By Jesse J. Holland/The Associated Press
WASHINGTON – The Supreme Court on Tuesday rejected a lower court standard that investors say would have made it almost impossible for them to sue over “excessive” fees on mutual funds, a popular investment vehicle for millions of Americans.
The high court, however, used its unanimous opinion to endorse a standard that a judge has already used once to throw out this particular lawsuit brought by investors against a mutual fund company for charging excessive fees.
Justice Samuel Alito, writing for the court, said the 7th U.S. Circuit Court of Appeals in Chicago should have made its decision using the widely used standard set by the courts in 1982 in the case Gartenberg v. Merrill Lynch Asset Management. The 7th Circuit used a new standard to throw out the case, one it made up for itself.
To face liability under Gartenberg, “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,” Alito said.
The court sent the case back down for the courts to apply Gartenberg.
However, that does not bode well for the plaintiffs, because the original federal judge who heard the case threw it out using the Gartenberg standard.
Mutual funds have become a popular way for Americans to invest, with more than $10 trillion in assets placed in mutual fund investment vehicles such as 529 college education plans or 401(k) retirements plans. The more money the adviser charges in fees, the less money goes into the mutual fund for investors.
In the case decided by the high court, Jerry N. Jones, Mary F. Jones and Arline Winerman sued Harris Associates L.P., which advises on the Oakmark complex of mutual funds. The plaintiffs, who own shares in several Oakmark funds, say that Harris’ fees are so high they violate the federal Investment Company Act, which is supposed to combat excessive investment adviser fees.
Harris appoints Oakmark’s board of trustees, which in turn hires Harris as the mutual fund adviser and sets the fees.
The federal judge who originally heard the case threw it out, saying the plaintiff had not shown that the fee were so disproportionately high they bear “no reasonable relationship to the services rendered.” The appeals court agreed, but rejected the Gartenberg standard.
Instead, the 7th Circuit said such lawsuits cannot be brought unless shareholders can prove that the adviser misled the fund directors who approved the fee.
The mutual fund industry called the decision to tell courts to use the Gartenberg standard a victory.
“For 30 years, the industry has been measuring itself against the so-called Gartenberg Standard, that says fees are appropriate unless a plaintiff proves they are so disproportionate they could have not been bargained at arm’s length. The Supreme Court has now made that the law of the land,” said John Donovan, an attorney for Harris Associates.
But William Birdthistle, an assistant professor at the Chicago-Kent School of Law who filed a brief signed by 25 other professors in support of the challenge against Harris Associates, said the ruling “was not a home run for either side.”
He said the high court’s decision will allow judges to look at what advisers charge institutions like pension funds, which often pay half of what investors pay in fees.
“I think in the past, many of these types of lawsuits would be dismissed no matter how great the fee disparity, because judges would have said, ‘It’s not a Gartenberg factor. We don’t look at that.’ Well, now you have to look at it,” Birdthistle said.
The court’s decision was unanimous, with Justice Clarence Thomas writing a separate opinion concurring with the result. “I would not say that in doing so we endorse the ‘Gartenberg standard,’” said Thomas, who said judges can use that standard to conduct “free-ranging judicial fairness reviews of fees.”
The case is Jones v. Harris Associates, 08-586.