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115th Congress    }                                 {   Rept. 115-662
                        HOUSE OF REPRESENTATIVES
 2d Session       }                                 {          Part 1

======================================================================



 
                   MUTUAL FUND LITIGATION REFORM ACT

                                _______
                                

  May 7, 2018.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

Mr. Hensarling, from the Committee on Financial Services, submitted the 
                               following

                              R E P O R T

                             together with

                             MINORITY VIEWS

                        [To accompany H.R. 4738]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Financial Services, to whom was referred 
the bill (H.R. 4738) to amend the Investment Company Act of 
1940 to provide complaint and burden of proof requirements for 
certain actions for breach of fiduciary duty, having considered 
the same, report favorably thereon without amendment and 
recommend that the bill do pass.

                          Purpose and Summary

    On January 8, 2018, Representative Tom Emmer introduced H.R 
4738, the ``Mutual Fund Litigation Reform Act.'' H.R. 4738 
amends section 36(b) of the Investment Company Act of 1940 
(ICA) to provide that in a derivative action brought pursuant 
to the ICA a claim for breach of fiduciary must state with 
particularity all the facts that establish the breach of 
fiduciary duty and the breach of fiduciary duty must be shown 
by clear and convincing evidence.

                  Background and Need for Legislation

    The goal of H.R. 4738 is to reduce abusive litigation 
against mutual fund advisers that lack merit, waste the time 
and resources of an already burdened court system, and 
traditionally seem to operate to the benefit of plaintiffs' 
lawyers rather than the mutual fund shareholders on whose 
behalf they purport to be filed.
    In 1970, Congress enacted section 36(b) of the ICA to: (1) 
create a federal fiduciary duty on the part of fund advisers 
with respect to the receipt of compensation for services; and 
(2) provide fund shareholders and the Securities and Exchange 
Commission (SEC) a right of action in federal courts against 
investment advisers for breach of fiduciary duty with respect 
to compensation. The purpose of the 1970 legislation was to 
protect shareholders and prevent conflicts of interest by 
allowing fund shareholders the right to sue mutual fund 
advisers for charging fees that are excessive to the point of 
breaching of fiduciary duty.
    Section 36(b), however, does not define what constitutes an 
excessive fee that violates a mutual fund adviser's fiduciary 
duty. The Supreme Court resolved some of this ambiguity in 2010 
when it held in Jones v. Harris Associates L.P. (559 U.S. 335) 
that the ``Gartenberg Standard'' is the appropriate test for a 
breach of fiduciary duty under section 36(b), with Justice 
Samuel Alito writing for unanimous Court. This legal standard 
provides: ``To be guilty of a violation of 36(b) . . . the 
adviser-manager 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 arms-length 
bargaining.''
    Unfortunately, while Jones offered clarity on what an 
excessive fee might be, the Supreme Court did not specifically 
address certain problematic aspects of section 36(b) lawsuits--
aspects which continue to incentivize the plaintiffs' bar to 
file claims regardless of merit. Further, while the Supreme 
Court indicated that as lower courts evaluate section 36(b) 
claims they should defer to a fund board's determination if the 
board had a good process and received appropriate information--
an indication that 36(b) claims should be evaluated against a 
heightened standard of proof--the Court did not explicitly 
articulate what that burden of proof is and how it relates to 
the ``preponderance of the evidence'' burden of proof. H.R. 
4738 resolves this open legal question by providing that the 
appropriate burden of proof for 36(b) claims is ``clear and 
convincing evidence''--one step up from the preponderance 
burden. This is a change long overdue.
    In the past 45 years, not a single section 36(b) action has 
resulted in a final judgment against a defendant adviser. But 
such a track record does not mean that significant costs are 
not imposed on the mutual fund industry to respond and defend 
against these claims--costs disproportionately higher than what 
it costs to simply assert a claim. For example, litigation 
costs are estimated to be three-to-four times higher for 
defendant advisers than the plaintiffs, largely because 
plaintiffs' attorneys can file multiple similar lawsuits, while 
advisers have to respond to expensive and time-consuming 
discovery, ultimately taking away an advisers ability to 
effectively manage their funds. In other words, under the 
current litigation regime, plaintiffs' attorneys know that non-
meritorious claims still can result in a fees windfall because 
it often is in a company's best financial interest to settle in 
lieu of spending money on pre-trial discovery, or on a trial. 
Unfortunately for shareholders, though, the financial incentive 
is not passed onto the shareholders, as the settlements rarely 
result in material payments for shareholders--while conversely 
increasing costs on mutual funds that ultimately are borne by 
investors.
    The reason plaintiffs' attorneys can so easily shake down 
fund advisers is that a 36(b) claim need only to allege 
``enough factual matter'' to make the plaintiff's claim 
``plausible on its face.'' This is an extremely low burden of 
proof for plaintiffs, which essentially allows plaintiffs' 
firms to rely on cookie-cutter complaints at little expense to 
the filing party. Further, the current requirement to only 
prove a claim by a preponderance of the evidence means that--
even after extensive, costly discovery--plaintiffs can 
relatively easily defeat a motion for summary judgment (which 
requires a defendant to show there is no genuine issue of 
material fact that remains for the court to decide).
    Representative Emmer's bill, H.R. 4738, addresses these 
problems by requiring 36(b) claims to be pleaded with 
particularity and clarifying that such claims should be subject 
to the clear and convincing standard of proof. It also requires 
any claim for breach of fiduciary duty to be pleaded with 
particularity. The heightened pleading requirement will make it 
less likely for plaintiffs' attorneys to file cookie-cutter 
complaints and still survive a motion to dismiss; and the clear 
and convincing evidence standard will allow courts to more 
easily end Section 36(b) cases on summary judgement. This 
change is reasonable approach to this problem because it does 
not bar shareholders or the SEC from challenging fees with a 
section 36(b) claim, but it discourages non-meritorious 
lawsuits that may be filed simply to threaten funds into 
settlement to avoid disproportionate litigation costs.
    Requiring plaintiffs to plead claims with particularity is 
not a new solution and is well-established in the Private 
Securities Litigation Reform Act (PSLRA). Congress passed the 
PSLRA, in part, as a response to frivolous class actions 
alleging securities fraud under both the Securities Act of 1933 
and Securities Exchange Act of 1934. The PSLRA reforms state 
that if a plaintiff is alleging the defendant made misleading 
statements and omissions, ``the complaint shall specify each 
statement alleged to have been misleading, the reason or 
reasons why the statement is misleading, and, if an allegation 
regarding the statement or omission is made on information and 
belief, the complaint shall state with particularity all facts 
on which that belief is formed.'' Additionally, under the PSLRA 
if the plaintiff alleges intent against the defendant, ``the 
complaint shall, with respect to each act or omission alleged 
to violate this chapter, state with particularity facts giving 
rise to a strong inference that the defendant acted with the 
required state of mind.''
    The clear and convincing evidentiary burden also is not 
new. It is the standard required for lawsuits under the 
Employee Retirement Income Security Act, various federal 
whistleblower statutes (e.g., Sarbanes-Oxley Act of 2002), 
patent law, and several other federal statutes.
    Using the PSLRA as a model, H.R. 4738 requires plaintiffs 
to allege specific facts to demonstrate each element of the 
claim. This requirement will facilitate the ability of courts 
to terminate lawsuits that lack merit on motions to dismiss and 
save much of the expense of pre-trial discovery. Mr. Emmer's 
bill also requires plaintiffs to show that their claims are 
substantially more likely to be true than not before they can 
recover. This standard--higher than the typical ``preponderance 
of the evidence'' for civil lawsuits--will facilitate the 
ability of courts to terminate Section 36(b) lawsuits that lack 
merit on summary judgment and avoid the expense and waste of 
resources of trial.

                                Hearings

    The Committee on Financial Services held a hearing 
examining matters relating to H.R. 4738 on April 26, 2017, and 
April 28, 2017.

                        Committee Consideration

    The Committee on Financial Services met in open session on 
January 17, 2018, and January 18, 2018, and ordered H.R. 4738 
to be reported favorably to the House without amendment by a 
recorded vote of 31 yeas to 25 nays (recorded vote no. FC-148), 
a quorum being present.

                            Committee Votes

    Clause 3(b) of rule XIII of the Rules of the House of 
Representatives requires the Committee to list the record votes 
on the motion to report legislation and amendments thereto. The 
sole recorded vote was on a motion by Chairman Hensarling to 
report the bill favorably to the House without amendment. The 
motion was agreed to by a recorded vote of 31 yeas to 25 nays 
(Record vote no. FC-148), a quorum being present.

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                      Committee Oversight Findings

    Pursuant to clause 3(c)(1) of rule XIII of the Rules of the 
House of Representatives, the findings and recommendations of 
the Committee based on oversight activities under clause 
2(b)(1) of rule X of the Rules of the House of Representatives, 
are incorporated in the descriptive portions of this report.

                    Performance Goals and Objectives

    Pursuant to clause 3(c)(4) of rule XIII of the Rules of the 
House of Representatives, the Committee states that H.R. 4738 
will reduce unsubstantiated lawsuits against mutual fund 
advisers by updating the burden of proof for section 36(b) 
claims to clear and convincing evidence, and requiring that any 
complaint be pleaded with particularity.

   New Budget Authority, Entitlement Authority, and Tax Expenditures

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee adopts as its 
own the estimate of new budget authority, entitlement 
authority, or tax expenditures or revenues contained in the 
cost estimate prepared by the Director of the Congressional 
Budget Office pursuant to section 402 of the Congressional 
Budget Act of 1974.

                 Congressional Budget Office Estimates

    Pursuant to clause 3(c)(3) of rule XIII of the Rules of the 
House of Representatives, the following is the cost estimate 
provided by the Congressional Budget Office pursuant to section 
402 of the Congressional Budget Act of 1974:

                                     U.S. Congress,
                               Congressional Budget Office,
                                    Washington, DC, April 10, 2018.
Hon. Jeb Hensarling,
Chairman, Committee on Financial Services,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 4738, the Mutual 
Fund Litigation Reform Act.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Stephen 
Rabent.
            Sincerely,
                                                Keith Hall,
                                                          Director.
    Enclosure.

H.R. 4738--Mutual Fund Litigation Reform Act

    H.R. 4738 would raise the burden of proof required for a 
security holder of a registered investment company to bring a 
civil action and to prove a breach of fiduciary duty by an 
investment advisor in certain circumstances.
    Using information from the Securities and Exchange 
Commission (SEC), CBO estimates that implementing H.R. 4738 
would have no significant effect on the agency's costs or 
operations. Moreover, the SEC is authorized to collect fees 
sufficient to offset its annual appropriation; therefore, CBO 
estimates that the net effect on discretionary spending would 
be negligible, assuming appropriation actions consistent with 
that authority.
    Enacting H.R. 4738 would not affect direct spending or 
revenues; therefore, pay-as-you-go procedures do not apply.
    CBO estimates that enacting H.R. 4738 would not increase 
net direct spending or on-budget deficits in any of the four 
consecutive 10-year periods beginning in 2029.
    H.R. 4738 contains no intergovernmental or private-sector 
mandates as defined in the Unfunded Mandates Reform Act.
    The CBO staff contact for this estimate is Stephen Rabent. 
The estimate was approved by H. Samuel Papenfuss, Deputy 
Assistant Director for Budget Analysis.

                       Federal Mandates Statement

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995.
    The Committee has determined that the bill does not contain 
Federal mandates on the private sector. The Committee has 
determined that the bill does not impose a Federal 
intergovernmental mandate on State, local, or tribal 
governments.

                      Advisory Committee Statement

    No advisory committees within the meaning of section 5(b) 
of the Federal Advisory Committee Act were created by this 
legislation.

                  Applicability to Legislative Branch

    The Committee finds that the legislation does not relate to 
the terms and conditions of employment or access to public 
services or accommodations within the meaning of the section 
102(b)(3) of the Congressional Accountability Act.

                         Earmark Identification

    With respect to clause 9 of rule XXI of the Rules of the 
House of Representatives, the Committee has carefully reviewed 
the provisions of the bill and states that the provisions of 
the bill do not contain any congressional earmarks, limited tax 
benefits, or limited tariff benefits within the meaning of the 
rule.

                    Duplication of Federal Programs

    In compliance with clause 3(c)(5) of rule XIII of the Rules 
of the House of Representatives, the Committee states that no 
provision of the bill establishes or reauthorizes: (1) a 
program of the Federal Government known to be duplicative of 
another Federal program; (2) a program included in any report 
from the Government Accountability Office to Congress pursuant 
to section 21 of Public Law 111-139; or (3) a program related 
to a program identified in the most recent Catalog of Federal 
Domestic Assistance, published pursuant to the Federal Program 
Information Act (Pub. L. No. 95-220, as amended by Pub. L. No. 
98-169).

                   Disclosure of Directed Rulemaking

    Pursuant to section 3(i) of H. Res. 5, (115th Congress), 
the following statement is made concerning directed 
rulemakings: The Committee estimates that the bill requires no 
directed rulemakings within the meaning of such section.

             Section-by-Section Analysis of the Legislation


Section 1. Short title

    This section cites H.R. 4738 as the ``Mutual Fund 
Litigation Reform Act''.

Section 2. Complaint and burden of proof requirements for certain 
        actions for breach of fiduciary duty

    This section amends Section 36(b) of the Investment Company 
Act of 1940 to provide that in actions alleging a breach of 
fiduciary duty the plaintiff must state with particularity the 
facts establishing a breach of fiduciary duty and that the 
plaintiff must prove the breach of fiduciary duty by clear and 
convincing evidence.

         Changes in Existing Law Made by the Bill, as Reported

    In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (existing law 
proposed to be omitted is enclosed in black brackets, new 
matter is printed in italics, and existing law in which no 
change is proposed is shown in roman):

         Changes in Existing Law Made by the Bill, as Reported

  In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (new matter is 
printed in italics and existing law in which no change is 
proposed is shown in roman):

                     INVESTMENT COMPANY ACT OF 1940


TITLE I--INVESTMENT COMPANIES

           *       *       *       *       *       *       *



                        breach of fiduciary duty

  Sec. 36. (a) The Commission is authorized to bring an action 
in the proper district court of the United States, or in the 
United States court of any territory or other place subject to 
the jurisdiction of the United States, alleging that a person 
who is, or at the time of the alleged misconduct was, serving 
or acting in one or more of the following capacities has 
engaged within five years of the commencement of the action or 
is about to engage in any act or practice constituting a breach 
of fiduciary duty involving personal misconduct in respect of 
any registered investment company for which such person so 
serves or acts, or at the time of the alleged misconduct, so 
served or acted--
          (1) as officer, director, member of any advisory 
        board, investment adviser, or depositor; or
          (2) as principal underwriter, if such registered 
        company is an open-end company, unit investment trust, 
        or face-amount certificate company.
If such allegations are established, the court may enjoin such 
persons from acting in any or all such capacities either 
permanently or temporarily and award such injunctive or other 
relief against such person as may be reasonable and appropriate 
in the circumstances, having due regard to the protection of 
investors and to the effectuation of the policies declared in 
section 1(b) of this title.
  (b) For the purposes of this subsection, the investment 
adviser of a registered investment company shall be deemed to 
have 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, or by the security 
holders thereof, to such investment adviser or any affiliated 
person of such investment adviser. An action may be brought 
under this subsection by the Commission, or by a security 
holder of such registered investment company on behalf of such 
company, against such investment adviser, or any affiliated 
person of such investment adviser, or any other person 
enumerated in subsection (a) of this section who has a 
fiduciary duty concerning such compensation or payments, 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. 
With respect to any such action the following provisions shall 
apply:
          (1) It shall not be necessary to allege or prove that 
        any defendant engaged in personal misconduct, and the 
        plaintiff shall have the burden of proving a breach of 
        fiduciary duty.
          (2) In any such action approval by the board of 
        directors of such investment company of such 
        compensation or payments, or of contracts or other 
        arrangements providing for such compensation or 
        payments, and ratification or approval of such 
        compensation or payments, or of contracts or other 
        arrangements providing for such compensation or 
        payments, by the shareholders of such investment 
        company, shall be given such consideration by the court 
        as is deemed appropriate under all the circumstances.
          (3) No such action shall be brought or maintained 
        against any person other than the recipient of such 
        compensation or payments, and no damages or other 
        relief shall be granted against any person other than 
        the recipient of such compensation or payments. No 
        award of damages shall be recoverable for any period 
        prior to one year before the action was instituted. Any 
        award of damages against such recipient shall be 
        limited to the actual damages resulting from the breach 
        of fiduciary duty and shall in no event exceed the 
        amount of compensation or payments received from such 
        investment company, or the security holders thereof, by 
        such recipient.
          (4) This subsection shall not apply to compensation 
        or payments made in connection with transactions 
        subject to section 17 of this title, or rules, 
        regulations, or orders thereunder, or to sales loads 
        for the acquisition of any security issued by a 
        registered investment company.
          (5) Any action pursuant to this subsection may be 
        brought only in an appropriate district court of the 
        United States.
          (6) No finding by a court with respect to a breach of 
        fiduciary duty under this subsection shall be made a 
        basis (A) for a finding of a violation of this title 
        for the purposes of sections 9 and 49 of this title, 
        section 15 of the Securities Exchange Act of 1934, or 
        section 203 of title II of this Act, or (B) for an 
        injunction to prohibit any person from serving in any 
        of the capacities enumerated in subsection (a) of this 
        section.
          (7) In any such action brought by a security holder 
        of a registered investment company on behalf of such 
        company--
                  (A) the complaint shall state with 
                particularity all facts establishing a breach 
                of fiduciary duty, and, if an allegation of any 
                such facts is based on information and belief, 
                the complaint shall state with particularity 
                all facts on which that belief is formed; and
                  (B) such security holder shall have the 
                burden of proving a breach of fiduciary duty by 
                clear and convincing evidence.
  (c) For the purposes of subsections (a) and (b) of this 
section, the term ``investment adviser'' includes a corporate 
or other trustee performing the functions of an investment 
adviser.

           *       *       *       *       *       *       *

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                             MINORITY VIEWS

    H.R. 4738 was unanimously rejected by Committee Democrats 
as it would make it harder for mutual fund investors to reign 
in excessive advisory fees.
    Mutual funds are a popular choice for Americans saving for 
school, retirement or a rainy day, but when advisers levy 
excessive fees, they rob everyday working people of their 
future. In 1970, Congress bolstered protections for mutual fund 
investors by amending the Investment Company Act of 1940 to (1) 
require that investment advisers act in the best interest of 
their mutual fund clients when assessing advisory fees, and (2) 
provide mutual fund investors the right to sue when investment 
advisers breach this duty by charging excessive fees. 
Importantly, the right to challenge excessive advisory fees is 
the only private cause of action granted to investors under the 
Investment Company Act.
    In 2010, the U.S. Supreme Court in Jones v. Harris 
Associates L.P., 559 U.S. 335 (2010), adopted a pro-industry 
standard that has kept investors who try to challenge excessive 
advisory fees from prevailing in court. The standard is nearly 
impossible to meet as it requires investors to prove 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.'' As a 
result, excessive fee lawsuits rarely proceed to trial.
    H.R. 4738 would make it even harder for mutual fund 
investors seeking to challenge excessive and arbitrary advisory 
fees to get their day in court. The bill would increase both 
the pleading standard and the burden of proof for excessive fee 
lawsuits above and beyond what is generally required of civil 
plaintiffs in federal court. Currently, an excessive fee 
complaint, like most federal civil pleadings, is subject to 
dismissal unless it includes sufficient facts to state a 
plausible claim for relief. H.R. 4738 would increase the 
likelihood of dismissal for excessive fee claims by requiring 
that the complaint ``state with particularity all facts 
establishing a breach of fiduciary,'' even before the plaintiff 
gets access to such evidence through the civil discovery 
process. Additionally, H.R. 4738 would increase the burden of 
proof from the traditional ``preponderance of the evidence'' 
standard, to ``clear and convincing evidence.'' That means that 
investors would have almost no chance of winning excessive fee 
cases even if they successfully plead their claims.
    The North American Securities Administrators Association 
(``NASAA''), which represents our state securities regulators, 
wrote to the Committee opposing H.R. 4738. NASAA stated that 
H.R. 4738 would ``tip the scales of justice in [excessive fee] 
disputes strongly in favor of investment advisers, to the 
detriment of ordinary American retail investors.''
    Investor advocacy groups, like Americans for Financial 
Reform (``AFR'') and Consumer Federation of America (``CFA''), 
also oppose H.R. 4738. CFA, citing large price differences in 
even cost-sensitive investment vehicles like S&P 500 index 
funds, found that existing legal restraints have not been 
uniformly effective in controlling excessive fees. CFA advised 
that Congress should ``look[] for ways to further discipline 
excessive fund costs, rather than further undermin[e] the 
already inadequate protections against excessive fees.''
    We agree and oppose H.R. 4738.
                                   Maxine Waters.
                                   Al Green.
                                   Stephen F. Lynch.
                                   Juan Vargas.
                                   Carolyn B. Maloney.
                                   Emanuel Cleaver.
                                   Brad Sherman.
                                   Joyce Beatty.
                                   Daniel T. Kildee.
                                   Michael E. Capuano.
                                   Nydia M. Velazquez.
                                   Gwen Moore.
                                   Keith Ellison.

                                  [all]