On Tap at the Supreme Court: Posner v. Easterbrook

[WSJ_law_blog]

One of the larger law-n-business cases on the Supreme Court’s 2009-1010 docket moves into the spotlight on Monday. At issue: whether the money-management fees that drive the mutual-fund industry are too high.

According to the WSJ’s Jess Bravin and Jane Kim, a ruling for shareholders could push down fees that last year approached $100 billion by some estimates in the $10 trillion industry. Click here for coverage from the USA Today; here for the Bloomberg story; here for links to all the relevant documents, courtesy of Scotusblog.

The case, Jones v. Harris Associates, strikes at the heart of the workings of the mutual-fund industry. Typically, the investment-advisory company that manages a mutual fund takes a percentage of the assets, say 1%. That fee is negotiated with the mutual-fund board, which is set up to represent investors.

In 1970, Congress imposed on investment advisers “a fiduciary duty with respect to . . . compensation for services.” Advisers said that means they should disclose fees, costs and profits to the mutual-fund board, which can then strike a deal on behalf of investors. The existence of nearly 8,000 mutual funds gives investors plenty of alternatives if they believe fees are too high, the mutual-fund industry said.

The shareholder plaintiffs, backed by the SEC, argue, on the other hand, that fund boards often are too closely tied to the advisers to drive hard bargains. They have a different definition of fiduciary duty, saying in their brief that Congress meant the fees “must be fair” to investors and “comparable to an arms-length deal.”

“The law, as it stands now, just went down the wrong road and let management fees get totally out of hand,” said John Bogle, founder of mutual-fund company Vanguard Group, which sells mostly low-fee index funds. Bogle filed an amicus brief backing shareholders.

The case was filed in 2004 by three shareholders in the Oakmark Funds, which were developed and run by Harris Associates, a Chicago firm that said it oversees about $48 billion in assets. The plaintiffs said Harris charged Oakmark an effective rate of 0.88% on $6.3 billion in assets, nearly twice the 0.45% rate for an unrelated institutional client like a pension fund.

The fee for independent clients, plaintiffs argue, should be a benchmark for what an arm’s-length transaction would look like. Harris responds that servicing the Oakmark Funds is more demanding than work for independent clients.

The dispute divided Seventh Circuit judges Frank Easterbrook and Richard Posner, who are both known for their market-based views of the law. In this case, however, the pair differed on whether the market works well in this instance.

Judge Easterbrook wrote the opinion rejecting the shareholder suit.

“Holding costs down is vital” for mutual funds, he wrote, because “management fees are a substantial component” of the costs and even small differences in rates can have a big impact on returns. He said that gives fund boards a reason to keep fees low, or investment advisers an incentive to deliver net returns that justify extraordinary pay.

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