Jones v. Harris Associates L. P.

Supreme Court of the United States
176 L. Ed. 2d 265, 130 S. Ct. 1418, 2010 U.S. LEXIS 2926 (2010)

ELI5:

Rule of Law:

Under § 36(b) of the Investment Company Act of 1940, an investment adviser's fee constitutes a breach of fiduciary duty if it 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.

Facts:

Harris Associates L.P. served as the investment adviser for several mutual funds.
Petitioners were shareholders in three of these mutual funds.
Harris Associates provided management, investment, and other services to the funds in exchange for compensation.
The funds' boards of directors, which included independent members as required by law, annually reviewed and approved the advisory fee agreements with Harris Associates.
The fees Harris Associates charged to the mutual funds were allegedly higher than fees it charged to other, non-mutual fund institutional clients.
The shareholders believed the fees were excessive and disproportionate to the services provided, leading them to initiate a lawsuit.

Procedural Posture:

Shareholders (Petitioners) sued Harris Associates L.P. in the U.S. District Court for the Northern District of Illinois, alleging a breach of fiduciary duty under § 36(b) of the Investment Company Act.
The District Court granted summary judgment in favor of Harris Associates, applying the Gartenberg standard and finding the shareholders had failed to raise a triable issue of fact.
The shareholders appealed to the U.S. Court of Appeals for the Seventh Circuit.
A panel of the Seventh Circuit affirmed the judgment but explicitly rejected the Gartenberg standard, adopting a more deferential standard focused on disclosure and abdication of duty.
The Seventh Circuit denied a petition for rehearing en banc by an equally divided vote.
The U.S. Supreme Court granted certiorari to resolve the circuit split regarding the proper standard under § 36(b).

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Issue:

Does the standard established in Gartenberg v. Merrill Lynch Asset Management, Inc. correctly articulate the fiduciary duty an investment adviser owes regarding compensation under § 36(b) of the Investment Company Act of 1940?

Opinions:

Majority - Justice Alito

Yes. The standard from Gartenberg correctly articulates the fiduciary duty under § 36(b). To face liability, 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. This standard reflects the congressional compromise in the 1970 amendments, which sought to provide shareholders a stronger remedy than the common-law 'corporate waste' standard without authorizing courts to engage in 'reasonableness' review or rate-setting. The Act places the burden of proof on the plaintiff and gives significant weight to the approval of the fee by a fund's independent board of directors. A court must give board approval such consideration as is appropriate under all the circumstances, affording more deference when the board's process is robust and the directors are fully informed.

Concurring - Justice Thomas

Yes. While agreeing with the majority's conclusion and reasoning, this opinion expresses reluctance to endorse the 'Gartenberg standard' by name. The concern is that the Gartenberg opinion itself could be misread to permit a free-ranging judicial 'fairness' review that amounts to rate regulation, which Congress rejected. The proper approach, affirmed by the Court today, is rooted in the statutory text and fiduciary principles, which require significant deference to the informed conclusions of disinterested boards and hold plaintiffs to a heavy burden of proof. This decision correctly affirms the practice of post-Gartenberg courts that have wisely eschewed any form of judicial rate-setting.

Analysis:

This decision resolves a circuit split and establishes the Gartenberg standard as the uniform national test for claims under § 36(b) of the Investment Company Act. It strikes a balance between deferring to the business judgment of informed, independent fund directors and providing a substantive, albeit high, hurdle for shareholder challenges to excessive advisory fees. By rejecting the Seventh Circuit's more lenient, disclosure-focused standard, the Court ensures that shareholder litigation remains a viable, if difficult, check on adviser compensation. The ruling provides clarity for the mutual fund industry and reinforces the central role of independent directors as the primary 'watchdogs' for shareholder interests.

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