Jones v. Harris Supreme Court Case
Rev. 07/23/10; E-mail Alert 2010-11

On March 30, 2010, the Supreme Court unanimously rejected the standard used by a Seventh Circuit Court to determine whether excessive fees had been paid to a mutual fund’s investment adviser.  The Supreme Court ruled that fees paid to an investment adviser would not be considered excessive unless the fees were so disproportionate that they could not have been the product of arm’s-length bargaining.  The outcome of Jones v. Harris Associates L.P. (No. 08-586) may influence the standard used by courts to determine future ERISA excessive fee cases. 

The plaintiffs claimed the defendant violated section 36(b) of the Investment Company Act of 1940 (the Act) by charging excessive fund investment adviser fees.  Section 36(b) subjects an investment adviser to fiduciary duties with respect to compensation received for services.  The Act also requires a fund’s board of trustees to annually review and approve the fund’s contract with the adviser and the amount of compensation the adviser earns from the fund. 

In reversing the Seventh Circuit’s decision, the Supreme Court applied the ‘Gartenberg’ standard for determining whether the defendant violated section 36(b).  In Gartenberg v. Merrill Lynch Asset Management Inc., the second circuit federal appeals court held that to be guilty of a violation of section 36(b) an 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."  The Supreme Court also added that although the Gartenberg standard may lack some clarity, “it accurately reflects the compromise embodied in section 36(b) as to the appropriate method of testing investment adviser compensation, and it has provided a workable standard for nearly three decades.”  Since 1982, other federal courts have adopted the Gartenberg standard, and Securities and Exchange Commission regulations have recognized certain aspects of this standard.  In this case both the plaintiffs and the defendant endorsed the Gartenberg approach but disagreed over its meaning.
 
The fees charged by Harris Associates in this case were comparable to fees charged by other advisers, but nearly twice the amount it charged institutional clients for similar services.  The U.S. District Court for the Northern District of Illinois ruled that the fees were not excessive under the Gartenberg standard.  On appeal, the Seventh U.S. Circuit Court of Appeals affirmed the District Court’s judgment despite rejecting the Gartenberg standard.  The Seventh Circuit’s decision instead focused on disclosure standards, finding that an investment adviser must make full disclosure of its fees but is not subject to compensation limits.  Plaintiffs appealed to the Supreme Court, which vacated the Seventh Circuit’s ruling and remanded it to lower courts for further proceedings.

While announcing the decision, Justice Samuel Alito warned that courts should not rely too heavily on comparing fees of one investment adviser to that of another investment adviser because the fees may not have resulted from arm’s length negotiations.  The Supreme Court also held that the courts should reject comparisons of an investment adviser’s fee charged to a mutual fund client versus that charged to an institutional fund client if the services provided are quite different.  It was noted that mutual funds might have a greater frequency of redemptions, higher marketing costs, and a higher turnover of assets when compared to institutional funds. Justice Alito also stressed that the mutual fund board’s decision to approve a particular fee after all relevant factors are considered carries a considerable weight. 

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