Wednesday, November 4, 2009

Mutual fund fees before SCOTUS

The Supreme Court of the United States considered mutual fund fees in oral arguments in the case of Jones v. Harris Associates, on Monday.

The plaintiffs in this litigation contend that retail shareholders are paying higher fees that institutional shareholders and that this is unfair. Harris Associates runs the Oakmark Fund, which apparently charges less than one-half of one percent to an unnamed institutional investor for managing assets of $160 million, or $720,000. But individual investors pay 0.88% on the same portfolio. Is that fair? More to the point, is it a violation of fiduciary duties?

The established precedent is the Gartenberg decision of 27 years ago. In that decision, the Second Circuit said that breach of fiduciary duty will be found only if the fee charged by an investment advisor 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." Subsequently, the Second Circuit enumerated five factors that may be used to inform this test, and other Circuits have until quite recently followed its lead. Those factors are:

•The nature and quality of services provided to fund shareholders by the adviser;
•The profitability of the fund to the adviser;
•The fall-out benefits enjoyed by the adviser;
•The existence of economies of scale; and
•The independence and conscientiousness of the trustees.

It is this test that the plaintiffs said the Harris Associates' tiered structure of fees, at the expense of the retail investors, violates. And it is the seventh circuit thathas rocked this doctrinal boat, rejecting Gartenberg in the Jones v. Harris Associates matter. The Secenth Circuit Court said that investors do not need judicial protection so long as the advisors make full disclosure concerning their fees. Investors are then free to avoid or sell high-cost funds, in effect voting with their feet.

This was the issue before SCOTUS. For more, go here.

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