Summary: Jones v. Harris Associates L.P.
Oral arguments before the U.S. Supreme Court on November 2
The trial bar is pushing a new legal standard for mutual fund advisory fees that could hurt investors by reducing competition, choice, and services, and by increasing investor costs.
Jones v. Harris Associates L.P. is an attempt by trial lawyers to subject yet another industry to perpetual lawsuits by establishing a new and unworkable legal standard for evaluating excessive fee claims against mutual fund advisers. The lawsuit was brought by investors (Jones and others), claiming that Harris Associates L.P. violated its fiduciary duty by charging excessive advisory fees in managing the Oakmark family of mutual funds. Among other things, the plaintiffs argued that the court should compare Harris’ mutual fund advisory fees to the lower fees it charged large institutional separate accounts.
The U.S. District Court dismissed the suit, and the U.S. Seventh Circuit Court of Appeals upheld that decision. The plaintiffs appealed, and in March, the U.S. Supreme Court agreed to hear the case. The questions before the Justices pertain to the legal standards and proper comparisons for evaluating mutual fund advisory fees.
The mutual fund industry is virtually a textbook case of a competitive market, with more than 8,000 funds vying for the investment dollars of cost-conscious investors. The industry has flourished because it has met the challenge of competition by providing investors with more investment choices and more services—while the cost of fund investing has fallen by about 60 percent since 1980. By contrast, the picture that the petitioners paint—helpless investors at the mercy of fund advisers, who charge fees that are unconstrained by any market forces—is so distorted as to be unrecognizable.
ICI also strongly disagrees with petitioners’ argument that courts should compare mutual fund advisory fees to fees for institutional accounts. ICI and other Harris supporters provide extensive evidence that mutual funds and institutional accounts (pension funds, for example) operate in two separate markets. They both may receive portfolio management services from the same advisers—but the precise services, capital commitments, risks, and regulations are worlds apart.
If the petitioners had their way, America’s 87 million mutual fund investors could lose many of the choices and services they currently use and value. Their standard would open the door to endless and unnecessary fee litigation, with legal costs that could drive advisory fees up—not down.
The case turns on Section 36(b) of the Investment Company Act, added by Congress in 1970. Section 36(b) imposes a narrowly tailored fiduciary duty on a mutual fund’s investment adviser “with respect to the receipt of compensation for services” from the fund. As the Supreme Court has recognized, Congress intended Section 36(b) to serve as a check on excessive compensation. Under Section 36(b), the Securities and Exchange Commission or shareholders may sue an adviser for violations of that duty. A 1982 decision by the Second Circuit Court of Appeals in Gartenberg v. Merrill Lynch Asset Management Inc. established a legal standard—known as the Gartenberg standard—that courts have consistently used to evaluate whether an adviser violated its fiduciary duty by receiving an excessive fee. The Seventh Circuit decision departed from Gartenberg, creating a split between judicial circuits.
The Right Outcome
ICI and others are urging the Supreme Court to endorse the Gartenberg standard. It has effectively served investors, independent directors (who provide rigorous oversight of adviser fees), courts, and regulators for almost 30 years. During this period, investors have benefited from increasing choices and innovations in mutual funds and client services, while fees have fallen about 60 percent from 1980 to 2008 .