The high-court's move in a key case could trigger flood of mutual fund lawsuits
The Supreme Court today sent a groundbreaking lawsuit over excessive fund fees back to a lower court, prompting a huge sigh of relief from the mutual fund industry.
The ruling should make it easier for mutual fund operators to fend off shareholder suits alleging excessive fees but also could expose them to more such suits.
The 2004 case, Jones v. Harris, involves a suit filed by a group of investors against Harris Associates LP, the adviser to the Oakmark Funds. In the case, the plaintiffs allege that Harris breached its fiduciary duty by charging excessive management fees. Specifically, plaintiffs claimed the fees were double what Harris charged institutional clients for the same services
In 2008, the 7th U.S. Circuit Court of Appeals dismissed the case. Its ruling stated that as long as there is transparency and no fraud has been committed, a fund provider hasn't breached its fiduciary responsibility to investors. But the court also rejected the standard used by the industry in determining whether mutual fund fees are excessive.
That standard — called the Gartenberg standard after the plaintiff in a 1982 case — basically states that fees should be determined from “arm's-length bargaining” between a fund's adviser and its board of directors. The 7th Circuit said it rejected this standard because it “relies too little on markets.”
In its ruling today, the Supreme Court stated that the Gartenberg standard should be applied but stressed that the law — and not market forces — should dictate mutual fund pricing. The court pointed out that, under the Investment Company Act of 1940, a fund's board members are charged with acting as the fund's fiduciaries. And that should help keep fees from being excessive, the court said in its opinion.
Indeed, the high court spent considerable time explaining why fee decisions should be left to the mutual fund boards, rather than the courts. The law relies "largely upon independent director watchdogs to protect shareholder interests," said Justice Samuel A. Alito Jr., and judges owe "considerable deference" to the fees agreed upon by the board and its investment advisors.
Nevertheless, shareholder advocates saw the decision as a victory. Mercer Bullard, president and founder of Fund Democracy Inc., noted that, over the past 10 years, defendants in excessive mutual fund fee cases have increasingly used the argument that market competition determines pricing to ward off plaintiffs' charges. But now that the Supreme Court has thrown out that argument, he said, it's going to be harder to make.
“This is definitely a win for fund shareholders,” Mr. Bullard said. “They are more likely to win an excessive fee case now than they were before the 7th Circuit opinion.”
Mutual fund industry representatives however, didn't see the court's decision as a win for potential plaintiffs in fund fee cases. “That's a real stretch,” Paul Schott Stevens, president and chief executive of the Investment Company Institute, said when asked if the opinion could expose the industry to further lawsuits. “I think it confirms the standard that we have been using is the appropriate one and is consistent with the text of the statute and the intent of Congress.”
