The investment industry declared victory Tuesday as the U.S. Supreme Court ruled in a closely watched case that investor advocates had hoped would make it easier to challenge high fees charged by advisers in the $9 trillion mutual fund business.
But industry critics also claimed a win in the case of Jones v. Harris Associates, asserting that the high court decision allows plaintiffs to use the kinds of fee comparisons that could help them prove that advisers' fees are excessive.
"This is a tremendous victory for investors," said David Frederick of Washington's Kellogg, Huber, Hansen, Todd, Evans & Figel, who argued for the investors in the case before the Court. Frederick dismissed as "typical industry spin" the favorable comments made by the investment industry in the aftermath of Tuesday's ruling.
When told about Frederick's comments about the case, his adversary, John Donovan Jr., said, "I'm a little surprised by that." Donovan, a partner at Ropes & Gray in Boston, represented Harris Associates L.P., a Chicago financial firm whose fees were at issue. "The Court sharply limited the role of the courts" in second-guessing advisers' fees, Donovan said, and did not open the door to litigation "one inch more."
The disagreement over the meaning of Tuesday's decision likely foreshadows another wave of litigation over alleged excessive fees charged by investment advisers.
Paul Stevens of the Investment Company Institute echoed Donovan's applause, saying the ruling "brings stability and certainty for mutual funds, their directors and almost 90 million investors by endorsing the long-standing framework under which courts consider claims of excessive fund advisory fees."
The framework Stevens referred to is the standard adopted in 1982 by the 2nd U.S. Circuit Court of Appeals in Gartenberg v. Merrill Lynch Asset Management, under which a fee would be deemed excessive only if it "bears no relationship to the services rendered and could not have been the product of arm's length bargaining." That test has generally protected industry fees ever since. Investors complain that too-close relationships between advisers and the mutual funds they create and handle have led to runaway fees unchecked by the Gartenberg standard.
The suit ruled on Tuesday was brought by a group of shareholders in the Oakmark family of mutual funds, for which Harris Associates is the investment adviser. They claimed Harris charged the funds fees that, in percentage terms, were twice what Harris charged nonfund clients for similar services. The funds would have saved between $37 million and $56 million a year if they had been charged the same rate as other Harris clients. The district court and the 7th U.S. Circuit Court of Appeals dismissed the suit, but the circuit panel also disapproved of the Gartenberg test, asserting that it "relies too little on markets."
In Tuesday's unanimous ruling, the high court embraced the Gartenberg test for the first time, with Justice Samuel Alito Jr. stating that it is "correct in the basic formulation" of what the Investment Company Act requires regarding fees. Industry lawyer Donovan pointed to that endorsement in applauding the decision. "Gartenberg is what the industry has lived with for nearly 30 years to the benefit of funds, advisers and, most importantly, investors," he said.
But Alito's decision also contained language that gave a boost to plaintiffs, Frederick claimed on Tuesday. The Court rejected a "categorical rule" that would dictate how to evaluate comparisons between fees charged by advisers to "captive" funds and fees charged to independent clients. Alito warned against "inapt comparisons," but indicated some kinds of comparisons would be appropriate. In addition, Alito said judges must take a "more rigorous look" at the fees when the process used to set the fees was deficient or overly secretive. "These standards protect investors," Frederick said. "We're thrilled."
Plaintiffs attorney Janine Pollack of Milberg in New York agreed that the decision offers good news for investors. "There is now an even greater emphasis on process," she said. "The Court is saying that if you think the process for setting fees is lacking, you the judge need to exercise extraordinary scrutiny. Rubber-stamping isn't enough anymore."