 6. But the Complaint itself explains that the Long/Short Fund commenced operations in 2006 (Opp. at 14) and the fact that it once was a much smaller fund proves nothing. As reflected in Exhibit E to the Complaint, the Long/Short Fund s assets have grown only modestly since 2011, when they were about $7.5 billion. In other words, almost all of the Long/Short Fund s growth occurred during its first five years well before Plaintiff filed her Section 36(b) claim with its one-year limitation on damages. The Fund has remained roughly the same size since then, during which time the challenged fee has come down by 28%. Finally, neither the Complaint nor the Opposition contains any discussion of the actual transaction costs JPMIM incurred during this period and whether they increased or decreased as Fund assets rose and fell. Prospect Capital, 232 F. Supp. 3d at 507. Again, these mere conclusory statements regarding economies of scale are not supported by the facts alleged, and therefore are not entitled to the assumption of truth. Iqbal, 556 U.S. at B. Quality of Services The Opposition contends that persistent underperformance by a fund is the best barometer of the services it receives. Opp. at 22 (emphasis omitted). But the Opposition (like the Complaint) concedes that the Long/Short Fund has not suffered persistent underperformance. Rather, both the Complaint and the Opposition acknowledge that performance has been average. Opp. at 22; Compl. 154, 219. Pleading that a fund s performance has been average is not the same as saying that the quality of services is poor, and 7 Unlike the complaint in In re Blackrock Mutual Funds Advisory Fee Litig., No. 14 Civ. 1165, 2015 WL , at *6 (D.N.J. Mar. 27, 2015), the Complaint here does not allege what proportion of the economies of scale the adviser failed to share. 7

11 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 11 of 15 does not support a claim for a violation of Section 36(b). Prospect Capital, 232 F. Supp. 3d at 506. Any suggestion that the quality of the services JPMIM provides to the Long/Short Fund does not justify its fee therefore is nothing more than a mere conclusion and not entitled to the assumption of truth. Iqbal, 556 U.S. at 679. C. Profitability Acknowledging that it has no actual information regarding JPMIM s profitability in managing the Long/Short Fund, the Opposition nevertheless characterizes the Fund as highly profitable. Opp. at 8. The Opposition contends that JPMIM actually uses more personnel which translates into a higher cost to manage the [Long-Only] Fund versus the [Long/Short] Fund. Opp. at 8. The Complaint, however, alleges only that largely the same investment management team manages both funds. It alleges nothing about how that team allocates its time between the two funds. And the Complaint itself alleges that the Long/Short Fund has almost twice as many securities positions and much higher portfolio turnover than the Long-Only Fund (Compl. Ex. A, at 2), refuting the inference that the Long/Short Fund s costs are the same or lower than the Long-Only Fund. The Opposition s unsupported speculation about JPMIM s costs, in the absence of any allegations about JPMIM s actual costs offers no more than conclusions that cannot support a claim under Section 36(b). Prospect Capital, 232 F. Supp. 3d at 506; Iqbal, 556 U.S. at 679. D. Fall-Out Benefits The Opposition does not dispute that the Long/Short Fund had to contract with someone to provide the Fund with administrative, shareholder, and custodial services. Nor does it dispute that JPMIM and its affiliates could have been hired to provide those services even if JPMIM were not the Long/Short Fund s investment adviser. As such, the Opposition does not explain how payment for those services could satisfy the but for requirement to constitute fall-out 8

12 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 12 of 15 benefits. Krinsk v. Fund Asset Mgmt., Inc., 715 F. Supp. 472, 495 (S.D.N.Y. 1988) (Walker, J.), aff d, 875 F.2d 404 (2d Cir. 1989). The Opposition does nothing to remedy the Complaint s failure to allege facts sufficient to plausibly suggest that JPMIM earned any fall-out benefits, let alone sufficient profits from those fall-out benefits so that the Long/Short Fund s advisory fee falls outside the range of arm s length bargaining. E. Board Process The Opposition concedes that allegations regarding a mutual fund board s process cannot state a claim for excessive fees. Opp. at The Opposition nevertheless clings to those allegations based upon the misguided belief that the Gartenberg factors, rather than the Supreme Court s standard in Jones, constitute the elements of a claim under Section 36(b). Even under that misapprehension, the Opposition points to nothing suggesting that the fee the Board negotiated could not have resulted from arm s length bargaining. Jones, 559 U.S. at 344. Further, allegations that a more rigorous board process could have resulted in a lower fee do not suffice to show that the fees the board approved were excessive. See Prospect Capital, 232 F. Supp. 3d at The Opposition s characterization of the Board process therefore fails to support the Section 36(b) claim. III. THE LONG/SHORT FUND S FEE SATISFIES THE JONES STANDARD. Following its decision, the Supreme Court remanded Jones to the Seventh Circuit. That court concluded that the Supreme Court s standard was easily satisfied where (i) the challenged fees were in line with those charged by advisers for other comparable funds and (ii) the fund s returns (net of fees) exceeded the norm for comparable investment vehicles. Jones II, 611 F. App x at When evaluated against comparable funds, both the fee and the performance of the Long/Short Fund meet this test. The performance of the Long/Short Fund is highly rated by both 9

13 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 13 of 15 Lipper and Morningstar. 8 In fact, the performance of the Long/Short Fund is among the best in its Lipper class. 9 During the 1-year, 3-year, 5-year, and 10-year periods ending June 30, 2017, the Long/Short Fund s performance has never fallen outside of the second quintile that is, the top 40% of comparable funds and has often exceeded that. Id. During the 1-year period, it was ranked 3 rd out of 29 funds. Id. During the 10-year period, it was ranked 2 nd out of 11 funds. Id. Similarly, after comparing it to over eight hundred funds in the same category, Morningstar has given the Long/Short Fund a five-star rating (i.e., top 10%) in all of those performance periods, except for the 3-year period, for which the Long/Short Fund received three stars (i.e., middle 35%). Id. 10 And, as previously noted, the Long/Short Fund s fee is among the lowest of comparable funds that engage in a short-selling strategy. Mot. at Under the standard established by Jones, therefore, the Complaint cannot state a claim under Section 36(b). CONCLUSION For the foregoing reasons, and for the reasons stated in the Motion, the Complaint should be dismissed. 8 Lipper and Morningstar are independent third-party providers of research on mutual funds. See Laboy v. Bd. Of Trs. Of Bldg. Serv. 32 BJ SRSP, No. 11 Civ. 5127, 2012 WL , at *4 & n.2 (S.D.N.Y. Aug. 7, 2012) ( Morningstar, Inc. is an independent research organization that evaluates mutual funds ), aff d, 513 F. App x 78 (2d Cir. 2013); SEC v. Daifotis, 874 F. Supp. 2d 870, 883 (N.D. Cal. 2012) ( Morningstar and Lipper, two independent third-party research firms that categorize mutual funds ). 9 J.P. Morgan Asset Management, JP Morgan U.S. Large Cap Core Plus Fund, Class I (JLPSX), PERFORMANCE, a2389 (last visited Aug. 29, 2017). As JPMIM explained in its opening brief, [t]aking judicial notice of information published on a website is appropriate for purposes of a Rule 12(b)(6) motion, including Lipper index figures. Mot. at 14 n Under Morningstar s rating system, the performance of a fund that receives five stars is in the top 10% of its Morningstar category, and the performance of a fund that receives three stars is in the middle 35% of its Morningstar category. Morningstar, The Morningstar Rating for Funds, (2010), _FactSheet.pdf. 10

14 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 14 of 15 Respectfully submitted, Dated: August 29, 2017 /s/ Mark Holland Mark Holland Valerie A. Haggans Charles A. Brown Elizabeth S. David GOODWIN PROCTER LLP The New York Times Building 620 Eighth Avenue New York, NY Tel: (212) Fax: (212) Michael K. Isenman (admitted pro hac vice) GOODWIN PROCTER LLP 901 New York Ave NW Washington, DC Tel: (202) Fax: (202) Attorneys for Defendant J.P. Morgan Investment Management Inc. 11

15 Case 1:17-cv GBD Document 29 Filed 08/29/17 Page 15 of 15 CERTIFICATE OF SERVICE I hereby certify that on August 29, 2017, I caused a true and correct copy of the foregoing Reply Memorandum of Law in Further Support of Defendant s Motion to Dismiss the Complaint to be served by electronic means, via the Court s CM/ECF system, on all counsel registered to receive electronic notices. /s/ Mark Holland Mark Holland