• Supreme Court Agrees to Hear Mutual Fund Case
  • April 1, 2009 | Authors: Jeffrey T. Skinner; Thomas W. Steed; Tanya L. Goins; Adwoa M. Awotwi; Andrew B. Sachs; Matthew S. Chambers
  • Law Firms: Kilpatrick Stockton LLP - Winston-Salem Office ; Kilpatrick Stockton LLP - Raleigh Office ; Kilpatrick Stockton LLP - Atlanta Office ; Kilpatrick Stockton LLP - Winston-Salem Office
  • On March 9, 2009, the United States Supreme Court announced that it would hear the case of Jones v. Harris Associates,[1] which will be the first case focused on a mutual fund industry issue to come before the Court in a number of years. The case is an appeal of the Seventh Circuit Court of Appeals’ decision in May 2008 that generally disregarded long-standing principles for reviews of investment management contracts and, in particular, fees paid to investment advisers of investment companies, that had previously been established in the 1982 Second Circuit case of Gartenberg v. Merrill Lynch Asset Management, Inc.[2]

    The plaintiffs in Jones, three shareholders of mutual funds in the Oakmark Family of Funds, argued that the investment adviser of the funds, Harris Associates L.P. (“Harris”), charged excessive fees for their advisory services to the funds. Specifically, they claimed that Harris’ fees for the mutual funds were more than twice the fees Harris charged to similiar non-affiliated funds and other institutional accounts. They argued that these fees violated Section 36(b) of the Investment Company Act of 1940. In making the claim, the plaintiffs relied on the standard set forth in Gartenberg, which held that an investment company advisory fee violates Section 36(b) when it 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." Gartenberg considered all facts and circumstances relevant to the receipt of compensation, and it provided six particular factors to determine whether a fee is excessive:

    • The nature and quality of the services provided to fund shareholders
    • The profitability of the fund to the adviser
    • Economies of scale of operating the fund as it grows larger
    • Fee structures of comparable funds
    • The independence and conscientiousness of the trustees
    • Fall-out benefits (i.e., indirect profits to the adviser attributable in some way to the existence of the fund)

    In Jones, however, the Seventh Circuit disregarded the Gartenberg factors and instead focused on the fiduciary duties of the adviser under Section 36(b), with particular emphasis on the competitive nature of the mutual fund marketplace: “A fiduciary duty differs from rate regulation. A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation. The trustees (and in the end investors, who vote with their feet and dollars), rather than a judge or jury, determine how much advisory services are worth.”[3]

    The case is important because investment companies (particularly mutual funds) and investment advisers have relied on the Gartenberg standard for 25 years[4], and the Jones decision has created uncertainity in the investment company industry regarding the appropriate standard for advisory fee reviews. The Supreme Court will hear the case in its next term, which begins on October 5, 2009.


    [1] Jones v. Harris Assoc., 527 F.3d 627 (7th Cir. 2008), cert. granted, (U.S. Mar. 9, 2009) (No. 08-586).

    [2] 694 F.2d 923 (2d Cir. 1982).

    [3] Jones v. Harris Assoc., 527 F.3d 627 (7th Cir. 2008).

    [4] In fact, most of the factors have been incorporated by the Securities and Exchange Commission (SEC) into the disclosure requirements related to reviews of advisory contracts by investment company boards of directors for annual reports on Form N-CSR.