On March 30, 2010, the Supreme Court affirmed the seminal Gartenberg standard as the test to examine excessive fee challenges in its decision in Jones v. Harris Associates.
In Jones v. Harris Associates, fund shareholders accused the adviser, Harris, of violating its fiduciary obligations under §36(b) of the Investment Company Act of 1940 (the Act) by charging excessive fees to several mutual funds Harris advises. Section 36(b) imposes a fiduciary duty upon investment advisers with respect to compensation received from a mutual fund, and allows a shareholder to consider the board of directors’ approval of advisory fees in its suit against the adviser.
In 2008, the U.S. Court of Appeals for the Seventh Circuit rejected the shareholders’ claim, and in doing so deviated from a standard that courts have relied upon in excessive fee cases since 1982. This standard, established in Gartenberg v. Merrill Lynch Asset Management, Inc, states that an advisory fee violates §36(b) of the Act 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.” The Seventh Circuit instead applied a standard that relies on the market rather than the courts. In his opinion, Judge Easterbrook noted that 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.” This new test implied that as long as an advisor fully discloses a fee, it meets its fiduciary duty under §36(b). If investors think the fee is excessive, they will vote with their feet and move their money elsewhere.
The Supreme Court unanimously disagreed. While it agreed that Gartenberg “may lack sharp analytical clarity,” it concluded that the standard correctly incorporates the fiduciary duty found in §36(b). It also gave weight to the consensus that has developed in the federal courts and the SEC to follow the Gartenberg factors.
In affirming Gartenberg, the Court also provided some guidance regarding the comparison of fees charged to a “captive” mutual fund versus an independent fund. Although the Court admitted there can be no categorical rule governing the comparison of fees charged to different types of clients, “courts may give such comparisons the weight that they merit in light of the similarities and differences between the services that the clients in question require.” If the services in question are so different that a comparison is not warranted, then courts “must reject such a comparison.”
Furthermore, the Court acknowledged the importance of a “fully informed mutual fund board” when approving an adviser's fee, especially the disinterested directors. The opinion, authored by Justice Alito, states that if the board’s process for reviewing adviser compensation is “robust,” then its “decision to approve a particular fee agreement is entitled to considerable weight, even if a court might weigh the factors differently.” Contrarily, if a court determines that a board does not accord the proper diligence in reviewing an adviser’s fees, greater scrutiny of the process by the court is justified.
A related excessive fee case, John E. Gallus v. Ameriprise Financial, was remanded to the lower court for further consideration due to the Court’s decision in Jones.