The U.S. Supreme Court, ruling in Jerry N. Jones, et al. vs. Harris Associates LP, puts the board of directors of mutual funds at the center of determining if investment advisers have fulfilled their fiduciary duty and charged fair fees to clients.
It is an important decision affecting 401(k) and other defined contribution investors and the fairness of the fees they pay.
The court, ruling unanimously March 30, holds investment company boards of directors to high standards of objectivity and independence in overseeing investment advisers and the fees they charge.
Likewise, investment companies have to hold their boards to high standards in representing the interests of fund shareholders. They should do so by putting forth knowledgeable, dedicated candidates, while investors must actively participate in the voting to elect directors to boards. The court said boards must review and approve the contracts of the investment advisers to funds, and approve an adviser's compensation.
An investment adviser, the court also noted, has a fiduciary duty in regard to its compensation. “A fiduciary must make full disclosure and play no tricks” in providing information on its compensation, otherwise, investors would have grounds to sue about excessive fees.
For defined contribution plans, sponsors need to vote for directors who will act in investors' interest to strengthen corporate governance. Plan sponsors often hire trustees, typically bank trust departments or investment institutions, to serve as fiduciaries and vote proxies. The plan executives should evaluate such votes to determine if trustees are indeed serving participants' interests. Investment companies have encouraged board independence. At 88% of mutual fund complexes, at least 75% of the directors are independent and 63% of the complexes are chaired by an independent director, according to the Investment Company Institute.
Investors should encourage annual election of directors, to bring greater accountability. An election now need only be called when there is an opening, according to ICI, which had no data on the average term of directors.
The Securities and Exchange Commission's proposed proxy access rule would allow mutual fund investors to use proxy materials to nominate directors to boards, similar to the way the proposal would provide access for shareholders to nominate directors to corporate boards.
It is important that investors have such access to help ensure directors serve the interests of investors.
The ruling by no means settles issues involving investment fees facing fiduciaries and boards of investment companies. A number of suits are pending. For example, Tussey vs. ABB Inc., a class action pending resolution in U.S. District Court for the Western District of Missouri after a bench trial last year, involves a dispute on purported excessive fees in a 401(k) plan.
The risk to fund companies and boards of directors that don't the serve interests of investors is litigation. That would be costly and protracted to a mutual fund, as well as to plan participants, even if they ultimately win.
As the decision noted, independent directors should serve as “watchdogs” to protect shareholders' interests.