[14917]
July 12, 2002
TO: CLOSED-END INVESTMENT COMPANY MEMBERS No. 25-02
DIRECTOR SERVICES COMMITTEE No. 6-02
SEC RULES MEMBERS No. 50-02
RE: APPEALS COURT AFFIRMS SUMMARY JUDGMENT RULING IN SECTION 36(b)
CASE
The Seventh Circuit Court of Appeals recently affirmed a grant of summary judgment in
a case alleging breach of fiduciary duty under Section 36(b) of the Investment Company Act of
1940.* The case was brought by common shareholders of six closed-end, tax-exempt municipal
bond funds.
The funds in this case were leveraged to increase the amount of income generated. The
plaintiffs argued that the advisory fee, which was based on a percentage of the daily net assets
of the funds, created an incentive on the part of the adviser to excessively leverage the funds.
They further argued that this fee arrangement, in turn, created a conflict of interest for the
adviser and amounted to a per se breach of fiduciary duty.
The district court had found that the plaintiffs failed to meet their burden of establishing
a breach of fiduciary duty under Section 36(b). The Seventh Circuit agreed and said that, while
an abuse of an inherent conflict may violate Section 36(b), the mere existence of the conflict does
not. The court noted as significant the fact that the adviser in this case did not have the
authority to make final leveraging decisions for the fund; the directors maintained ultimate
control over the extent of the funds’ leverage and the decision whether or not to deleverage at
any given time.
The appeals court also noted that investment company adviser compensation schemes
are commonly based on a percentage of assets. The mere fact that this scheme could create an
incentive for advisers to keep an investment fund leveraged to an extent that may not be best
for a fund’s common shareholders does not, by itself, create a breach of fiduciary duty under
Section 36(b). Moreover, the court observed, such arrangements are expressly approved of by
the Investment Advisers Act.
* Green v. Nuveen Advisory Corp., Case No. 01-3671 (7th Cir., July 8, 2002).
2
The court affirmed the lower court’s ruling, finding that the plaintiffs had failed to
produce any evidence showing that the adviser actually abused its position. The court
determined that the existence of an independent board that ultimately controlled the extent of
the funds’ leverage and annually approved the advisory compensation agreements, supports
summary judgment in this case.
Marguerite C. Bateman
Associate Counsel
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