A federal appeals court judge ruled on Monday that courts should not cap fees for mutual fund advisers in a decision that could change the way such fees are regulated.
In his decision in Jones v. Harris Associates, in which several investors accused the fund adviser of deceiving investors and receiving excessive compensation, Judge Frank Easterbrook of the 7th U.S. Circuit Court of Appeals in Chicago said courts should play no part in determining whether fees for mutual fund advisers are reasonable. Market forces guarantee fees will be fair, Easterbrook wrote, and investors will leave a fund if advisers are getting paid too much.
"The trustees [and ultimately investors, who vote with their feet and dollars], rather than a judge or jury, determine how much advisory services are worth," Easterbrook wrote.
The decision upheld fees paid to Harris Associates, the advisers who oversaw the Oakmark Funds in Chicago, says John Donovan, a litigation partner at Ropes & Gray who represented Harris in the case.
Donovan says the ruling could scuttle pending cases against mutual fund advisers and reverse the precedent, set in the 1980s, of allowing judges to regulate fees.
At least a dozen plaintiffs classes have filed suit in the last five years charging fund advisers with receiving excessive compensation, according to Donovan.
Ernest Young, a law professor at Duke University who argued for the plaintiffs, agrees with Donovan about the potential impact of the case.
"It may represent a real abdication of judging the reasonableness of the fee," Young says.
Young and plaintiffs counsel from Richardson, Patrick, Westbrook and Brickman argued that Harris violated federal law by failing to disclose connections to the mutual fund's trustees and other facts.
They claimed the advisers hid data about their profit levels and charged greater fees for mutual funds than for other types of funds, including pension funds, according to a copy of the complaint. "The judge ignored the record before him," says lead plaintiffs lawyer Jim Bradley. Easterbrook dismissed that argument. Young says he is worried that Easterbrook's ruling, which is binding only in the 7th Circuit, will lead judges away from making sure compensation levels are set according to federal rules.
"I hope it's not interpreted that way," Young said.
Michael Doluisio, a securities litigation partner at Dechert who has defended mutual fund advisers in similar cases, said the ruling is a major break from precedent.
"It is an important decision," Doluisio said. "It tries to let free markets set compensation rather than have courts second-guess those decisions."
