Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Tuesday, March 30, 2010

U.S. Supreme Court Uphelds Gartenberg Standard; Sends Message of Judicial Deference to Mutual Fund Board's Fee Decisions

The U.S. Supreme Court decided Jones v, Harris Associates L.P. (Download Jones v. harris associates sup ct opinion) today and, in an unanimous decision (Justice Thomas wrote a brief concurrence), upheld the Gartenberg standard for determining excessive mutual fund fees under section 36(b) of the Investment Company Act of 1940.  This decision is not a surprise, since by the time of the oral argument no one was supporting the 7th Circuit's test -- that specifically disapproved the Gartenberg approach and replaced it with a "full disclosure and no tricks" approach.  Instead, both petitioners and respondents generally endorsed the Gartenberg standard, although they disagreed about its meaning and application.

The opinion, written by Justice Alito, does not provide much, if anything, that will be of assistance to shareholders in mutual funds that seek to challenge fees as breach of the investment adviser's fiduciary duty.  The Court adopts the Gartenberg standard, which the district court in this case had relied upon in dismissing petitioners' claims.  (Indeed, at least as of a few years ago, no shareholder has ever persuaded a court that mutual fund fees were excessive under the Gartenberg standard.)  Thus, plaintiff bears the burden of establishing that an investment adviser charged 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 Court then goes on to make clear that plaintiff's burden is considerable.  Thus, the judgment of the mutual fund's board is entitled to judicial deference.  The Court discounts the significance of comparisons between the fees that an adviser charges a captive mutual fund (high) and the fees that it charges its independent clients (lower), because there may be significant differences between the nature of the services provided.  Moreover, "[e]ven if the services provided and fees charged to an independent fund are relevant, courts should be mindful that the Act does not necessarily ensure fee parity between mutual funds and institutional clients contrary to petitioners' contentions."  By the same token, "courts should not rely too heavily" on comparisions with fees charged to mutual funds by other advisers; these comparisions may be "problematic" because they may not be the product of arm's length negotiations.

In addition, the U.S. Supreme Court sounds much like the Delaware Suprem Court in discussing the deference afforded to the mutual fund board's judgment.  It extols the value of independent directors; it rewards good process.  "Thus, if the disinterested directors considered the relevant factors, their decision to approve a particular fee agreement is entitled to considerable weight, even if a court might weigh the factors differently."  And to reinforce the point -- "It is also important to note that the standard for fiduciary breach under section 36(b) does not call for judicial second-guessing of informed board decisions."

Justice Thomas concurred because he was worried that by endorsing the Gartenbergy standard the Court might be misunderstood as "countenanc[ing] free-ranging judicial 'fairness' review of fees that Gartenberg could be read to authorize" even though lower courts, in fact, had not done so. 

Don't worry, Justice Thomas, we get it -- plaintiffs can't win 36(b) cases.  Gartenberg deference prevails.

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