Employees Retirement System of the City of St. Louis v. FS/KKR Advisor Challenges Advisory Fees Under Section 36(b)

The Employees Retirement System of the City of St. Louis has filed a derivative lawsuit on behalf of FS KKR Capital Corporation against FS/KKR Advisor, LLC, a Delaware LLC and registered investment adviser. The plaintiff contends that these fees violated fiduciary duties laid out under Section 36(b) of the Investment Company Act of 1940 (15 U.S.C. § 80a-35(b)).

According to the complaint, FS/KKR Advisor's management of valuation processes and income-recognition policies played a significant role in inflating the advisory fees. The plaintiff argues that these fees are "so disproportionately large that it bears no reasonable relationship to the services rendered" (Compl. ¶194) and have contributed to a $1.144 billion excess over the net cash returns generated for investors. The complaint details that "fair value accounting is not merely an accounting input... it is the mechanism through which advisory compensation is generated" (Compl. ¶195).

The Employees Retirement System of the City of St. Louis maintains ownership of FS KKR Capital Corporation stock since at least February 2020, underpinning its standing to file the derivative suit. As of now, the allegations within this lawsuit remain unproven, and no response from the defendant has been filed.

Alleged Mechanism: Valuation-Driven Fee Escalation

The Employees Retirement System of the City of St. Louis, derivative plaintiff in the litigation against FS/KKR Advisor, LLC, alleges that the defendant exploited its role as FS KKR Capital Corporation's SEC-designated Valuation Designee to inflate advisory fees through manipulated valuations. According to the complaint, FS/KKR Advisor, LLC has the responsibility for quarterly determining the fair value estimates of FSK’s investment portfolio, a process integral to calculating its management fees.

The plaintiff also argues that the fair value to amortized cost (FV/AC) ratio of FSK’s portfolio displayed unusual stability over a significant period. This stability is characterized as anomalous, allegedly pointing towards strategic "smoothing" of valuations to shield FS/KKR Advisor's fees from reflecting the actual declining economic environment. The complaint notes that an abrupt markdown in Q1 2026 implied that previous asset valuation practices had deferred the recognition of portfolio deterioration.

The legal claims hinge on the assertion that such valuation-driven fee escalation by FS/KKR Advisor, LLC, undercut the fiduciary duties owed to FS KKR Capital Corporation and its stockholders. The complaint asserts that "Defendant was paid on values and income streams that Defendant itself substantially controlled" (Compl. ¶200). The allegations remain unproven, and no responses from the defendant have been noted in the record.

Alleged Mechanism: PIK Income Exploitation

The complaint alleges that FS/KKR Advisor, LLC has exploited Payment-in-Kind (PIK) income to inflate advisory fees. According to the filing, the Defendant accrues non-cash PIK interest as income, increasing both FS KKR Capital Corporation’s gross assets and boosting net investment income (NII) even though no cash is received. FSK’s investments totaled approximately $12.3 billion at fair value as of March 31, 2026 (Compl. ¶53). This allegedly allowed FS/KKR Advisor, LLC to accrue higher fees based on inflated portfolio values.

This discrepancy allegedly allowed the Defendant to charge fees on income that might never be realized in cash. In these cases, loans were restructured to permit PIK, and valuations exhibited marked discrepancies influenced by PIK accretion, which in turn inflated reported asset values. The filing suggests that such practices allowed FS/KKR Advisor, LLC to accrue higher fees based on inflated portfolio values.

These allegations form a key part of the claim under Section 36(b) of the Investment Company Act of 1940, arguing that the advisory fees extracted were excessive and resulted from valuation judgments that overly relied on non-cash income metrics. The case raises questions about the structural incentives in valuation processes and how such incentives may impact fee structures when left unchecked, particularly in illiquid asset environments.

Macro/Industry Context

The complaint comes amid a broader economic context where alarming projections about private credit and market conditions play a significant role. According to research cited in the complaint, potential defaults in U.S. private credit due to AI disruption are estimated to range between $75 to $120 billion (Compl. ¶168). The credit investments sector is highlighted by KKR Credit's significant presence in the financial landscape with assets under management (AUM) of $288 billion (Compl. ¶ 168). As of March 2025, BDC assets under management were reported at $475 billion, with Future Standard holding approximately $94 billion AUM as of March 31, 2026 (Compl. ¶167, ¶168).

The Money: Fees and Losses

The Employees Retirement System of the City of St. Louis alleges in its derivative complaint that FS/KKR Advisor, LLC collected excessive advisory fees from FS KKR Capital Corporation (FSK) over a five-year period from fiscal years 2021 to 2025. According to the complaint, the defendant received $1.696 billion in total advisory fees during this timeframe, with $1.066 billion attributable to base management fees alone. FS/KKR Advisor's advisory compensation is suggested to be disproportionately high as reflected by the FY2025 base management fee of $206 million, which comprised approximately 3.52% of FSK's $5.849 billion year-end net assets (Compl. ¶206).

The Parties and Their Roles

The plaintiff in this derivative action, filed on behalf of FS KKR Capital Corporation (FSK), is the Employees Retirement System of the City of St. Louis. The plaintiff claims to have been a stockholder of FSK since at least February 2020. The suit contends that it seeks to address the alleged excessive advisory fees extracted by FS/KKR Advisor, LLC, acting as the investment adviser to FSK. According to the complaint, these excessive fees are said to have violated Section 36(b) of the Investment Company Act of 1940. The Employees Retirement System of the City of St. Louis argues that such actions have not been in the best interest of the nominal defendant, FSK.

The defendant, FS/KKR Advisor, LLC, is a Delaware limited liability company that is registered with the SEC as an investment adviser. Its principal place of business is in Philadelphia, Pennsylvania, but its largest branch office is located at 30 Hudson Yards, New York, NY 10001. FS/KKR Advisor, LLC, acts as the sole investment adviser to FSK under an Investment Advisory Agreement, which plaintiff claims has led to the alleged improper collection of advisory and incentive fees.

FS KKR Capital Corporation (FSK), a Maryland corporation, serves as the nominal defendant in this case. As a closed-end management investment company operating as a business development company and regulated investment company, FSK’s role in the complaint is as the entity purported to have suffered economic harms due to the practices of FS/KKR Advisor, LLC, as alleged by the Employees Retirement System of the City of St. Louis.

The allegations in this complaint remain unproven at this time, and no defendant has yet responded to these claims.

Claim Counts: Breach of Fiduciary Duty

The complaint filed by the Employees Retirement System of the City of St. Louis alleges a breach of fiduciary duty by FS/KKR Advisor, LLC under Section 36(b) of the Investment Company Act of 1940 (15 U.S.C. § 80a-35(b)). This claim centers on what the plaintiffs describe as "excessive fees" extracted from FS KKR Capital Corporation (FSK) by the defendant. According to the filing, these fees were derived from asset valuations and income streams which FS/KKR Advisor, LLC "substantially controlled" through its role as valuation designee.

Ultimately, the plaintiff seeks a legal remedy to recover these allegedly excessive fees for the benefit of FSK, emphasizing the need for reevaluation and remedy of the investment advisory structure to prevent such fiduciary breaches in the future.

These allegations remain unproven, and no response has yet been filed by FS/KKR Advisor, LLC.

Claim Counts: Equitable Relief

The Employees Retirement System of the City of St. Louis is seeking equitable relief through Count II of its derivative complaint, filed under Sections 36(b) and 47(b) of the Investment Company Act of 1940. According to the complaint, the plaintiff argues that the Investment Advisory Agreement between FS KKR Capital Corporation (FSK) and FS/KKR Advisor, LLC (the Defendant) should be rescinded or reformed. The claim is grounded in the assertion of excessive advisory fees collected by the Defendant, which the filing suggests contravene Section 36(b)'s fiduciary duty requirements.

Distinctive Pleadings in the Complaint

The Employees Retirement System of the City of St. Louis has filed a derivative complaint against FS/KKR Advisor, LLC, emphasizing the alleged misuse of valuation discretion and income recognition in its advisory practices. Central to the lawsuit is the role of the defendant's discretion over Level 3 assets. The complaint states that the fair value of these illiquid assets, which are pivotal to determining advisory fees, stems from models that the defendant controls. This degree of control allegedly creates a conflict of interest, allowing the defendant to potentially inflate valuations for increased fee calculations.

Relief Sought and Procedural Posture

The Employees Retirement System of the City of St. Louis, as the derivative plaintiff, seeks to recover losses on behalf of FS KKR Capital Corporation (FSK) by challenging the advisory fees collected by FS/KKR Advisor, LLC. The complaint alleges these fees are excessive and unlawful under Section 36(b) of the Investment Company Act of 1940 (15 U.S.C. § 80a-35(b)), and seeks equitable relief under Sections 36(b) and 47(b) of the Act.

Filed on July 15, 2026, the complaint requests remedies that include the rescission or reformation of the existing Investment Advisory Agreement between FSK and FS/KKR Advisor, LLC. The plaintiff contends that the fees extracted by the advisor bear no reasonable relationship to the services provided and could not have resulted from arm's-length bargaining, thus breaching fiduciary duties owed under the federal securities laws.

This legal action is guided by statutory provisions that govern fiduciary duty obligations and advisor compensation structures within investment vehicles like FSK, a closed-end management investment company. The case tests the application of fiduciary standards on advisory fee arrangements within the context of heightened reliance on valuation judgments and non-cash income streams, as evidenced by prior corporate maneuvers outlined throughout the complaint.

As of the filing date, no responses from the defendant have been recorded, and the claims detailed remain allegations pending adjudication.

The allegations described here are taken from the filing and remain unproven; no responsive pleading is reflected in the source document.

David Brunk is a civil litigation attorney. He can be reached at david@newmanbrunk.com.

Questions about this topic: david@newmanbrunk.com

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