Asset Management | Norwegian supreme court awards management fee reduction to investors in «closet indexer»

Background

The case concerned a claim for management fee reduction from investors in three Norwegian mutual funds managed by DNB Asset Management, the asset management arm of Norwegian financial group DNB, and was one of the first class action law suits in Norway. After having been acquitted in the city court (in January 2018), DNB was held liable by the appellate court (in May 2019), a decision now upheld by the supreme court.

The lawsuit was filed following a decision by the Norwegian regulator after an inspection in 2015, finding that the relevant funds were not managed actively in accordance with the fund documentation. DNB did not appeal this decision, and made certain amendments to the fund documentation and management subsequent to it.

Main points of the judgement

The claim by the investors was for a reduction in the management fee, based on the claim that the fund was not managed actively in accordance with the fund documentation but substantially as an index fund for which a lower management fee would be appropriate. All funds were to invest the main part of their assets in the largest companies listed on the stock exchange, but they could also invest up to 20 % of their assets in instruments not listed or traded on a Norwegian venue.

The supreme court agreed with the appellate court that the main legal question was whether or not the manager had complied with its contractual obligations towards the investors. As Norwegian mutual funds do not have own corporate organs, claims may be filed directly by investors against the manager.

According to the supreme court, the general conduct of business rules and the fact that the funds were retail funds was relevant in the interpretation of the contractual obligations of the manager under the fund documentation, as was the size of the management fee (1.8 %).

Based on the merits, the supreme court found that the funds had not been managed sufficiently active to enable the opportunities for return that the investors had a reason to expect based on the fund documentation.

Differing from the approach by the regulator and the appellate court, the supreme court does not find that quantitative approaches for determining the level of activity (such as tracking error) is decisive. Rather, the supreme court finds that the combination of a low level of activity (compared to similar funds) and a high management fee (also compared to similar funds) clearly indicate that the level of activity is lower than the fund documentation has led investors to expect.

Based on this, the supreme court found that the conditions for a reduction in price are met. In this regard, the actual performance of the fund is disregarded, based on the principle that the investors have paid for a service not rendered by the manager.

Our take

The underlying case started almost six years ago following an inspection by the regulator, and most Norwegian mutual funds have likely adapted to the guidelines of the regulator in those decisions.

The supreme court acknowledges that the relevant regulatory rules and conduct of business rules do not require any specific level of active asset management, but that this depends on the agreement between the manager and the investors.

Fund managers should take care in their communication of the investment mandate and investment guidelines. In particular, the supreme court found that subsequent reporting to investors concerning the management would not absolve the manager in this respect, and sufficient disclosures must be made in advance of an investment. This may be somewhat different in relation to funds that are not open to retail investors.

It may be argued that obtaining a sufficient level of active management within an investment mandate essentially restricted to instruments listed on Oslo Børs may be difficult, as there is a limited number of instruments available.

Outside the realm of mutual funds, the judgement by the supreme court may be relevant for individual portfolio management, ongoing investment advice and model portfolios. It may also be of particular relevance to fund-of-funds products where the duplication of fees further will reduce the potential for return for investors.