Mutual fund companies may have to better justify charging retail mutual fund customers dramatically more than institutional investors in similar separate-account strategies, under a U.S. Supreme Court decision today.
In a unanimous decision in Jones vs. Harris Associates, the high court affirmed the longtime precedent handed down in the 1982 Gartenberg vs. Merrill Lynch Asset Management decision, that a fee charged to manage a mutual fund is appropriate as long as it isn't “so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's-length negotiation.”
The suit, originally filed by investors in Harris' Oakmark mutual funds, claimed the firm charged more than double the fees for investing in its Oakmark funds than it charged pension funds and other independent institutional investors for managing similar strategies in separate accounts. The U.S. District Court for the Northern District of Illinois ruled in favor of Harris in 2007. The U.S. Court of Appeals in Chicago affirmed that decision in 2008 but rejected the Gartenberg precedent.
The Supreme Court opinion, written by Associate Justice Samuel Alito Jr., sent the case back to the U.S. appeals court.
The Alito opinion emphasized that courts must consider the differences between the fees charged to retail and institutional clients when considering excessive-fee lawsuits.
“In doing so, the court must be wary of inapt comparisons based on significant differences between those services and must be mindful that the (Investment Company Act of 1940) does not necessarily ensure fee parity between the two types of clients,” the opinion said.
“Finally, a court's evaluation of an investment adviser's fiduciary duty must take into account both procedure and substance,” the opinion continued. “Where disinterested (mutual fund board) directors consider all of the relevant factors, their decision to approve a particular fee agreement is entitled to considerable weight, even if the court might weigh the factors differently. In contrast, where the board's process was deficient or the adviser withheld important information, the court must take a more rigorous look at the outcome.”
William Birdthistle, an assistant professor at Chicago-Kent College of Law and an expert on mutual fund issues, said the high court's decision was pro-investor.
“It's Gartenberg-plus,” Mr. Birdthistle said in an interview. “It reaffirms Gartenberg, but it does so with particular emphasis on the difference between the rates paid by institutional vs. retail investors.”
“The Supreme Court's unanimous decision brings stability and certainty for mutual funds, their directors, and almost 90 million investors, by endorsing the Gartenberg standard under which courts have long considered claims of excessive fund advisory fees,” added Paul Schott Stevens, president and CEO of the mutual fund industry's Investment Company Institute, in a statement. “This standard has well served the interests of funds and fund shareholders, who have seen their cost of investing fall by half in the last 20 years.”