Legal News

High Court Loosens Liability Standard in Mutual-Fund Fees Case

By Ashby Jones

The issue in the Harris Associates v. Jones case, decided by the U.S. Supreme Court Tuesday morning, was a relatively narrow one: What is the test courts apply in deciding whether a mutual fund can be held liable for allegedly charging excessive fees?

On Tuesday, the Court, in a unanimous opinion authored by Justice Samuel Alito, ruled that the test applied by the lower court — the Seventh Circuit — was incorrect; the Chicago-based appellate panel should have used a test established by the Second Circuit in 1982. The court sent the case back to the Seventh Circuit to examine the facts of the case in light of the Second Circuit test. Click here for the early Dow Jones Newswires story; here for the opinion; here for LB background on the case, posted shortly after the arguments last fall.

A group of investors had sued Harris Associates LP, which manages a family of Oakmark funds, alleging that Harris charged excessive fees. Harris said its fees were unremarkable, priced at or slightly above medians for comparable mutual funds.

The Seventh Circuit sided with Harris, ruling that fund managers could not be held liable for charging excessive fees unless there is fraud involved. That court said market forces could do a better job than judges of keeping fees in check.

But the Supreme Court rejected the Seventh Circuit’s strict standard and instead adopted the legal standard employed by most federal courts — one announced by the Second Circuit in 1982. The Second Circuit standard says fund fees did not violate the law unless they were “so disproportionately large” that they could not have been the product of arm’s-length bargaining.

The case has been closely watched by the mutual-fund industry.

According to Mark Anderson’s writeup at Dow Jones Newswires, the new standard, while arguably better for jilted investors than was the one applied by the Seventh Circuit, still won’t make winning lawsuits a cinch for investors who feel they’ve been treated unfairly.

Consider, for example, this language, from Justice Alito:

We conclude that [the Second Circuit case] Gartenberg was correct in its basic formulation . . . to face liability . . . an investment 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.”

In this post from last fall, Morningstar’s John Rekenthaler characterizing the outcome handed down by the court on Tuesday as “what the fund industry seeks.”

The Gartenberg standard looks strict, Rekenthaler wrote, “requiring among other items that mutual-fund fees be ‘within range of what would be produced by arms-length bargaining.’ However, they have the virtue, from the industry perspective, of being nearly toothless.”

Full post as published by Law Blog - WSJ.com on March 30, 2010 (boomark / email).