Full opinion text
FINDINGS AND OPINION MILTON POLLACK, District Judge. Preliminary Over 1,100,000 persons and institutions were at the time of trial herein shareholders in a money market fund whose net assets at that time exceeded $19 billion, known as the “Merrill Lynch Ready Assets Trust” (the “Fund” hereafter). Two individual shareholders, Irving Gartenberg and Simone Andre, have brought this suit under Section 36(b) of the Investment Act of 1940, 15 U.S.C. Section 80a-35(b) (the “Act”) complaining of the size of the annual compensation paid to the Fund’s Investment Adviser in 1980-81 under its percentage contract with the Fund. The fee paid to the Adviser, “Merrill Lynch Asset Management, Inc.” (“MLAM” hereafter) is contingent on the average daily value of the net assets of the Fund during the period; the annual compensation amounted to 0.288% or slightly above V) of one percent of those net assets. The Gartenberg complaint names as defendants, i) the Fund, ii) MLAM, a wholly-owned subsidiary of Merrill Lynch & Co., Inc. (“Merrill Lynch”), which supplies the Fund with investment management, administration and required services, and iii) “Merrill Lynch, Pierce, Fenner & Smith Incorporated” (MLPF&S) another wholly-owned subsidiary of Merrill Lynch, which processes the vast bulk of the daily orders of the Fund’s shareholders. The Andre complaint names only the Fund and MLAM as defendants. There is no claim by the plaintiffs that the shareholders individually did not receive their money’s worth from MLAM, i.e., that the services supplied were not worth the fractional percentage attributable to the net assets they had in the Fund. Rather, the plaintiffs claim that because of the size of the Fund, MLAM made too much money from the application of the agreed percentage. As of December 31, 1980, plaintiff Gartenberg held 986 shares (valued at $1 per share) of the Fund and plaintiff Andre held 2,850 shares and they have continued to hold those shares together with additional shares received daily as dividends. The Fund and the Merrill Lynch organization The Fund was organized in 1975 as an unincorporated business trust under the laws of Massachusetts and registered with the Securities and Exchange Commission (“SEC”) as a diversified, open-end investment company. It is a no-load money market mutual fund (meaning that there is no cost to purchase its shares) and invests primarily in short-term money market securities. The Fund’s Board of Trustees is comprised of eight Trustees, two of whom are “interested persons” as defined in the Act. The six “non-interested” or “unaffiliated” Trustees make up the Audit Committee of the Fund. The Fund has no employees of its own. Its business is conducted from the offices of MLAM as is the business of other Merrill Lynch investment companies. MLAM, a Delaware corporation, has served as the Investment Advisor of the Fund since June 1976. MLAM also acts as the investment adviser for four other mutual funds sponsored by Merrill Lynch. MLAM selects the Fund’s investments and trades in money market securities for the Fund’s account. MLAM performs or provides the administrative and management services for the Fund and provides the Fund with office space and facilities, equipment and personnel. It imports the services of its affiliate, defendant MLPF&S, the brokerage subsidiary of Merrill Lynch, to process the principal volume of the huge number of daily orders of the Fund shareholders for the deposit and withdrawal of money to and from the Fund. MLAM also provides investment management services to individuals and institutions. The services performed for the Fund by MLAM and its affiliates can be divided into three categories: portfolio management; general administrative services; and money market fund shareholder services. The Merrill Lynch brokerage branch office system consists of 408 domestic offices in which its more than 7,000 account executives are located, all of whom are available to process shareholder orders and administer shareholder accounts for the Fund without any commission. An average of more than 30,000 shareholder orders per day are processed in that way by MLPF&S involving the purchase and redemption of shares of the Fund and other services. Much of the success of the Fund in terms of its acceptance by shareholders can be attributed to the fulsome shareholder service provided by that system. In making its investment decisions, MLAM has access to the advice and expertise of all Merrill Lynch affiliates, and particularly Merrill Lynch Economics, Inc., Merrill Lynch Government Securities, Inc. and MLPF&S. The first of these affiliates provides basic economic research and forecasting; the second is one of the largest dealers in United States Government securities and Government Agency securities; and MLPF&S is the largest registered broker-dealer in the United States and provides fundamental research on bank and other corporate issuers. The compensation attributable to the individual shareholder for the services provided by MLAM and its affiliates was far below the cost of any available alternative for similar service. The administrative services provided for the Fund by MLAM amply serve the Fund’s requirements and go well beyond mere office matters. Substantial efforts are necessary to maintain compliance with SEC and state regulatory requirements, including recordkeeping and reporting requirements. MLAM renders these services to the Fund. Additionally Merrill Lynch Funds Distributor, Inc. (MLFD), which is a 100% owned subsidiary of MLAM, acts as distributor of Fund shares and maintains a staffed answer-telephone for inquiries from shareholders. MLFD has waived its right to commissions on the sale of Fund shares. The Money Fund Industry and the Growth of the Fund Money market funds make available to small investors and short term cash depositors substantially higher interest rates than are obtainable through bank deposits. They offer redeemable participations in terms of shares in a portfolio of securities. The first such fund was started in 1972. The money market fund industry has experienced extraordinary growth in the last few years. New money market funds have been sprouting up regularly — there is no difficulty in entering the field. In 1975, there were 32 money market funds. By 1978 there were 54 and today there are 139 such funds. The assets under management in all the money market funds have likewise grown enormously and dramatically. In June 1978 there was a total of about $6.8 billion of assets in money market funds; today their assets total more than $185 billion — a 25-fold growth. The Fund involved herein is by far the largest money market fund in existence. The principal reason for the prodigious growth of the Fund under MLAM’s supervision, from $100 million to over $19 billion in just a few years, has been the spectacular surge in interest rates and the availability of the Merrill Lynch system to cope with the processing services required — to administer the dramatic growth of the Fund and to satisfy the daily orders and other demands of its shareholders. It was conceded by plaintiffs’ expert that there is no adequate substitute readily available for the Merrill Lynch system to handle the Fund. The enormous gap between interest rates paid by banks and money funds renders' the Fund an attractive short-term investment for high daily income returns, in a medium available without any cost to the customer to buy or sell the investment, by easy means of deposits and withdrawals in every geographical area of the United States (and beyond), subject to simple check withdrawals, as frequently as desired by the shareholder, with relative security of the principal meanwhile. The net asset value of shares of the Fund remains constant at $1 per share and net income (including realized and unrealized gains and losses of the Fund’s portfolio) is credited daily to shareholder accounts in the form of dividend shares declared daily. Thus, the fluctuations in the value of a shareholder’s investment in the Fund are reflected in the number of shares held in the shareholder’s account. The deposits and withdrawals by participants in the Fund are somewhat euphemistically styled as purchases and sales of shares of the value of those deposits and withdrawals. In a very real sense, an account in a money market fund is more like a bank account than a traditional investment in securities; and unlike an equity stock investment or other types of securities. The funds in a money market fund are not tied up for a fixed or long time. The Investment Advisory Agreement The Fund commenced operations on February 18, 1975 as the “Lionel D. Edie Ready Assets Trust”. The initial investment advisory agreement provided for an advisory fee of 0.50% of the net average daily assets. MLAM was formed in 1976 as the investment management subsidiary of Merrill Lynch so that a single Merrill Lynch company could utilize the vast resources of the entire Merrill Lynch organization in determining and achieving the specific investment objectives of institutional portfolios. On April 29, 1976, the Fund Trustees approved the first investment advisory agreement with MLAM. It provided for a schedule of contingent advisory fees starting with an annual charge of 0.50% of the first $500 million of average daily net assets, and followed by reduced percentages at a series of breakpoints as the net assets of the Fund increased. At the time the net assets of the Fund were just over $100 million. In June 1976, MLAM began acting as investment advisor to the Fund pursuant to their first advisory agreement, and the name of the Fund was changed to the “Merrill Lynch Ready Assets Trust”. The following year, on April 28,1977, the Trustees approved continuance of the same investment advisory agreement. The Fund’s assets were then approximately $288 million. One year later the assets of the Fund had grown to approximately $750 million, and MLAM proposed a revised fee schedule that would have continued the 1977 rates at existing breakpoints but would have added an additional breakpoint providing for an annual fee of 0.375% on assets in excess of $1 billion. The independent Trustees accepted MLAM’s proposal to add a new breakpoint at the $1 billion level, but insisted on reducing the proposed fee rate to 0.425% and 0.375% on assets in excess of $500 million and $750 million respectively and to 0.35% at the new $1 billion level. Although MLAM was opposed to these revisions in its fee schedule, it accepted the Trustees’ decision and on April 27, 1978, the Trustees approved an agreement containing the fee reductions as initiated by the independent Trustees. During late 1978, the assets of the Fund increased substantially. On January 24, 1979, while the 1978 agreement was still in effect, MLAM again voluntarily reduced its fee by introducing two additional breakpoints at the $1.5 and $2 billion levels. These additional breakpoints reduced the advisory fee to 0.325% of assets over $1.5 billion and 0.30% of assets over $2 billion. At that time the Fund had net assets of approximately $2 billion. The Fund continued to grow rapidly during 1979, and in May its assets reached $3.5 billion. On May 8, 1979, the Trustees approved an advisory agreement, which added yet another breakpoint at the $2.5 billion asset level. The schedule of advisory fees payable to MLAM under the 1979 and subsequent agreements is set forth in the table below: Advisory Portion of average daily value of net assets: Fee Not exceeding $500 million ............. 0.50% In excess of $500 million but not exceeding $750 million ..................... 0.425% In excess of $750 million but not exceeding $1 billion ...................... 0.375% In excess of $1 billion but not exceeding $1.5 billion..................... 0.35% In excess of $1.5 billion but not exceeding $2 billion ...................... 0.325% In excess of $2 billion but not exceeding $2.5 billion ...................... 0.30% In excess of $2.5 billion ................ 0.275% This fee schedule was reviewed and approved by the Trustees of the Fund for another year on April 24, 1980, when the size of the Fund was $9.8 billion, and again on May 7, 1981, when the size of the Fund was $17 billion. At the trial date level of over $19 billion, the effective rate of the fee under the above schedule approximated 0.288%, or $2.88 annually for each $1,000 invested. This rate is among the lowest in the industry for a Fund of this type and, at the trial date level of the Fund, the average of the size of shareholders’ accounts (approximately $15,500) incurs an annual charge, for advisory and deposit and withdrawal services, of about $45. Processing Orders for the Fund A Fund account may be opened at the option of the customer either through MLPF&S, the Broker affiliate, or directly through The Bank of New York, the Fund’s custodian and transfer agent,-which is under contract as such to the Fund. A depositor in the Fund has the option of placing orders to purchase or redeem shares of the Fund through the Broker or directly through the transfer agent. MLPF&S (the Broker affiliate) during the period under review received and processed approximately 80% of the orders for purchases of shares made by the shareholders of the Fund. When an investor purchases or redeems shares of the Fund through the Broker, such transactions are processed through a brokerage account with the Broker which is opened either specifically for purposes of deposits in the Fund, i.e., purchase of Fund shares, or through an account previously opened in connection with transactions in other securities. No charge is made to the Fund’s customer for accepting the deposit, opening and maintaining the securities brokerage account, or for the shares obtained by the deposit, or for redemptions, even if an account is opened and utilized solely for purposes of transactions in Fund shares. Orders for the purchase or redemption of Fund shares placed through the Broker are transmitted from the branch offices by wire to computer facilities and administrative personnel in the Merrill Lynch home office. Plaintiffs’ Contentions Plaintiffs claim that Congress intended to limit the fees of Advisers to fair charges and that the compensation to MLAM is unreasonably high and disproportionate to the services rendered and their co.sts. Plaintiffs offer as an apt comparison for the compensation payable by the Fund, the compensation (unspecified) that pension fund managers are paid which plaintiffs say is only a fraction of the compensation which the Fund pays. Turning from the price paid by the Fund, the plaintiffs claim that the costs of servicing the contract by MLAM should be considered in evaluating the fairness of its compensation but should not include the expense incurred by MLAM’s affiliate, MLPF&S, in the handling of the service requirements of the Fund investors and shareholders. They claim that the Broker is “unnecessarily” rendering such services and that the Transfer Agent, The Bank of New York, is allegedly capable and should perform them. They claim that the fall-out benefits to the Broker from opening accounts and servicing the money market fund needs of the investors should be considered as an offset to the expense of the Broker in processing the orders of the shareholders of the Fund. Additionally, plaintiffs attack the studies made of the costs of those services, studies made by Merrill Lynch staff as well as by independent cost accounting experts, which quantified the processing costs; they characterize those studies as improperly performed and vastly overstating the real expense incurred. Plaintiffs add, that at all events, such expenses in reality should be considered as a cost of distribution of securities and in their view, the federal statute and regulations do not permit a mutual fund to pass along such an expense to the shareholders. Plaintiffs also challenge the approvals of the fees to MLAM by the Trustees and the shareholders of the Fund and assert that in considering whether the compensation received was in breach of fiduciary duty, no weight should be given by the Court to their respective approvals of the advisory fee, because the Trustees allegedly failed to consider critical facts and allegedly were misled and because the shareholders were not provided with correct or adequate information on which to make a knowledgeable ratification. A critical examination of the actual and relevant facts concerning the issue of whether the compensation received by MLAM constituted a breach of fiduciary duty exposes the unreality and invalidity of each of plaintiffs’ contentions. The Statute Section 36(b) of the Investment Company Act of 1940 provides that “the investment adviser . . . 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.” The statute expressly provides that “plaintiff shall have the burden of proving a breach of fiduciary duty.” Section 36(b) was added to the Act in 1970. Its enactment was precipitated as the result of the abuses which Congress had perceived with respect to equity load funds during the 1960’s. See generally S.Rep.No. 184, 91st Cong., 1st Sess., accompanying S. 2224, reprinted in [1970] U.S. Code Cong. & Ad. News 4897 [hereinafter “Senate Report”]. Money market funds were not in existence at that time. It seems clear from that fact that Congress had in mind front-end load equity funds and not today’s money market funds which are no-load and in which a shareholder can redeem his shares without the payment of any penalty or tax consequences, and freely invest his funds without expense, on virtually the same terms, in any one of the large number of other funds available in the market place. The basic contention of plaintiffs in these cases is that MLAM is making “too much” money and that this, in and of itself, constitutes a violation of the fiduciary duty imposed upon investment advisers by Section 36(b). However, Congress explicitly, recognized “the fact that the investment adviser is entitled to make a profit. Nothing in the bill is intended to imply otherwise ...” Senate Report at 6, U.S. Code Cong. & Admin. News 1970, p. 4902. The price charged for the service is the key fact — the cost to the fiduciary of rendering the service is of relative unimportance. Congress has made it very clear in the legislative history that it rejected any concept that Section 36(b) should impose a “cost plus” basis as a standard or that the Court should engage in rate-making. The Senate Report cited above accompanying the 1970 amendments makes it evident that Congress did not intend the Courts to “second-guess” the business judgment of the independent trustees with respect to the size of the investment advisory fee: Nothing in the bill is intended to ... suggest that a “cost-plus” type of contract would be required. It is not intended to introduce general concepts of rate regulation as applied to public utilities. * * * * * ¡Jc This section is not intended to authorize a Court to substitute its business judgment for that of the mutual fund’s board of directors in the area of management fees. * * * * * * Th[is] section is not intended to shift the responsibility for managing an investment company in the best interest of its shareholders from the directors of such company to the judiciary. Senate Report at 6-7, U.S. Code Cong. & Admin. News 1970, p. 4902. (Emphasis supplied). As one commentator pointed out, Congress moved away from testing the amount of the compensation and focused instead on the adviser’s conduct: The deletion of the reasonableness standard and substitution of the adviser’s fiduciary obligation changed not only the standard of judicial review but the method for testing management’s compensation. The test no longer modified the fee in Sec. 15 but was made part of the adviser’s duties under Sec. 36. Nutt, A Study of Mutual Fund Independent Directors, 120 U.Pa.L.Rev. 179, 190 n. 61 (1971). The Second Circuit, in its opinion affirming this Court’s decision to strike plaintiff’s jury demand, specifically adopted the Pennsylvania Law Review analysis: The original bills introduced in the Senate and the House provided that the propriety of charges should be determined by the test of “reasonableness”. (Citations omitted). Influenced in part by industry opposition to the “reasonableness” standard, Congress shifted, to the standard of “fiduciary duty” that is in the present act. In re Gartenberg, 636 F.2d 16, 17 (2d Cir. 1980), cert. denied, 451 U.S. 910, 101 S.Ct. 1979, 68 L.Ed.2d 298 (1981). The Congress was not precise in delineating the test for compliance with the fiduciary standard by which to judge the acceptability of compensation to a money market fund advisor. The fiduciary standard “imposes a high degree of legal commitment to treat the fund with utmost fairness.” 116 Cong.Rec. 33282 (1970) (remarks of Rep. Springer.) Some members of Congress left open the possibility that in certain limited circumstances, the fee, considered by itself, might be enough to prove a breach of the Section 36(b) standard. Senator Bennett, in his remarks on the bill, stated that the section authorized lawsuits “in the event that the fee received is claimed to be so excessive as to constitute a breach of fiduciary duty.” 115 Cong.Rec. 13693 (1969) (emphasis added). In the House, Representative Moss stated that the duty was “a legal obligation to so administer and so charge the fund so that [the adviser] does not commit an excess against the fund.” 116 Cong.Rec. 33281 (1970) (emphasis added). While Congress rejected any attempt to rest the inquiry on what was “reasonable,” it did not indicate that the common law standard of “corporate waste,” which had previously been available to challenge advisory fees, was to be disregarded as an element of the Court’s inquiry. The Senate committee explicitly “decided [only] that the standard of ‘corporate waste’ [was] unduly restrictive.” Senate Report, at 5, U.S. Code Cong. & Admin. News 1970, p. 4901. Section 36(b) was an attempt to strengthen, not erode, that standard. See Tannenbaum v. Zeller, 552 F.2d 402, 416 n.20 (2d Cir. 1977), cert. denied 431 U.S. 934, 98 S.Ct. 421, 54 L.Ed.2d 293 (1977); Herzog v. Russell, 483 F.Supp. 1346, 1349 n.1 (E.D. N.Y.1979). Specific purposes to be served under Section 36(b) were stated in the legislative history and these may be summarized as follows. These purposes serve as the only congressional guide to the principles of the judicial review of compensation obtained by a fiduciary of a money market fund. The Intention of the Legislation 1. What is intended: (a) That the investment adviser is entitled to make a profit. 2. What is not intended: (a) That a cost-plus type of contract is required. (b) That general concepts of rate regulation as applies to public utilities are to be introduced. (c) That the standard of “corporate waste” is to be applied. (d) That management fees should be tested on whether they are “reasonable”. (e) That a congressional finding has been made that the present industry level or that the fee of any particular adviser is too high. (f) That the Court is authorized to substitute its business judgment for that of the directors. (g) That the responsibility for management is to be shifted from directors to the judiciary. (h) That economies of scale are necessarily applicable at every stage of growth of the Fund. 3. The test of fairness is to be made by the Court, in part: (a) By reference to industry practice. (b) By reference to industry level of management fees. 4. The Court shall determine whether (c) The attention of directors was fixed on their responsibilities. (d) The directors requested and obtained information reasonably necessary to evaluate the terms of the management contract. (e) The directors having the primary responsibility for looking after the best interests of the Fund’s shareholders, have evaluated such information accordingly. The net intent of the legislation to the extent it was expressed would seem to leave it to the federal courts to interpret compliance with “fiduciary duty” in the common law tradition (in this case “federal common law”, really federal equity jurisprudence). Thus viewed, Section 36(b) represents a political compromise of a highly emotional nature which eschews rate regulation for personal services but nonetheless caps compensatiqn at market acceptability accompanied by good faith and fair disclosure of that range. An examination of the case authorities also fails to illumine precisely the path to be followed by the Court in weighing the compensation of the investment adviser of a money market fund under fiduciary standards. Only general concepts have been articulated. The standard of fiduciary duty under Section 36(b) “is concerned solely with fairness and equity.” In re Gartenberg, 636 F.2d 16, 17 (2d Cir. 1980), cert. denied, 451 U.S. 910, 101 S.Ct. 1979, 68 L.Ed.2d 298 (1981). “The essence of the [fiduciary] test is whether or not under all the circumstances the transaction carries the earmarks of an arm’s length bargain.” Pepper v. Litton, 308 U.S. 295, 306-07, 60 S.Ct. 238, 245-46, 84 L.Ed. 281 (1939). The conduct of the investment adviser must be governed by the “duty of uncompromising fidelity” and “undivided loyalty” to the Fund’s shareholders that is imposed by Section 36(b). Galfand v. Chestnutt, 545 F.2d 807, 809, 811 (2d Cir. 1976). For example, the investment adviser because he is a fiduciary, may not sell his office for personal gain. Rosenfeld v. Black, 445 F.2d 1337, 1342 (2d Cir. 1971), cert. dismissed 409 U.S. 802, 93 S.Ct. 24, 34 L.Ed.2d 62 (1972). When “endeavoring to influence the selection of a successor,” a fiduciary must act “with an eye single to the best interests of the beneficiaries.” Id. Moreover, it is well settled that the investment adviser owes a duty of full disclosure to the trustees and shareholders of the Fund. Galfand, 545 F.2d at 811. See Tannenbaum v. Zeller, 552 F.2d 402, 417 (2d Cir.), cert. denied, 431 U.S. 934, 98 S.Ct. 421, 54 L.Ed.2d 293 (1977) (Sec. 36(a)); Fogel v. Chestnutt, 533 F.2d 731, 750 (2d Cir. 1975), cert. denied, 429 U.S. 824, 97 S.Ct. 77, 50 L.Ed.2d 86 (1976); Moses v. Burgin, 445 F.2d 369 (1st Cir. 1971), cert. denied, 404 U.S. 994, 92 S.Ct. 532, 30 L.Ed.2d 547 (1971). And even when full disclosure has been made, the courts must “subject the transaction to rigorous scrutiny for fairness.” Galfand, 545 F.2d at 811-12; Krasner v. Dreyfus Corp., 90 F.R.D. 665 (S.D.N.Y.1981). The Fairness of the Advisory Fee In determining whether MLAM has breached its fiduciary duty, this Court must primarily examine what the Fund paid and what it received. The Court must consider the “nature, quality and extent” of the services to the Fund in relation to the fee paid by the Fund. Note, Mutual Fund Advisory Fees — Too Much for Too Little? 48 Fordham L.Rev. 530, 545 (1980). Accord, Krasner v. Dreyfus Corp., 500 F.Supp. 36 (S.D.N.Y.1980). Congress intended that the court look to all facts in connection with the determination and receipt of such compensation, including all services rendered to the fund or its shareholders and all compensation and payments received, in order to reach a decision as to whether the adviser has properly acted as a fiduciary in relation to such compensation. Senate Report, at 15, House Report, at 37, U.S. Code Cong. & Admin. News 1970, p. 4910. The legislation permits the Court to give such weight as it may allow to the approval of the investment advisory agreement by the trustees and shareholders of the Fund. It bears repeating that in order- to provide relief under Section 36(b), it is not enough for this Court to find that a better bargain was possible. Instead, plaintiffs can prevail only if this Court finds that MLAM received compensation under an agreement that was unfair to the Fund and its shareholders. A. The Nature, Quality and Extent of the Services Provided in Relation to the Fee Paid. 1. The services provided Merrill Lynch provides three types of services to the Fund. MLAM manages the Fund’s portfolio and has important administrative functions, while MLPF&S, under a contractual arrangement with MLFD, provides the overwhelming bulk of shareholder services. Plaintiffs contend that MLAM’s performance in managing the Fund’s portfolio has been “only fair.” Defendants counter that the Fund’s performance has been “substantially above average.” According to Donoghue’s Money Fund Report, whether all money market funds are considered, or only stockbroker-sponsored funds, the Fund’s yield has been above average for 1978, 1979, and 1980. For 1980, in terms of its yield, the Fund ranked 37th out of all 76 money funds and 10th out of the 22 stockbroker-sponsored money funds. These figures are not entirely inconclusive. While the Fund’s performance, as measured by its yield, has not been spectacular, neither has it been disappointing. The Fund’s performance assures its customers that they may safely take advantage of the high interest rates afforded by money market instruments without fear that their return will be below the industry average. Pursuant to the investment advisory agreement, MLAM furnishes to the Fund “office space and all necessary office facilities for managing the affairs and investments and keeping the books of the [Fund].” MLAM is responsible for the Fund’s compliance with all the applicable record-keeping and reporting requirements of federal securities and state Blue Sky laws. Moreover, MLAM coordinates the operation of the various entities that perform services for the Fund, such as the accountant, Transfer Agent and Broker. Neither plaintiff has denied that MLAM has been fully competent in performing these general administrative services, despite the unprecedented size of the Fund. It is the shareholder services provided to Fund shareholders by MLPF&S that distinguish it from its competitors in the money market industry. Under section 7 of the distribution agreement, MLFD entered into a selected dealer agreement with MLPF&S. As a result, the vast facilities of the Broker are available to transmit and process Fund orders. In particular, any one of the MLPF&S account executives can enter a shareholder’s order to purchase or redeem Fund shares, and can provide information concerning the Fund’s current yield and the status of the shareholder’s account over the telephone. Moreover, the account executive can arrange to invest funds in the Fund or redeem shares overnight, and can place idle money in the Fund for as little as one day. MLPF&S has continued to provide these services and the number of Fund orders processed through the Broker has almost doubled from 1979 to 1980. Indeed, during the first six months of 1981 the rate at which orders were processed was nearly 3% times the 1979 rate. 2. The fee paid In return for these services, the Fund pays MLAM a fee according to a schedule that is the subject of the present suit. In evaluating this fee, it must be recognized that the Fund is by far the largest money market fund in existence, and has been so during the period with which this suit is concerned. In such a situation, industry comparisons can never be entirely persuasive. Even with this caveat in mind, MLAM’s fee compares very favorably with others in the industry. First of all, the Fund pays one of the lowest effective rates of any money market fund. At current asset levels, the effective fee is less than 0.29%, or less than $2.90 for every $1,000 invested in the Fund. Moreover, the Fund’s ratio of expenses to average net assets is in line. At least 16 funds of all types had higher expense ratios, while five had lower ratios. 3. The net earnings as a resuit of providing the services The price that the market will pay for the services involved is a principal consideration in evaluating its fairness. Costs of the services enter into the determination of the price to be demanded by the Adviser, but price to the Fund is critical, not cost to the supplier. The competitive price in the market is what sells the services; cost to the Adviser is not the way the service is sold. Plaintiffs contend that direct costs to MLAM, including personnel costs, bookkeeping and office supplies, only, may properly be considered in determining whether the fee is fair. They contend, moreover, that the costs incurred by MLPF&S associated with the opening of a Fund account and in providing the shareholder services that are one of the most distinguishing features of the Fund, may not properly be considered, because MLPF&S is not obligated to perform them. Nothing in Section 36(b) obligates this Court, in assessing the fairness of the investment advisory compensation, to restrict its vision only to those services performed directly by MLAM. Indeed, the statute recognizes that in order to properly assess the fairness of advisory compensation, the courts cannot be strictly bound by corporate structure and ignore closely related entities whose functions intimately impinge on one another. The statute itself speaks of payment for the services of the advisor “or any' affiliated person of such investment adviser.” 15 U.S.C. Sec. 80a-35(b) (1976). As both the Senate and the House reports stated: [I]t is intended that the court look at all the facts in connection with the determination and receipt of such compensation, including all services rendered to the fund or its shareholders and all compensation and payments received, in order to reach a decision as to whether the adviser has properly acted as fiduciary in relation to such compensation. Senate Report at 15; House Report, at 37, U.S. Code Cong. & Admin. News 1970, p. 4910. That the courts are not required blindly to adhere to corporate organization when there is no reason to do so also follows from the equitable nature of their task under Section 36(b). Equity has traditionally refused to be hemmed in by rigid boundaries; on the contrary, equitable powers are inherently flexible. “Equity always attempts to get at the substance of things, and to ascertain, uphold, and enforce rights and duties which spring from the real relations of parties.” 1 J. Pomeroy, A Treatise on Equity Jurisprudence Sec. 378 (4th ed. 1918). In this case, both MLAM and MLPF&S are wholly-owned by Merrill Lynch & Co., Inc. MLPF&S has a selected dealer agreement with the Fund’s Distributor which authorizes it to process Fund orders. Most importantly, MLPF&S provides Fund customers with convenient access to the Fund through the enormous Merrill Lynch brokerage system. It is undoubtedly as a result of the convenience to them that the customers select MLPF&S to process the overwhelming majority of Fund orders and the Fund has become the largest of its kind in the world. And yet, since the investors are not charged a sales load for processing Fund orders, MLPF&S is not compensated directly for providing these shareholder services. There are significant advantages to purchasing and redeeming shares of the Fund through a securities brokerage account maintained with MLPF&S which are not available to individuals who process their transactions through the Transfer Agent. The flexibility available to an investor to swing from one form of investment to another, simply, efficiently and without cost is of considerable advantage to the Fund shareholder. In sum, it appears that MLPF&S provides an essential portion of the total package of services that may properly be compensated by the advisory fee. Certainly Merrill Lynch’s own internal actions demonstrate that it believed this to be the case, since for the past two years it has required MLAM to reimburse MLPF&S for estimates of its costs in processing Fund orders, based on the lowest internal estimates thereof. In view of these considerations, the processing costs to MLPF&S may properly be considered in assessing the fairness of the compensation paid by the Fund. 4. Costs of providing the processing services The record shows that the costs to MLPF&S of providing processing services to the Fund, though uncertain in amount, were substantial. There have been three basic'estimates of the costs to MLPF&S of processing Fund orders, ranging from $2 to $7.50 per transaction. These studies were undertaken as a result of the exploding volume of orders that the Fund was experiencing. The earliest estimate was calculated by Robert Diemer, an official with Merrill Lynch’s Diversified Financial Services Group, which oversees Merrill Lynch’s money funds. Using figures for the first quarter of 1979, Diemer combined the direct processing costs to MLPF&S (essentially the costs of entering and executing a Fund order) with an allocation for the costs of Merrill Lynch’s branch offices, and concluded that it cost MLPF&S $5.06 for every Fund order it processed. Even though Diemer had stated earlier that any allocation of branch expenses “would be subjective at best,” he concluded that an allocation of branch expenses based on MLAM revenue as a percentage of total Merrill Lynch “production credits” would be most appropriate. Since MLAM revenue constituted 1.3% of all production credits, Diemer allocated 1.3% of MLPF&S branch expenses to the processing of Fund orders. Diemer’s estimate was met with firm opposition from Arthur Zeikel, the president of ML AM, who thought it overstated the Fund’s burden on MLPF&S. Diemer had allocated a portion of total branch expenses to arrive at his estimate, but Zeikel thought an incremental cost approach would be more accurate, since most of MLPF&S branch costs would still remain even if the Fund were not in existence. On August 24, 1979, a memo was prepared by F. G. FitzGerald, vice-president and chief financial officer of Merrill Lynch & Co., Inc., which showed the incremental costs of the Fund to MLPF&S for the first quarter of 1979 to be $2.02 per order. On the basis of his' figures, Fitz-Gerald recommended that MLAM reimburse MLPF&S for allocated processing costs according to the following schedule: First 500,000 orders $3.00 per order Second 500,000 orders $2.00 per order Balance $1.50 per order The most recent estimate of MLPF&S’s processing costs was made by the independent accounting firm of Peat, Marwick, Mitchell & Co. (“PMM”) in anticipation of this litigation. The results of the study were reported to the Fund’s Trustees on April 24, 1980 in connection with their annual consideration of the fee schedule of the Fund. Rather than constructing an entire new system of cost analysis of their own, PMM conducted an independent evaluation of how the costs should be allocated. PMM accountants visited a representative sample of Merrill Lynch branches all over the country and studied how much of their time was spent on Fund business. PMM dealt most extensively with figures for the third quarter of 1979, and updated its findings quarterly until the first quarter of 1981. For the third quarter of 1979, PMM found that it cost MLPF&S $9.74 per order to process Fund orders. For the fourth quarter of 1979, its study showed that processing costs were $7.47 per order. Since then, in PMM’s view, processing costs have remained in the range of $7.00 per order. The PMM study was by far the most comprehensive of the three, and the only one that involved any independent investigation of the costs at all. The partner in charge, Russell Peppet, presently vice-chairman of PMM and a cost accountant for over twenty years, testified that over 1,500 man-hours were spent on the study. It would be an exceedingly difficult task for this Court to choose the proper method of accounting for determining the costs to MLPF&S of processing Fund orders. The problem with using full cost accounting in allocating MLPF&S branch expenses to the Fund is that branch personnel and facilities were largely in place before the Fund existed and will be needed to nearly the same extent if the Fund were discontinued. Yet. the extraordinary success of the Fund has meant that an incremental cost accounting approach is probably inappropriate as well. At the end of April, 1981, Fund orders constituted 37% of all business processed by MLPF&S. To handle the additional volume generated by the shareholders and customers of the Fund, Merrill Lynch had to hire approximately 3,000 non-sales personnel. By the time the Trustees met on May 7, 1981, these considerations had convinced even Arthur Zeikel, who had originally pressed for such an approach, that the costs of processing Fund orders were too great to be analyzed on a strictly incremental basis. The compensation accepted by the Adviser was not unfair whether viewed with or without consideration of the processing costs. The fees that are in dispute in .this case derive from the schedule approved by the Trustees on April 24, 1980 and May 7, 1981. It cannot be gainsaid herein that the rate of fees are thoroughly in line with the market; the trial exhibits are conclusive on this score. In the month of April, 1980, the compensation actually paid to MLAM was approximately $2,479,565, which amounted to an annualized rate of $29,754,780. In April, 1981, just before the latest renewal of the fee schedule, the payments were running at a rate of $3,998,961 per month, or $47,987,532 per year. On the other hand, it appears to the Court to be entirely proper for the fiduciary to consider the totality of the values placed at the disposal of the shareholders in appraising the fairness of the compensation, or else form would be substituted for substance. Considering its current size, the Fund could not be administered without the branch office and wire system provided by MLPF&S to handle the enormous volume of orders from shareholders for the purchase and redemption of shares and the informational services supplied. Moreover, it is self-evident that the larger the size of the Fund, the greater the investment advantages to the shareholders, advantages not available to smaller funds. 5. The “distribution expense” argument Plaintiffs argue that these cost estimates for servicing the interests of the Fund and its shareholders do not measure expenses properly compensable by the Fund because they constitute “distribution” expenses under Section 12(b) of the Investment Company Act of 1940, which provides that: It shall be unlawful for any registered open-end company (other than a company complying with the provisions of section 80a-10(d) of this title) to act as a distributor of securities of which it is the issuer, except through an underwriter, in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors. 15 U.S.C. Sec. 80a-12(b) (1976). However, plaintiffs have failed to prove that any of MLPF&S’s processing costs are of the character of forbidden “distribution” expenses. The costs associated with the booking of orders and administrative costs associated with share orders and maintaining the accounts of investors in the Fund are managerial functions rather than promotional expenses. Under Rule 12b-l, an investment company “will be deemed to be acting as a distributor of securities of which it is the issuer, other than through an underwriter, if it engages directly or indirectly in financing any activity which is primarily intended to result in the sale of shares issued by such company.” 17 C.F.R. Sec. 270.12b-1(2) (1981). The activity here of MLPF&S was not “primarily intended to result in the sale of shares.” In support of their argument seeking to ascribe distribution to the processing function, plaintiffs point to the fact that Merrill Lynch’s internal documents referred to the branch expenses portion of MLPF&S processing costs as “branch office selling expenses.” By attempting to equate Merrill Lynch’s use of the word “selling” with forbidden “distribution” under the SEC rule, plaintiffs had hoped-but failed-to show that some portion of the processing costs were in reality distribution costs which cannot be considered in ássessing the reasonableness of the advisory fee. Plaintiffs have failed to demonstrate that the branch office selling expenses were in fact related to activity intended to result in the sale of Fund shares. Branch expenses were allocated in order to derive a figure for how much it cost MLPF&S to process Fund orders; the allocated expenses did not pretend to describe what activities branch personnel actually performed in processing Fund orders. Even PMM, which did the most detailed survey of branch activity, only calculated how much time branch personnel devoted to Fund processing and not whether they devoted that time to selling or not. What evidence there is goes against plaintiffs’ contention that a significant portion of MLPF&S’ processing costs are distribution expenses. Much of MLPF&S’ processing costs have to do with the redemption of Fund shares and the administrative functions involved in servicing existing shareholder accounts. Such costs do not relate to the sale of Fund shares at all. It is apparent, moreover, that all throughout the period under consideration the compelling impetus has been to seek high interest returns on money deposits. In essence, therefore, Fund shares have been bought, not sold; there was no basis in the evidence of activity primarily intended to result in the sale of Fund shares. If there is indeed any relevance to costs as contrasted with the price of services as established in the market, then processing costs are properly to be taken account of in measuring performance of fiduciary obligation. Moreover, this Court does not have to choose the most accurate cost accounting method to measure the processing costs attributable to the requirements of investors and the Fund, for whichever estimate of cost to MLPF&S of processing Fund orders is used, the net compensation to the Merrill Lynch organization as a whole does not appear unfair. Indeed, as the following chart shows, utilizing the Diemer and the PMM cost estimates in the calculation of MLAM’s after-tax income suggests that the Fund may currently even be a net losing proposition to the Merrill Lynch organization. Even using Fitz-Gerald’s lower estimate for processing costs, it appears that the Merrill Lynch organization received less than $6.2 million in after-tax income in compensation for servicing the billions of dollars managed for the Fund and its shareholders in the twelve month period ending June 30, 1981 and a little over $5 million in the calendar year 1980. It is obviously appropriate to view the net results to the fiduciary of the compensation he receives, after taxes, in considering the question of the fairness with which a fiduciary serves a fund. See Black v. Parker Mfg. Co., 329 Mass. 105, 117, 106 N.E.2d 544, 552 (1952) (“The effect of taxes on the income of the individual, as well as on the income of the corporation, is properly to be considered in determining the reasonableness of the salaries paid.”). To the same effect, see Heller v. Boylan, 29 N.Y. S.2d 653, 674 (N.Y.Sup.Ct. 1941), aff’d, 263 App.Div. 815, 32 N.Y.S.2d 131 (1st Dep’t 1941) (“A consideration of these enormous payments cannot ignore the high toll of the tax collector”). ML ASSET MANAGEMENT. INC. ML Ready Assets Trust Calendar Year 1980 6/30/80 - 6/30/81 Average Net Assets $11.16 billion $13.52 billion Average No. of Shareholders 675,324 835,618 Management Fee — MLAM MLAM Direct Expenses $33,008,025 $39,369,587 Office & Salary $ 1,567,847 $ 1,567,847* Income Tax (55.774%) $17,535,445 $21,083,543 Net Earnings $13,904,733 $16,718,197 Order Volume Through MLPF&S 4,949,200 6,096,537 ML MANAGEMENT, INC. Processing Costs Calendar Year 1980 6/30/80 - 6/30/81 Reimbursement to MLPF&S $ 8,563,000** N/A ML (Fitz-Gerald) - estimated $ 8,813,800 $10,534,805 ML (Diemer) - estimated $25,042,952 $30,848,477 PMM & Co. - estimated $36,970,524 $45,541,131 Profitability of Services Supplied After reimbursement to MLPF&S $ 5,341,733 N/A After ML (Fitz-Gerald) estimate $ 5,090,933 $ 6,183,392 After ML (Diemer) estimate ($11,138,219)*** ($14,130,280)** After PMM & Co. estimate ($23,065,791)*:** ($28,822,934)** *The figure for'office and salary expenses in calendar year 1980 was used as an estimate for such expenses for the period 6/30/80 - 6/30/81. ** Reimbursement was based on the Fitz-Gerald schedule, but differs slightly from it because different (evidently tentative) figures for order volume were used. *** Subject to adjustment of the income tax liability shown above. Even adopting the lowest estimate of the processing costs (the reimbursement figure of the Fitz-Gerald estimate), the profitability of administering the Fund and the shareholder services amounted to four and a half ten thousandths (0.00045) of the average net assets under supervision. Plaintiffs also argue that the processing services of MLPF&S involved in the foregoing estimates of cost overlap aspects of MLPF&S’s obligations under its Distribution Agreement with the Fund. The attempt to illustrate this on cross-examination failed and the exhibits do not support that claim beyond the possibility of some minor portion of the services rendered by MLPF&S. The bulk of the processing services are not the same services that MLFD is bound by contract to perform; the processing costs, while difficult to ascertain with any precision, are clearly of great magnitude for which no adequate substitute is readily available. B. Economics of Scale As one factor in assessing the fairness of the advisory agreement, Congress intended that the courts determine whether the investment advisor has taken account of any economies of scale in the management of the fund in setting the advisory fee. “[T]his bill recognizes that investors should share equitably, as they do in other areas, in the economies available as a result of the growth and general acceptance of mutual funds.” Senate Report at 4 U.S.Code Cong. & Admin. News 1970, p. 4901. As Senator Percy stated: Adequate compensation and incentives must be provided to companies and individuals which advise the fund on its investments and market fund shares; however, individual investors must share equitably in the economies of scale available as a result of tremendous growth in this industry. 115 Cong. Rec. 13699-700 (1969). Congress implicitly recognized that it might be impossible in some instances to conform to the “desirable tendency on the part of some fund managers to reduce their effective charges as the fund grows in size. Accordingly, the best industry practice will provide a guide.” Senate Report, at 6 U.S. Code Cong. & Admin. News 1970, p. 4902. Clearly, the present schedule takes account of economies of scale; the rate of fees diminishes progressively. See Krasner v. Dreyfus Corp., 90 F.R.D. 665, 669 (S.D.N.Y.1981). Defendants have raised doubts as to whether there are further economies of scale in the provision of the services. While the unit costs of portfolio management and general administrative services have almost certainly declined as the Fund has grown, the far greater costs of providing shareholder services appear to have remained relatively stable. As the trustees were informed in 1980, this was MLAM’s reason for refusing to introduce any additional breakpoints. MLAM does not propose to introduce additional breakpoints at assets levels over $2.5 billion because it believes the economies of scale applicable at lower asset levels tend to diminish when the fee rate reaches 0.275%.....[Tjhis “diminishing return” occurs largely because the costs of MLAM and Merrill Lynch associated with processing orders and administering shareholder accounts have not diminished as assets increase beyond the $2.5 billion level. Of the three studies of processing costs available to the Court, the only one which was performed over a significant number of quarterly periods was the PMM study. That study found that unit processing costs did not significantly diminish as the Fund grew larger. In the fourth quarter of 1979, for example, costs per order amounted to $7.63, while by the first quarter of 1981 they were only 35 <t less. Of course, if the number of shareholder orders increased at a slower rate than the asset level, Merrill Lynch would still be making more money even though the cost of processing a single order remained the same. However, it appears that the ratio of order volume to assets did not diminish as the Fund grew larger. From June 1980 to June 1981 the ratio of order volume to Fund assets actually increased, from .0000287 to .0000392. That processing costs do not significantly diminish as Fund assets increase accords with logic and common sense. While it may be almost as easy to invest a block of $100 million as a block of $10 million, it requires substantially more time, money and personnel to process 1 million shareholder orders than 100,000 orders. The ease and speed with which Fund shares can be bought or redeemed is crucial to the success of any money market fund, especially since the investor loses money for every minute his funds lie unemployed. Merrill Lynch added more than 3,000 non-sales personnel to handle the additional transaction volume caused by the Fund. In any event, even if there do exist economies of scale, the present structure of MLAM’s fee means that its effective fee has decreased as the size of the Fund has grown. In view of the above considerations, the total compensation paid for the services supplied adequately passes a “rigorous scrutiny for fairness”. See Galfand v. Chestnutt, 545 F.2d 807, 811-12 (2d Cir. 1976). The ultimate decision of the Trustees was objectively reasonable, as the total fee was fair to the Fund. C. The Benefits to Merrill Lynch As a Whole Because of the Fund Plaintiffs also contend that MLAM distorted the burden shouldered by MLPF&S by describing only the costs associated with Fund transactions without offsetting therefrom the value of associated fall-out business allegedly realized by MLPF&S. Plaintiffs argue that the Fund is an important sales tool for the Merrill Lynch organization as a whole, for it allows Merrill Lynch to attract new accounts and retain existing ones. They argue that having opened up an account with Merrill Lynch in order to gain access to the Fund, customers will find it convenient to transact other sorts of financial business with Merrill Lynch. Moreover, using the Fund, Merrill Lynch presumably can retain control over its customers’ money, since account executives can urge that customers deposit their money in the Fund between commission-generating securities trades. Lastly, plaintiffs say that Fund customers are more likely to choose Merrill Lynch as their broker in the event of an upturn in the stock market. The principal difficulty with plaintiffs’ contentions lies in measuring the value of these beneficial aspects of the relationship. Plaintiffs’ witness, Donald Peskin, an employee of the accounting firm of Laventhol & Horwath, testified that it would be possible to measure how much business came into Merrill Lynch from customers who were originally attracted by the Fund. For example, the study performed by PMM showed that 38% of those customers who opened an account with Merrill Lynch by buying shares of the Fund in the third quarter of 1979 did some non-Fund business by January 1980. Peskin thought it would be possible, as a statistical matter, to estimate how much non-Fund revenue such customers generated. However, as he conceded, some new customers who opened a Fund account and then did other business with Merrill Lynch might have done so even had the Fund not existed. Defendants’ expert, Russell Peppet, thought this problem of circularity would make any calculation of fall-out benefits “extremely difficult.” Similarly, even assuming that customers with Fund accounts did more than the average amount of brokerage business, it would be difficult to demonstrate whether the increase in brokerage activity was a result of the Fund’s existence, or whether customers who normally did an above-average level of brokerage business also tended to have Fund accounts. The difficulty in proving cause and effect is also present in measuring the value of having a large pool of customers’ assets close at hand in the event of development of an interest to invest in the stock market. While Peskin suggested that it would be possible to estimate the increase in brokerage business corresponding to a drop in the Fund’s asset level, he did not state how he could tell what portion of the funds would not have gone to Merrill Lynch in any event. After all, any developing interest in the stock market is bound to result in an increase in Merrill Lynch’s brokerage business from Fund customers. Even if it could be proved that persons with Fund accounts increased their brokerage business by a greater than average amount when the stock market improved, this would not demonstrate that the Fund’s existence was the cause. As with the issue of non-Fund brokerage business in general, the possibility exists that those customers that react most strongly to an incentive to participate in the securities market are also those most likely to have an account with the Fund at the' present time, and not vice-versa. The testimony of both Peskin and Peppet demonstrates that any study of the benefits to Merrill Lynch as a result of the Fund’s existence would be difficult, time-consuming and expensive, and probably entirely inconclusive, even if all of the logical problems could be resolved. Indeed, plaintiffs concede that they could not afford to hire Laventhol to perform any of the studies that they speculated were possible. Thus, the Court cannot be assured that all, or indeed any, of the studies' suggested (but not performed) by the plaintiffs were in fact practical or would be illuminating. As the Audit Committee minutes for its annual meetings in 1980 and 1981 show, the independent trustees were aware that there were “potential benefits to Merrill Lynch of the interface with the Trust . . . including new account opportunities and continued influence over the investment of Merrill Lynch customer assets.” It is true that they were not provided with dollar estimates of those benefits, but plaintiffs have not demonstrated that meaningful estimates could be provided even with extreme difficulty and expense. In these circumstances, MLAM discharged its fiduciary duty by making sure (which it did) that the Trustees were informed of the types of conceivable benefits the Fund’s existence might confer on the Merrill Lynch organization. Taken from another view, the hypothesized but not proved fall-out benefits proclaimed by the plaintiffs to have been obtained by Merrill Lynch through the servicing of Fund shareholder requirements furnish no offset to the cost of compensability of that processing. There is no logical reason why a mutual fund shareholder should not pay for processing the Fund orders executed for him because he also pays a commission to the brokerage firm on the purchase of stocks and bonds; one does not offset the other. Plaintiffs also argued that Merrill Lynch derives income from the “float” on checks to redeeming customers from reciprocal business from those institutions in which the Fund invests, and from transactions with the Fund as principal through Merrill Lynch Government Securities, Inc. The overwhelming majority of customers redeem Fund shares through the broker rather than the Transfer Agent, the Bank of New York. When a redemption occurs, money is transferred from the Fund to MLPF&S. From the time the ch