During an oral argument on Monday, November 2, several Supreme Court justices seemed to be wary of having courts determine the fees that investment funds can charge participants.
Depending on how the court rules, the case could involve courts in compensation decisions, setting the stage for the legal system gaining influence on executive remuneration. The case revolves around shareholders of Oakmark Mutual Funds suing Harris Associates, the fund sponsor, for charging excessive fees.
Harris is also the advisor to the mutual fund and appoints the Oakmark board of trustees. The board approved the fees, which were double the amount assessed institutional investors who were independent of Harris.
The Oakmark shareholders argued that Harris violated the Investment Company Act of 1940 with its fee schedule. A northern Illinois district court ruled against the plaintiffs. The 7th Circuit Court of Appeals upheld the verdict, arguing that absent an effort to mislead the trustees, the market should set fees.
But 7th Circuit Judge Richard Posner issued a strong dissent, writing that the idea that the market knows best is “ripe for reexamination.”
That’s exactly what the Supreme Court began to do during the November 2 oral argument.
“The one thing I’m sensing is a reluctance to have the court too intricately involved in setting fees,” said James Gregory, a partner at Proskauer Rose in New York who studied the argument transcript.
Chief Justice John Roberts Jr. was skeptical about the court’s ability to discern fee levels. For instance, what if a fund beats the market by 5 percent over five years?
“Does [the advisor] get double the normal compensation of the average fees?” Roberts asked. “Does he get triple? Fifty percent more? How is the court supposed to decide that?”
Justice Sonia Sotomayor also questioned how the court could determine whether a fund charges appropriate “arm’s-length” fees.
“Using the word ‘fair fee’ in my mind is meaningless, because it has to be fair in relationship to something,” Sotomayor said. “What’s the proof that a particular transaction is not arm’s length?”
David Frederick, the lawyer for Jeffrey Jones and the other shareholders, said that the problem lies in the fact that Harris bought the same stocks and performed the same duties for Oakmark and institutional funds but levied higher fees on the former.
The Oakmark shareholders cannot leave Harris because the Oakmark fund is “captive.”
“The director can’t fire and walk away from the advisor,” Frederick said. “In any arm’s-length transaction, if I sell you a car and you don’t like the price, you can walk away. Fair [is] what the advisor actually charged for same or similar services to an outsider who had the right to walk away.”
Justice Anthony Kennedy explored the meaning of the word “fiduciary” in the Investment Company Act and whether it can be applied more broadly.
“If I look at a standard that the fees must be reasonable and I compare that with what a fiduciary would do, I thought fiduciary has the highest possible duty,” Kennedy said. “But apparently the submission is the fiduciary has a lower duty, a lesser duty than to charge a reasonable fee. I don’t know why Congress didn’t use some other word.”
Justice Stephen Breyer attempted to define “reasonable” fee in such a way that judges are not on the hook for making the determination.
“The substance is to look and see if it’s reasonable, and if it’s reasonable, it certainly is the product of arm’s-length bargaining. If it’s not reasonable, how could it be?” Breyer asked. “So, that way, you see, the tone is ‘Be careful—you are a judge, you are not a rate-setter.’ ”
The exchanges regarding fiduciary duty and rate determination have broader implications because they show the court wrestling with how much sway it should have in regulating markets, according to Gregory.
“They’re looking at whether their opinion will have an effect on compensation at public companies,” Gregory said.
John Donovan Jr., the Harris attorney, argued that the market is the best arbiter of fees.
“These were funds that had best-in-class performance for fees that were at or below industry averages,” Donovan said. “That is not a record upon which a reasonable person could conclude that the advisor has overreached. That is at the heart of fiduciary duty.”
The case is Jones v. Harris Associates, docket number 08-586.
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