The U.S. Supreme Court has handed a victory to the $11 trillion mutual fund industry by endorsing the legal standard in place since the early 1980s in deciding the fairness of fund fees.
The justices unanimously rejected a U.S. appeals court ruling that individual shareholders who sue a mutual fund investment adviser for excessive fees must show that the fund's directors had been misled.
In the standard set out in a 1982 U.S. appeals court ruling, fees are deemed to be excessive only when they are so high they could not be the result of arm's-length negotiations and bear no reasonable relationship to the services provided.
Justice Samuel Alito wrote in the Supreme Court's 17-page ruling Tuesday that a consensus has developed regarding that standard, and it has been used by federal courts and in U.S. Securities and Exchange Commission regulations.
Alito said a federal appeals court in Chicago erred in rejecting the 1982 standard and requiring shareholders to show that an adviser had misled the fund's directors who approved an excessive fee.
The case involved a lawsuit by three shareholders of the Oakmark Funds. Harris Associates LP of Chicago serves as the funds' investment adviser, deciding which stocks to buy and sell. Harris is an indirect subsidiary of Natixis affiliate Natixis Global Asset Management LP.
"We are extremely happy with this," said John Donovan, a Ropes & Gray attorney in Boston who argued the case for Harris.
"This is a significant victory for the industry and for Harris," since it means the 1982 standard in a case known as Gartenberg will remain the standard. "That's what the Supreme Court has now made the law of the land," Donovan said.
In some cases plaintiffs can gain from Supreme Court rulings, but Donovan said he saw little that the plaintiffs might add in this case.
"The language of the Supreme Court, if it does anything, it closes the door for plaintiffs' lawyers," who now will have a harder time arguing that Gartenberg sets the wrong rules, Donovan said.
Paul Schott Stevens, president of the Investment Company Institute, the mutual fund industry trade group, praised the ruling.
"The Supreme Court's unanimous decision brings stability and certainty for mutual funds, their directors, and almost 90 million investors by endorsing the long-standing framework under which courts consider claims of excessive fund advisory fees," he said.
"The court's decision recognizes that this framework has worked for funds, advisers, boards, courts, and—most importantly—fund shareholders, who have seen their cost of investing fall by half in the last 20 years," Stevens said.
A lawyer for the three investors said Harris charged fees twice as high for individuals as for large institutional clients like pension funds. Harris defended the fees as in line with those charged by similar mutual funds.
In the Oakmark case, a federal judge and then the appeals court ruled against the shareholders. The Supreme Court set aside the appeals court's ruling because it used the wrong standard and sent the case back for further proceedings.
Alito said the 1982 standard has provided a workable framework for nearly three decades.
He said courts must compare the fees an investment adviser charges a mutual fund with those charged for its independent clients, like pension funds.
But Alito said that courts should be aware of the significant differences between those services, and the fees do not have to necessarily be the same for the two types of clients.
He said the decision of disinterested directors to approve a particular fee agreement is entitled to considerable weight by federal courts.
Should a board's process be deficient or should the adviser withhold important information, then a court should take a more rigorous look at the fees charged, Alito said.
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