U.S. Supreme Court Addresses Fiduciary Duty of Investment Advisors

U.S. Supreme Court Addresses Fiduciary Duty of Investment Advisors

In Jones v. Harris Associates, L.P., the U.S. Supreme Court last week decided an issue involving the fiduciary duty of investment advisors. Many legal scholars have already started to comment on this decision, e.g. here, here, here and here, adding to the prolific analysis that preceded this long-awaited SCOTUS decision today. See, e.g., here.

The syllabus from the Court's opinion provides as follows:

Based on §36(b)'s terms and the role that a shareholder action for breach of the investment adviser's fiduciary duty plays in the Act's overall structure, Gartenberg applied the correct standard.

(a) A consensus has developed regarding the standard Gartenberg set forth over 25 years ago: The standard has been adopted by other federal courts, and the Securities and Exchange Commission's regulations have recognized, and formalized, Gartenberg-like factors. ...

(b) Section 36(b)'s "fiduciary duty" phrase finds ts meaning in Pepper v. Linton, 308 U. S. 295, 306-307, where the Court discussed the concept in the analogous bankruptcy context: "The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm's length bargain. If it does not, equity will set it aside." Gartenberg's approach fully incorporates this understanding, insisting that all relevant circumstances be taken into account and using the range of fees that might result from arm's-length bargaining as the benchmark for reviewing challenged fees. ...

(c) Gartenberg's approach also reflects §36(b)'s place in the statutory scheme and, in particular, its relationship to the other protections the Act affords investors. Under the Act, scrutiny of investment adviser compensation by a fully informed mutual fund board, see Burks v. Lasker, 441 U. S. 471, 482, and shareholder suits under §36(b) are mutually reinforcing but independent mechanisms for controlling adviser conflicts of interest, see Daily Income Fund, Inc. v. Fox, 464 U. S. 523, 541. In recognition of the disinterested directors' role, the Act instructs courts to give board approval of an adviser's compensation "such consideration . . . as is deemed appropriate under all the circumstances." §80a-35(b)(1). It may be inferred from this formulation that (1) a measure of deference to a board's judgment may be appropriate in some instances, and (2) the appropriate measure of deference varies depending on the circumstances. Gartenberg heeds these precepts.

(d) First, since the Act requires consideration of all relevant factors, §80a-35(b)(2), courts must give comparisons between the fees an investment adviser charges a captive mutual fund and the fees it charges its independent clients the weight they merit in light of the similarities and differences between the services the clients in question require. In doing so, the Court must be wary of in-apt comparisons based on significant differences between those services and must be mindful that the Act does not necessarily ensure fee parity between the two types of clients. However, courts should not rely too heavily on comparisons with fees charged mutual funds by other advisers, which may not result from arm's-length negotiations. Finally, a court's evaluation of an investment adviser's fiduciary duty must take into account both procedure and substance.Where disinterested 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. Cf. Lasker, 441 U. S., at 486. 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. Id., at 484. Gartenberg's "so disproportionately large" standard, reflects Congress' choice to "rely largely upon [independent] 'watchdogs' to protect shareholders interests," Lasker, supra, at 482

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