Supreme Court sticks with longtime stand on fees for mutual funds

Investors must show that the fee charged by mutual fund managers "bears no reasonable relationship to the services rendered" in order to prevail in a suit charging the managers with violating their fiduciary duty, the Supreme Court ruled unanimously Tuesday.

In effect, the justices reinforced a standard that has been used by most lower courts for nearly 30 years, and made it clear that judges for the most part should be reluctant to impose their own views on what reasonable fees should be, leaving it to the marketplace.

But the ruling was so narrow and the standard so broad that both sides of the issue -- investors and the nearly $10 trillion mutual fund industry -- were able to claim victory.

Investors were glad that the justices rejected an appellate court's ruling that only fraud and a lack of transparency on the part of the mutual fund managers should give rise to lawsuits. But at the same time, the Supreme Court's decision made clear that judges should be careful when examining complaints that the fees charged are excessive.

Investment advisers violate their fiduciary duty when charging 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," wrote Justice Samuel A. Alito Jr. The opinion advised judges on what to consider when reviewing whether compensation is excessive but acknowledged that the standard "may lack sharp analytical clarity."

More than 92 million Americans had stakes in a mutual fund in 2008, generating $90 billion in management fees. Mutual funds are unusual enterprises, created by an investment adviser who also selects the fund's directors. They, in turn, approve the management fees.

In the case before the court, three investors in the Oakmark family of mutual funds alleged that the funds' manager, Harris Associates, violated its fiduciary duty by charging investors excessive fees -- more than twice the amounts Harris charged for advising other clients.

In one year alone, the mutual funds paid between $37 million and $58 million more in fees than they would have if they had been charged the same as other clients of Harris Associates, the investors group said. But because of the cozy relationships among the boards of the mutual funds -- whose members were all appointed by Harris Associates -- the fees were not challenged, the investors said.

Harris Associates argued that the fees charged for mutual fund work are not easily compared to fees charged other clients, and noted the funds' profitability. Investors were advised of the fees charged.

Consumer groups supported the investors, as did one of the giants of the mutual fund industry, John C. Bogle, founder of the Vanguard Group. He said in a brief that the explosive growth of the mutual fund industry has made it harder to monitor the "conflicting loyalties" of investment advisers and the failure of fund managers to share economies of scale with investors. Therefore, he said, it is up to the courts to enforce the "fiduciary duty" required by a 1970 law to ensure that fund managers charge only "reasonable" fees.

The case was set up for the high court by competing opinions of two of the appeals courts' leading thinkers on economics and the law.

Chief Judge Frank H. Easterbrook of the U.S. Court of Appeals for the 7th Circuit in Chicago found that the law requires only that the management's fee process be transparent. He noted that fund directors were not likely to fire the advisers for high fees but that investors could effectively fire the advisers by moving their money elsewhere. He wrote that there was no evidence that Harris "pulled the wool over the eyes" of its shareholders and that there was no reason to engage in "judicial price-setting."

But Easterbrook failed to convince a longtime colleague, Judge Richard A. Posner. When the full court split on whether to rehear the case, Posner penned a dissent that read like an invitation to the Supreme Court, writing that the notion that the market can police excessive compensation is "ripe for reexamination."

"Executive compensation in large publicly traded firms often is excessive because of the feeble incentives of boards of directors to police compensation," Posner wrote, adding that "competition in product and capital markets can't be counted on to solve the problem."

But those expansive arguments failed to interest the justices. Such a philosophical debate, Alito wrote, "is a matter for Congress, not the courts."

The justices sent the case back to be decided under the rule that most courts have used for years, called the Gartenberg standard, which Easterbrook had rejected. That keeps the suit alive but may not offer the investors much hope. A district judge already has ruled in favor of the mutual fund managers using the Gartenberg standard.

The case is Jones v. Harris Associates.