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Paskowitz v. Prospect Capital Management L.P.

United States District Court, S.D. New York

January 24, 2017

SUSAN PASKOWITZ, Plaintiff,
v.
PROSPECT CAPITAL MANAGEMENT L.P., and PROSPECT ADMINISTRATION LLC, Defendants.

          OPINION & ORDER

          LOUIS L. STANTON U.S.D.J.

         Plaintiff Susan Paskowitz seeks pursuant to Section 36(b) of the Investment Company Act of 1940 ("ICA"), 15 U.S.C. § 80a-35(b), to recover what she claims are excessive fees paid by Prospect Capital Corporation ("Prospect") to defendants Prospect Capital Management L.P. ("PCM") and Prospect Administration LLC ("PA") for investment advisory and administrative services. Defendants move to dismiss the complaint for failure to state a claim upon which relief can be granted.

         For the reasons that follow, defendants' motion is granted.

         BACKGROUND[1]

         Prospect, a Maryland corporation, is a registered investment company that trades on the NASDAQ stock market and operates as a business development company ("BDC") under Section 54 of the ICA, see 15 U.S.C. § 80a-53. Compl. (Dkt. No. 1) ¶¶ 14, 27. Prospect has a board of directors, but has no employees. Id. ¶ 4. Instead, Prospect contracts with PCM to provide it with investment advisory services, and with PA to provide it with administrative services and facilities. Id. ¶ 14.

         Plaintiff is and has been a shareholder of Prospect since October 2013, and brings this action on Prospect's behalf and for its benefit. Id. ¶¶ 13-14.

         PCM is a registered investment adviser. Id. ¶ 15. PCM created Prospect, and Prospect is PCM's only client. Id. ¶ 16. Under its agreement with Prospect, PCM (1) manages the investment and reinvestment of Prospect's assets in accordance with Prospect's investment objective, policies, and restrictions, and implements its investment decisions for Prospect; (2) arranges for Prospect's debt financing; and (3) maintains books and records concerning transactions in Prospect's portfolio, and periodically reports to Prospect's board of directors. Id. ¶ 56.

         In exchange for the services it provides to Prospect, each year PCM receives a base management fee equal to 2.00% of Prospect's gross assets, paid quarterly. Id. ¶ 63. Additionally, PCM is paid an incentive fee[2] which is calculated as follows: for quarters in which Prospect's net investment income[3] amounts to 2.1875% (i.e., 8.75% annually) or less of its net assets, PCM is paid 20.00% of the net investment income that exceeds 1.75% of net assets; for quarters in which Prospect's net investment income exceeds 2.1875% (i.e., 8.75% annually) of its net assets, PCM is paid 20.00% on all of Prospect's net investment income. Id. ¶ 65. During the fiscal year that ended on June 30, 2015, Prospect paid PCM a total of $225, 277, 000. Id. ¶ 78, Table 1. During the first two quarters of the fiscal year ending on June 30, 2016 it paid PCM a total of $112, 796, 000, which is roughly in line with what PCM earned the prior year. Id., ¶ 79, Table 2. Unlike PCM which provides investment advisory services, PA provides Prospect with administrative services, personnel, and facilities. Id. ¶ 71. PA is an LLC whose sole member is PCM, and its only client is Prospect. Id. 19. PA provides Prospect with office space and equipment, maintains Prospect's books and records, fulfils Prospect's reporting obligations to its shareholders and regulatory agencies, interacts with Prospect's third-party service providers (e.g., brokers, accountants, attorneys, banks, insurers, etc.), and provides Prospect with managerial assistance. Id., ¶¶ 72-73. Prospect reimburses PA for the costs and expenses it incurs in providing these services. Id. ¶¶ 75-76. During the fiscal year that ended on June 30, 2015, Prospect reimbursed PA $21, 906, 000. Id. ¶ 78, Table 1. During the first two quarters of the fiscal year ending on June 30, 2016 it reimbursed PA $6, 178, 000, which is a substantial decline from what PA was reimbursed the prior year. Id. ¶79, Table 2.

         Section 36(b) of the ICA imposes upon the investment adviser of a registered investment company "a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company ... to such investment adviser or any affiliated person of such investment adviser." 15 U.S.C. § 80a-35(b). It also authorizes a shareholder of a registered investment company to bring an action "on behalf of such company, against such investment adviser, or any affiliated person of such investment adviser . . . for breach of fiduciary duty in respect of such compensation or payments paid by such registered investment company or by the security holders thereof to such investment adviser or person." Id. The statute limits recovery to damages incurred up to one year before the action was instituted. Id. § 80a-35 (b) (3) .

         Plaintiff alleges that defendants breached their fiduciary duty by charging excessive fees, and seeks to recover damages that resulted from the breach on behalf of Prospect shareholders.

         DISCUSSION

         "To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face. A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged. This plausibility standard asks for more than a sheer possibility that a defendant has acted unlawfully." Wilson v. Merrill Lynch & Co., 671 F.3d 120, 128 (2d Cir. 2011) (citation and alteration omitted). While "all factual allegations in the complaint are accepted as true and all inferences are drawn in the plaintiff's favor, " Littlejohn v. City of New York, 795 F.3d 297, 306 (2d Cir. 2015), "bald assertions and conclusions of law will not suffice, " Amron v. Morgan Stanley Inv. Advisors, Inc., 464 F.3d 338, 344 (2d Cir. 2006). Adjourned (Matter Not Available).

         The complaint is predicated on the claim that the fees paid to defendants substantially exceed the average fee rate paid by comparable BDCs to their investment advisers and administrators for comparable services. Compl. ¶ 131. However, "to face liability under § 36(b), an investment adviser must charge a fee that 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, 346, 130 S.Ct. 1418, 1426 (2010). "[T]he test is essentially whether the fee schedule represents a charge within the range of what would have been negotiated at arm's-length in the light of all of the surrounding circumstances." R.W. Grand Lodge of F. & A.M. of Pa. v. Salomon Bros. All Cap Value Fund, 425 F.App'x 25, 30 (2d Cir. 2011) (summary order), quoting Gartenberg v. Merrill Lynch Asset Mqmt., 694 F.2d 923, 928 (2d Cir. 1982). "[T]he Supreme Court's approach does not allow a court to assess the fairness or reasonableness of advisers' fees; the goal is to identify the outer bounds of arm's length bargaining and not engage in rate regulation." Jones v. Harris Assocs. L.P. (Jones II), 611 F.App'x 359, 360 (7th Cir. 2015). As stated in the Supreme Court's unanimous opinion, Jones, 559 U.S. at 352-53, 130 S.Ct. at 1430:

Congress rejected a "reasonableness" requirement that was criticized as charging the courts with rate-setting responsibilities. See Daily Income Fund[ v. Fox, 464 U.S. 523], at 538-540[, 104 S.Ct. 831 (1984)]. Congress' approach recognizes that courts are not well suited to make such precise calculations. Cf. General Motors Corp. v. Tracy, 519 U.S. 278, 308[, 117 S.Ct. 811] (1997) ("[T]he Court is institutionally unsuited to gather the facts upon which economic predictions can be made, and professionally untrained to make them") [citing cases]. Gartenberg's "so disproportionately large" standard, 694 F.2d, at 928, reflects this congressional choice to "rely largely upon [independent director] 'watchdogs' to protect shareholders interests." Burks[ v. Lasker, 441 U.S. 471], at 485[, 99 S.Ct. 1831 (1979)].

         As Justice Thomas, concurring, stated, id. at 354-55, 130 S.Ct. at 1431:

most courts . . . have followed an approach (principally in deciding which cases may proceed past summary judgment) that defers to the informed conclusions of disinterested boards and holds plaintiffs to their heavy burden of proof in the manner the Act, and now the Court's opinion, requires. * * * *
. . . Whatever else might be said about today's decision, it does not countenance the free-ranging judicial "fairness" review of fees that Gartenberg could be read to authorize, see 694 F.2d, at 929-930, and that virtually all courts deciding § 36(b) cases since Gartenberg (including the Court of Appeals in this case) have wisely eschewed in the post-Gartenberg precedents we approve.

         "[T]he Act does not require courts to engage in a precise calculation of fees representative of arm's-length bargaining, " id. at 352, 130 S.Ct. at 1430, and it "does not necessarily ensure fee parity between mutual funds and institutional clients, " id. at 350, 130 S.Ct. at 1429. Plaintiff's burden is "to show that the fee is outside the range that arm's-length bargaining would produce." Id. at 347, 130 S.Ct. at 1427.

         Using this test, plaintiff has failed to plead facts creating a plausible inference that defendants are liable. The complaint conclusorily alleges that

As set forth in Sections VI-VIII [of the complaint], Defendants breached their fiduciary duties in violation of ICA Section 36(b) by extracting investment advisory and other fees from Prospect so disproportionately large that they bear no reasonable relationship to the value of the services provided by Defendants, and could not have been the product of arm's-length bargaining (hereinafter, "excessive" fees) ....

Compl. ¶ 7. But a careful review of the allegations made in Sections VI-VIII of the complaint reveals 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.

         The allegations address six factors that under Gartenberg, courts are to consider in deciding Section 36(b) claims. These are: “(1) the nature and quality of services provided to fund shareholders; (2) the profitability of the fund to the adviser-manager; (3) fall-out benefits; (4) economies of scale; (5) comparative fee structures; and (6) the independence and conscientiousness of the trustees." Mron, 464 F.3d at 344.[4]

         Upon consideration of these factors, the complaint fails to state a claim upon which relief can be granted.

         1. Comparative Fee Structures

         The complaint first addresses comparative fee structures. The complaint purports to show that $102.6 million of the fees paid to defendants for fiscal year 2015 are excessive and "At a minimum ... at least $54.4 million of the fees Prospect paid to Defendants are excessive." Compl. ¶ 7. It does so by comparing the fee rate paid to defendants with the average fee rate paid by other BDCs included in the Wells Fargo Business Development Company Index ("BDC Index")[5] (of which Prospect is one) going back to 2013. It divides those BDCs into two groups and looks at: (1) fees paid by internally-managed BDCs[6] to their advisers-employees, and (2) fees paid by other externally-managed BDCs to their investment advisers. Id. ¶¶ 115-35.

         In 2015 Prospect paid an effective fee rate of 6.68% of net assets to defendants. Id. ¶ 129, Table 7. The effective fee rate paid by seven of the nine[7] internally-managed BDCs included in the BDC Index ranged from 1.58% of net assets to 7.36% of net assets, and averaged 3.90% of net assets. Id. ¶ 116, Table 5.[8]The effective fee rate paid by thirty-four of the thirty five[9]externally-managed BDCs included in the BDC Index (of which Prospect ...


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