The Supreme Court's unanimous decision in Jones v. Harris may seem to be a setback for mutual fund shareholders who think that the fees charged by many fund companies are too high.
The Supreme Court's unanimous decision in Jones v. Harris may seem to be a setback for mutual fund shareholders who think that the fees charged by many fund companies are too high.
But the decision, announced March 30, in the long run might lead to better governance by mutual fund directors, and possibly even to lower mutual fund fees.
The case arose out of a suit brought by three shareholders in the Oakmark family of funds, which are managed by Harris Associates LP. The claim was that Harris Associates had breached its fiduciary duty by charging individual shareholders higher fees than institutional shareholders.
The U.S. District Court for the Northern District of Illinois granted summary judgment to Harris Associates, applying principles laid down in 1982 in the so-called Gartenberg decision from the 2nd U.S. Circuit Court of Appeals.
In the Gartenberg decision, the court said that to be guilty of a violation, the fund adviser must charge fees that are so disproportionately large that “they bear no reasonable relationship to the services rendered,” and could not have been negotiated at arm's length.
The plaintiffs argued that to determine if a violation had occurred, the fees charged by an adviser to mutual fund shareholders should be compared with those it charged to institutional clients.
The Supreme Court unanimously rejected the plaintiffs' argument and reaffirmed the Gartenberg standard, saying that it had provided a workable standard for almost three decades.
However, the court did rule that a comparison of the fees charged to individual and institutional shareholders may be considered but that courts must be wary of “inapt comparisons” because of the differences in services provided. It was also wary of comparisons of fees charged by other fund companies.
Where the Supreme Court's decision may benefit mutual fund shareholders in the long run lies in its deference to decisions made by fund directors.
“[If] the disinterested directors considered all the relevant factors,” the decision said, “their decision to approve a particular fee agreement is entitled to considerable weight, even if the court might weigh the factors differently.
“In contrast,” the decision continued, “where the board's process was deficient or the adviser withheld important information, the court must take a more rigorous look at the outcome.”
These two paragraphs seem to hold mutual fund boards of directors to high standards of objectivity and independence. They will have to demonstrate that the process they used in approving fees structures was logical and thorough.
These standards no doubt will apply to all decisions made by fund boards, including decisions on whether to retain particular advisers for funds after periods of underperformance.
In short, the Supreme Court has subtly reminded fund directors that they serve the interests of the fund shareholders, not the fund company that appointed the directors.
In addition, it reminded fund advisers that they must provide the directors with all the relevant information they need to represent the shareholders properly.
Should financial advisers fail to do so, fund shareholders may prevail in litigation.
Jones v. Harris, though a loss for the plaintiffs, might well result in a long-term win for all mutual fund shareholders, if, as seems likely, it leads fund directors to exercise their independence more fully, and this leads to better fund governance and perhaps lower fees.
