Some mutual fund investors fed up with what they believe to be excessive fees had their day in court Monday—the Supreme Court. In oral arguments in the case of Jones v. Harris Associates, retail shareholders of Oakmark Funds said the fund's adviser, Harris Associates, charged them fees that were twice as high as they charged other types of investors, such as institutional customers, but provided essentially the same services.
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The core legal issue in the case is whether Harris Associates, as the adviser to Oakmark Funds, breached its fiduciary duty under the Investment Company Act of 1940 by charging excessive fees. The shareholders were, in effect, asking the court to consider whether the adviser committed a breach of its fiduciary duty when the board of Oakmark Funds voted for what the plaintiffs consider an overly generous fee structure. The ICA was amended by Congress in 1970 to include a rule regarding fiduciary duty for mutual funds related to compensation, but exactly what constitutes such a duty was never defined. The case highlights the question of whether or not courts should intervene in issues related to executive compensation.
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The high court heard arguments from both sides and from Assistant Solicitor General Curtis Gannon, who appeared because Solicitor General Elena Kagan filed a brief in support of the petitioners' claim that funds shouldn't be allowed to charge investors excessive fees.
David Frederick, the lawyer representing Oakmark shareholders, was questioned by Chief Justice John Roberts and Justice Antonin Scalia about whether it was the court's place to rule in matters of fees and compensation, while John Donovan Jr., who represented Harris in the case, was pressed about the petitioners' claim that the services provided to institutional customers and retail customers were similar.
For mutual fund customers, the big issue is the relationship between the fund's adviser and its board of trustees. Harris Associates appoints members of the board of trustees for Oakmark Funds, who then approve the fees that Harris Associates set. The arrangement, critics say, creates a conflict of interest.
"Right now, advisers bargain for their fees with fund boards who the advisers initially appoint," says Ryan Leggio, a Morningstar fund analyst who attended the hearing. "The investment adviser usually stays with the mutual fund, and it's very rare that they're fired."
The counterargument, skeptics say, is that if investors aren't happy with a fund's fee structure, they can simply withdraw their money and invest it elsewhere. Chief Justice Roberts made that point, noting that fund information is available to all investors. "These days, all you have to do is push a button and you find out exactly what the management fees are," Roberts said. "You just look it up on Morningstar, and it's right there and you can make . . . whatever determination you'd like, including to take your money out."
While that's generally true, Leggio notes that some investors, like those in some 401(k) plans, face barriers to simply selling and walking away because their employers offer only funds managed by the offending adviser. "Shareholders have a difficult time leaving because sometimes their funds are in 401(k) plans," Leggio says. "In that context, if you're in the 401(k) plan, the directors aren't going to fire the advisers, and you can't leave your fund."
As to the question of excessive fees, Leggio adds that for the most part services for institutional investors are fairly similar to those for retail investors. "There are plenty of examples in the industry—exactly as in this case—where the strategy, the fund holdings, the personnel, the process, etc., are almost identical for both institutional and retail other than services you can strip out like marketing, administrative, and regulatory that you might not have for the institutional," he says. Using that argument, the petitioners in the case are questioning why the fees for retail investors are double the fees for institutional investors.
Most of the questioning in the hearing hovered around the differences in institutional and retail fees. Leggio says that "it's likely there will be some downward pressure eventually on retail mutual fund fees," but he said that no one can predict anything after this hearing. Ultimately, the case could have far-reaching effects. "If the SEC decides to be proactive they could see increased fee disclosure, but the other impact would be reduced fees for their funds," Leggio says.
It is still unclear how the case might alter existing fee structures for the mutual fund industry since litigation could take years. Leggio says the fee structure is only part of the issue and highlights what he believes to be an overarching problem of full disclosure when it comes to fund fees. "Morningstar thinks the disclosure of fees in the mutual fund industry really hampers an investor's ability to choose funds wisely because right now with regulations you get a total expense ratio and you get this big management fee, but you don't know where the fund fees are going," he says.
A decision in Jones v. Harris Associates is expected to be announced sometime between March and June, says Leggio.