On Monday, the Supreme Court heard the arguments on a case involving mutual fund fees. The case is trying to reconcile the standard for when mutual fund fees are too high.
Under §36(b) of the Investment Company Act of 1940 the “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.”
The traditional standard was that a breach of fiduciary duty occurs when the adviser charges a fee that is “so disproportionately large” or “excessive” that it “bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.” Gartenberg v. Merrill Lynch, 694 F.2d 923 (2nd Cir. 1982)
The Jones v. Harris case starts with the claim that the fees are excessive because they far exceed those charged to independent clients. Like many investment advisers, Harris charges less for institutional clients that invest in funds similar to its Oakmark funds. The plaintiffs take the position that a fiduciary should not charge a different price to its controlled clients than it does to its independent clients.
The parties argued their positions Monday in front of the Supreme Court. I was not there, but I thought I could collect some coverage and Tuesday Morning Quaterbacking of the arguments.
According to the coverage, neither party supported Chief Judge Easterbrook’s ruling in the Seventh Circuit. He had found that the marketplace may be trusted to curb excessive fees and that mutual fund investors unhappy with the fees they are charged could withdraw their money and invest it elsewhere.
The mutual fund side argued for the Gartenberg standard: Fees must be “within the range of what would have been negotiated at arm’s length in the light of all of the surrounding circumstances.”
The plaintiff side argued:
“It surely cannot be the case that where you are dealing with a fiduciary duty — which is a higher standard recognized in the law — that you can charge twice as much as what you are obtaining at arm’s length for services that you are providing.”
William Birdthistle thinks:
“If, as some of today’s questions seem to indicate, the eventual decision from the Court in Jones v. Harris will read like Gartenberg with just one additional factor included in an already long and nebulous evaluation, we might have to wait for the next wave of litigation in trial courts to see whether the new Jones standard makes any practical difference on fees. If, on the other hand, the justices highlight and strongly emphasize the institutional/individual fee comparison in an opinion that reads like Posner’s dissent or Ameriprise v. Gallus, the pressure upon the industry to lower fees could be more acute and immediate.”
Anna Christensen thinks:
There did not seem to be five votes for adopting the Seventh Circuit’s market-based approach. The Court may reject that standard and decide little else, perhaps adopting the basic Gartenberg test with some degree of explication, and sending the case back to the court of appeals for application of the test. On the other hand, the Court may decide that as the argument in this case demonstrates, the terms of Gartenberg test do not provide significant guidance on how to identify an unfairly large fee, and use the facts of this case to provide an object lesson to lower courts.
It sounds like the Supreme Court is unlikely to come out with a ruling that dramatically affects the industry. Inevitably, it will require additional work for compliance.