On March 30, 2010, the US Supreme Court issued its decision in Jones v Harris Associates, embracing the Gartenberg standard (from the Second Circuit) for evaluating advisory fees and rejecting the approach articulated by the Seventh Circuit, which looks to market efficiency and trust law fiduciary duty. In doing so, the Court resolved a circuit split and established the standard governing excessive fee claims arising under Section 36(b) of the 1940 Act. Furthermore, the Court provided clarity with respect to the scope of the fiduciary duty articulated in Section 36(b) of the 1940 Act. Additionally, on April 5, 2010, the Court vacated the decision in Gallus v. Ameriprise Financial Inc. and remanded the case to the U.S. Court of Appeals for the Eighth Circuit to be considered in light of Jones.

In an opinion authored by Justice Alito, the unanimous Court held in Jones that the Second Circuit, in Gartenberg, “was correct in its basic formulation: to face liability under Section 36(b), 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.” According to the Court, the Gartenberg approach “fully incorporates” the meaning of the phrase fiduciary duty as previously set forth by the Court: “the essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm’s length bargain.” In contrast to trust law fiduciary duty, the fiduciary duty set forth in Section 36(b) shifts the burden of proof from the fiduciary to the party claiming the breach. Thus, a successful claim arising under Section 36(b) requires a showing by the party claiming the violation that the fee charged by an investment adviser was outside of the range that arm’s-length bargaining would produce.

With respect to a court’s role in evaluating excessive fee claims arising under Section 36(b), the Court noted that “the standard for fiduciary breach under [Section] 36(b) does not call for judicial second-guessing of informed board decisions.” Furthermore, a court should not “supplant the judgment of disinterested directors apprised of all relevant information, without additional evidence that the fee exceeds the arm’s-length range.” However, the Court also noted that, where a board’s process is deficient or where the adviser withheld important information, “the court must take a more rigorous look at the outcome.” In cases of an adviser failing to disclose material information, “greater scrutiny is justified because the withheld information might have hampered the board’s ability to function as ‘an independent check upon management.’” According to the Court, “a court’s evaluation of an investment adviser’s fiduciary duty must take into account both procedure and substance.”

On the issue of whether courts may consider differences in rates that investment advisers charge institutional clients and funds in the context of Section 36(b) claims, the Court stated that, “[s]ince the [1940 Act] requires consideration of all relevant factors . . . there [cannot] be any categorical rule regarding the comparisons of the fees charged different types of clients . . . . Instead, courts may give such comparisons the weight that they merit in light of the similarities and differences between the services that the clients in question require . . . .” However, the Court went on to add that courts “must be wary of inapt comparisons,” as “there may be significant differences between the services provided by an investment adviser to a mutual fund and those it provides to a pension fund which are attributable to the greater frequency of shareholder redemptions in a mutual fund, the higher turnover of mutual fund assets, the more burdensome regulatory and legal obligations, and higher marketing costs.” The Court instructed that, “[i]f the services rendered are sufficiently different that a comparison is not probative, then courts must reject such a comparison. Even if the services provided and fees charged to an independent fund are relevant, courts should be mindful that the [1940] Act does not necessarily ensure fee parity between mutual funds and institutional clients. . . .” The Court further noted with respect to fee comparisons that “courts should not rely too heavily on comparisons with fees charged to mutual funds by other advisers . . . [as they] may not be the product of negotiations conducted at arm’s length.”

In a concurring opinion, Justice Thomas cautioned that the majority opinion should not be described “as an affirmation” of the Gartenberg standard, as it “does not countenance the free-ranging judicial ‘fairness’ review of fees that Gartenberg could be read to authorize and that virtually all courts deciding Section 36(b) cases since Gartenberg . . . have wisely eschewed in the post Gartenberg precedents we approve.” According to Justice Thomas, the Court’s opinion rightly emphasizes the statutory restraints on a court’s review of excessive fee claims arising under Section 36(b) and “follows an approach that defers to the informed conclusions of disinterested boards and holds plaintiffs to their heavy burden of proof in the manner the [1940] Act requires.”