An Investor Litmus Test for the New Supreme Court

by Jacob Zamansky on November 3rd, 2009 at 1:44 pm : Comments 000

Did the addition of Supreme Court Justice Sonya Satamayor make the court friendlier to investors?  That question should be answered shortly as the Supreme Court decides the case of “Jones v. Harris Associates,” which could impact the 92 million Americans that own shares in mutual funds.  The legal issue the court will address is whether the excessive fees and expenses mutual funds charge is a violation of Section 36 (b) of the Investment Company Act (ICA) that says mutual fund advisors have a “fiduciary duty” with respect to compensation for their services.  The ICA also provides mutual fund investors with the right to file lawsuits if mutual fund advisors violate the law’s provisions.

While the decision itself focuses on this issue, there are broader practices which will also be exposed. Rules state that decisions regarding fees must be done by a board of independent directors.  But it’s not always clear what constitutes being “independent” for this purpose.

In this case, Harris Associates is the manager of several mutual funds including the flagship “Oakmark Fund.”  Investors claim that annual expenses have inappropriately increased as the fund grew larger. Indeed, the firm allegedly increased its expense charges from 1.05% to 1.1% of total assets.  Traditionally, mutual funds decrease expenses as they grow larger because they gain economies of scale.  Moreover, investors contend that Harris charged a smaller fee to large pension funds.

Investors in the Oakmark Fund allege that the expense charges were increased without a careful review by the supposedly independent board that oversaw the fund.  A major problem is that directors are paid by these expenses and routinely mutual funds have a “good ole’ boy” network of directors.  Harris Associates actually had former employees on their mutual fund boards.

Ideally for small investors, the Supreme Court will come down hard on Harris Associates and by doing so accomplish much for these investors.  Mutual fund directors would be more independent, and thus less likely to approve extremely high fees, while at the same time reinforce the fiduciary standard rule as defined by the ICA.

It’s an important decision for investors but it’s also a potential indicator of future decisions that will be of importance to investors.

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and investors, mutual fund fees, supreme court decision