After years of litigation, investors looking to slap their fund providers with excessive fees lawsuits are more or less right back where they started. In a unanimous decision in Jones v. Harris Associates, the Supreme Court has kicked the case back to the Seventh U.S. Circuit Court of Appeals and essentially ordered the appeals court to adopt the decades-old Gartenberg standard. But what does that mean for investors?
The case in question involves plaintiffs who are shareholders in the Oakmark funds, which are run by Harris Associates. The Oakmark shareholders say that at the time they filed the suit in 2004, they were being charged management fees nearly twice as high—0.88 percent vs. 0.45 percent—as those assigned to Harris’s institutional clients.
Since 1982, courts have used the Gartenberg standard, established in Gartenberg v. Merrill Lynch Asset Management, to resolve fee disputes. Gartenberg states that in order for a fee to be considered excessive, it needs to be “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.”
But in considering Jones v. Harris Associates, the Seventh U.S. Circuit Court of Appeals essentially rejected Gartenberg. Despite the fact that Gartenberg is broadly deferential to fund providers, Chief Judge Frank Easterbrook unexpectedly created a new standard, one that would make it even more difficult for investors to prove that a fee is excessive.
Essentially, Easterbrook suggested that there must be deceit involved in the fee structure in order for a court to intervene. He said that a fiduciary’s duty is to “play no tricks” on investors and that market pressures rather than lawsuits are the solution to high fees.
Writing for the Supreme Court, Justice Samuel Alito rejected Easterbrook’s opinion and essentially reinstated Gartenberg. For investors, this is—at least superficially—good news since it makes it easier for them to bring excessive fees cases to court. But even if they can bring the cases, it doesn’t mean they’ll win favorable judgments, and even Gartenberg heavily favors fund companies in the courtroom.
Still, there’s a bit of a twist, since Alito’s opinion opens up the door to judges considering differences in the fees charged to retail versus institutional clients. “[We] do not think that there can be any categorical rule regarding the comparisons of the fees [paid by] different types of clients,” the opinion reads. “Instead, courts may give such comparisons the weight that they merit in light of the similarities and differences between the services that the clients in question require, but courts must be wary of inapt comparisons.”
In other words, Alito’s opinion acknowledges that fund providers often charge retail investors higher fees than institutional clients since retail investors’ accounts often need more attention on a day-to-day basis. But at the same time, it gives some wiggle room to investors who claim that certain fee differentials are abusive.
According to William Birdthistle, a professor at the Chicago-Kent College of Law who filed a brief with the Supreme Court in support of the Oakmark shareholders, this allowance takes advantage of a little-known footnote in the Gartenberg opinion that lets judges consider such differentials. He says that the language in Alito’s ruling has the potential to be “enormously friendly” to investors.
“Every ruling on mutual fund excessive fees going forward will be based on Jones v. Harris. That will be the doctrine, not Gartenberg. Because Jones v. Harris is Gartenberg with a few changes in emphasis,” he says.
The fund industry is also enthusiastic about the Supreme Court’s ruling. “The Supreme Court’s unanimous decision brings stability and certainty for mutual funds, their directors, and almost 90 million investors by endorsing the Gartenberg standard under which courts have long considered claims of excessive fund advisory fees,” the Investment Company Institute, which serves as the trade group for mutual funds, said in a statement.
As a result of the Supreme Court’s decision, the appeals court will once again review the Oakmark case. Regardless of that outcome, Birdthistle says that the precedent set by Alito’s ruling extends far beyond this single case. “It’s not really about the two parties in front of the court. That’s sort of small potatoes,” he says.