By Mark Jewell
AP Personal Finance Writer
BOSTON (AP) — When both sides claim victory after a U.S. Supreme Court decision, there’s some spin going on.
Yet it’s not as if anyone is being dishonest about last week’s ruling. Investors and the mutual fund industry alike have something to crow about.
At issue? What constitutes an excessive mutual fund fee, and what standard should be used to make that assessment.
A key sticking point is that individual investors often pay twice as much as big institutional clients such as pension funds.
Some observers argue the court’s ruling will pressure fund companies to reduce that gap and give smaller investors a break.
The ruling “was not a home run for either side,” but is investor-friendly, says William Birdthistle, an assistant professor at the Chicago-Kent School of Law.
Here’s a rundown of the wins and losses for both sides.
BACKGROUND: A group of investors sued Harris Associates, an adviser to the Oakmark family of mutual funds, arguing that its fees were excessive. The case reached the 7th U.S. Circuit Court of Appeals, which shocked the fund industry two years ago.
In its decision, that court abandoned a fee-challenge standard that had been considered largely unassailable since its adoption in 1982. The Gartenberg standard requires plaintiffs to show that fees were so out of whack that they couldn’t conceivably have been the product of above-board negotiations between the fund adviser and the independent board that approves the adviser’s fees.
The 7th Circuit went beyond the Gartenberg test and concluded that investors alleging excessive fees must also show that the fund’s adviser misled the fund’s board. That’s a higher standard — so high that investor advocates suggested successfully challenging excessive fees would be nearly impossible.
THE DECISION: The Supreme Court faulted the lower court, saying that the Gartenberg standard reflected Congress’ intent in the mutual fund laws on the books. The high court sent the case back for reconsideration applying Gartenberg.
Justice Samuel Alito, writing for the court, said Gartenberg correctly holds that any challenge must show a fee was so high that it couldn’t have been the product of “arm’s length bargaining” between the adviser and board. The court also warned against judicial second-guessing of fund board fee decisions.
WHAT INVESTORS WON: Investors will avoid the higher bar that the appeals court would have established for fee challenges.
Such a standard “would have virtually precluded any successful fee suit from proceeding,” says Mercer Bullard, a University of Mississippi securities law professor.
Bullard says excessive fee claims are now more likely to succeed. Advisers and boards will come under pressure to review why individuals are charged more than institutions, and justify the differential in case of a challenge.
It’s an important result stemming from the first time the high court squarely addressed the disparity in fees paid by individual investors and institutional clients.
The industry has plenty of justifications for charging smaller investors fees that are frequently twice as high for each dollar invested. Institutional clients enjoy what’s in essence a bulk rate because they don’t need as much support. For instance they don’t need toll-free customer hotlines, and don’t move relatively paltry sums in and out of a fund, adding to a fund’s transaction costs.
But still, the bigger bite from small investors’ returns can be galling.
For example, the lawsuit says investors in three Oakmark funds would have saved $37 million to $58 million in a single year, had they been paying fees as low as those of institutional clients.
That’s a substantial difference, given that the services provided were similar.
Alito wrote that courts must give such fee comparisons “the weight they merit in light of the similarities and differences between the services” that each client group needs.
Alito cautioned that the law “does not necessarily ensure fee parity,” and warned against making inapt comparisons.
What’s more, Bullard says the greater attention to fee disparities will put more pressure on fund managers to keep mutual fund fees within the range of institutional fees.
WHAT INVESTORS LOST: Although Gartenberg isn’t as strict as the 7th Circuit’s standard, it has still proved to be a high bar. Since Gartenberg has been in effect, no fee challenge has prevailed at trial. Plenty have been dismissed, although there have been settlements that provided refunds to investors.
“I don’t expect that to change,” Bullard says.
WHAT FUND COMPANIES WON: Predictability. Fund fee-setting deliberations came under a cloud after the appeals court tried to replace Gartenberg, says Paul Schott Stevens, president and CEO of the industry’s Investment Company Institute.
The high court’s support for the standard bolsters existing industry practices, bringing “stability and certainty for mutual funds, their directors, and almost 90 million investors,” Stevens says.
Additional confidence, he says, comes from the ruling’s carefully written guidelines to prevent apples-to-oranges comparisons of fees charged to individual investors with those of institutional clients.
WHAT FUND COMPANIES LOST: Their practice of charging small investors more is now being closely watched.
The ruling also means fund companies won’t get the greater fee-challenge protection they would have won from the appeals court’s rejected standard.
If there’s any clear loser from the Supreme Court’s unanimous ruling, it’s the Chicago-based appeals court. For the 7th Circuit, Bullard says, the decision was “a humiliating defeat.”
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