Doug Cornelius, Chief Compliance Officer
The Supreme Court issued its opinion
in Jones v. Harris Associates, addressing the
standard for when mutual fund fees are too high.
of the Investment Company Act of 1940 the "the investment adviser of
a registered investment company shall be deemed to have a fiduciary duty with
respect to the receipt of compensation for services, or of payments of a
material nature, paid by such registered investment company."
The traditional standard was that a
breach of fiduciary duty occurs when the adviser charges a fee that is "so
disproportionately large" or "excessive" that it "bears no reasonable
relationship to the services rendered and could not have been the product of
arm's-length bargaining." Gartenberg v. Merrill Lynch, 694 F.2d 923 (2nd
The Jones v. Harris case
starts with the claim that the fees are excessive because they far exceed those
charged to independent clients. Like many investment advisers, Harris charges
less for institutional clients that invest in funds similar to its Oakmark
funds. The plaintiffs take the position that a fiduciary should not charge a
different price to its controlled clients than it does to its independent
Judge Easterbrook in the Seventh
Circuit rejected the Gartenberg standard and crafted a new one.
The court adopted a standard that an allegation that an adviser charged
excessive fees for advisory services does not state a claim for breach of
fiduciary duty under § 36(b), unless the adviser also misled the fund's board
of directors in obtaining their approval of the compensation.
The Supreme Court concludes that
"Gartenberg was correct in
its basic formulation of what §36(b) requires: to face liability under §36(b),
an investment adviser must charge a fee that is so disproportionately large
that it bears no reasonable relationship to the services rendered and could not
have been the product of arm's length bargaining."
They also make it clear that the
burden of proof is on the party claiming the breach, not the fiduciary.
The Supreme Court found fault is
looking almost entirely at the element of disclosure. The result is that the
Supreme Court overturned the Seventh Circuit and remanded it back for further proceedings.
What does the standard mean?
The Investment Company Act does not
necessarily ensure fee parity between mutual funds and institutional clients.
Courts need to look at the similarities and differences in the services being
provided to different clients.
Courts should not rely too heavily
on comparing fees charged by other advisers. Fees may not be the product of
arm's length negotiations.
A court should give greater
deference to fund fees when a board's process for negotiating and reviewing compensation
is robust. "[I]f the disinterested directors considered the relevant factors,
their decision to approve a particular fee agreement is entitled to
considerable weight, even if a court might weigh the factors differently." If a
fund adviser fails to disclose material information to the board, the court
should use greater scrutiny.
"[A]n adviser's compliance or
non-compliance with its disclosure obligations is a factor that must be
considered in calibrating the degree of deference that is due a board's
decision to approve an adviser's fees."
The result is that courts should
defer to the "defers to the informed conclusions of disinterested boards" and
hold "plaintiffs to their heavy burden of proof."
For additional commentary on developments in compliance
and ethics, visit Compliance Building, a blog by Doug Cornelius.
Doug Cornelius is the Chief Compliance Officer for a real
estate private equity firm. On his blog, Compliance Building, he writes
about compliance and business ethics.