In a recent decision, the U.S. Supreme Court affirmed by a unanimous vote that the standards used by courts to settle disputes over the reasonableness of fees charged by mutual fund advisers as set out in Gartenberg v. Merrill Lynch were the appropriate standards, overturning a May 2008 decision by the U.S. Court of Appeals for the Seventh Circuit.
The Court's decision sent the case brought by a group of shareholders alleging that a certain mutual fund investment adviser charged excessive fees back to the lower court for further proceedings. This lawsuit is just one of several currently pending in which the plaintiffs claim that advisory fees for mutual funds are excessive.
The Second Circuit's decision in the Gartenberg case, which was affirmed by the Court, held that in order to find that the adviser's fees were excessive and therefore a violation of Section 36(b) under the Investment Company Act of 1940, the “adviser-manager 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 collective bargaining.” The Gartenberg court pointed to certain factors that could be used to determine where the adviser's fee is reasonable. Those factors include what the fees are charged by advisers at similar funds and the nature and quality of the services provided by such advisers. The Gartenberg standard has been used by the mutual fund industry and its boards of directors for the past three decades. In its decision, the Seventh Circuit went beyond the Gartenberg standards and concluded that investors alleging excessive fees also must show that the fund's adviser misled the fund's board of directors.
Whether or not the Court's decision rejecting the lower court's ruling and affirming Gartenberg was a victory for the mutual fund industry or plaintiff-investors depends on whose “spin” you believe. The mutual fund industry apparently believes that the Court's decision brings clarity to the issue and affirms the standards used by the industry for more than 30 years. On the other hand, some attorneys representing investor-plaintiffs in such cases view the decision as backing principals friendly to fund shareholders and rejecting the industry's interpretation of Gartenberg. Some observers believe that the Court's ruling will pressure fund companies to reduce the gap between what individual fund investors pay in fees versus what big institutional clients pay. Most observers believe that the decision keeps the door open for investor-plaintiffs to challenge mutual fund fees but only slightly and under limited circumstances. It should be clear to all observers that the decision provides more clarity for mutual fund boards of directors in determining the factors to consider while reviewing the appropriateness of the mutual fund fees. That clarity provided in the Court's ruling also underscores to fund managers the importance of examining their fee structures with the services they provide and whether it is appropriate for one client to pay more fees than another.