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From the Pages of The Pomerantz Monitor: Supreme Court Upholds Gartenberg Standard

By Carolyn Moskowitz

As reported in the March/April issue of The Pomerantz Monitor, on March 30 the Supreme Court decided Jones v. Harris, a case concerning reasonableness of fees charged by a mutual fund advisor to its funds, and adopted a standard that was set in a case litigated by the Pomerantz firm almost three decades ago. Then, on April 5, 2010, after The Pomerantz Monitor went to press, the Supreme Court sent a lawsuit against Ameriprise Financial Inc. over alleged overcharging for mutual fund fees back to the Eighth Circuit, finding that the Gartenberg fee dispute standard that was upheld in Jones v. Harris also applies to Ameriprise.

Section 36(b) of the Investment Company Act imposes a fiduciary duty on fund advisors ?with respect to the receipt of compensation,? and creates a private right of action for investors in the funds that paid those fees. This provision was enacted because Congress recognized that the fund directors who approve the fees are often not truly independent of the advisor, since the advisor created the funds in the first place and controls the appointment of the directors of the funds.

The Supreme Court in Jones v. Harris held that the Investment Company Act allows shareholders of mutual funds to challenge the reasonableness of fees charged by fund advisors, if those fees are so excessive as that they could not have been negotiated at arm?s length. The Court unanimously voted to reverse the decision of the Seventh Circuit, which had held that the marketplace, and not courts, should determine whether mutual fund fees are reasonable. The standard used by the Seventh Circuit rendered it almost impossible for shareholders to challenge fees.

In Jones v. Harris, the Supreme Court adopted the standard set by the Pomerantz Firm in Gartenberg v. Merrill Lynch, which was much easier for shareholders to meet than the Seventh Circuit?s standard. The Court also provided additional guidelines, which may further help shareholders to prevail in excessive fees case. Previously, lower courts have not been very receptive to such claims.

Jones v. Harris involved a claim that the fees charged by the advisor were excessive because they were far higher than the rates it charged to other advisees, such as pension plans, that the advisor does not control. The lower courts have been ignoring such comparisons for over forty years, on the theory that this is an apples to oranges comparison and that only the fees charged to other mutual funds can be used for comparison purposes. The Supreme Court has now held that the courts may consider, in deciding whether the fees charged are excessive, the fees the same advisor charges to other types of clients. In addition, the Court admonished lower courts not to rely too heavily on comparisons with fees charged to other mutual funds, because those fees might be just as inflated as the fees at issue in the action. 

Once the fees charged to other types of advisees are seriously considered, this will not only make current fees harder to justify, but might actually force mutual fund directors to consider those types of charges in approving new advisor fee agreements, which must be renewed each year.

The Court in Jones v. Harris also decided that courts should take a closer look at the fairness of the fees agreed to by the funds if the fee approval process is impaired, such as when an advisor withholds information, or makes misrepresentations, to mutual fund directors.

Full post as published by PomTalk on April 06, 2010 (boomark / email).