November 03, 2009
"Is the fiduciary standard the same?"
Posted by Gordon Smith

This is the question that preoccupied Justice Kennedy in yesterday's oral argument in Jones v. Harris. He asked it over and over again in various ways?

  • "Is Harris a fiduciary in the same sense as a corporate officer and a corporate director? Or does his fiduciary duty differ? Is it higher or lower, same with a guardian, same with a trustee?"
  • "The word 'fiduciary' -- does fiduciary imply different standards, depending on what kind of fiduciary you are?"
  • "Is the fiduciary standard the same, without getting into how its applied?"
  • "Is the fiduciary standard the same for [Harris], for a guardian, for a trustee, for a corporate officer or a corporate director, always the same?"
  • "Do you think Congress used the term 'fiduciary' in a very special sense here?"

Why is he so preoccupied with this question? After asking all those questions, he tells us:

I will just tell you the problem I'm having with the case. If I look at a standard that the fees must be reasonable and I compare that with what a fiduciary would do, I thought a fiduciary has the highest possible duty. But apparently the submission is the fiduciary has a lower duty, a lesser duty than to charge a reasonable fee. I just find that quite a puzzling use of the word "fiduciary.... I don't know why Congress didn't use some other word." (emphasis added)

I laughed out loud at that last sentence. I wonder if he had another word in mind?

In my experience, many business people and judges who do not specialize in fiduciary law (like Justice Kennedy) have a vague notion that the law imposes a standard set of (demanding) obligations on those who are called "fiduciaries." As I observe at the beginning of my article, The Critical Resource Theory of Fiduciary Duty, this is half right: "courts require fiduciaries to adhere to a general obligation of loyalty, but countless variations on that theme tailor the general obligation to the specific context." So it seems to me that Larry Ribstein is on the right track when he asks, "What fiduciary duties are appropriate to this particular standard form?" (If you are in the mood for a more extensive treatment of this issue in the context of this case, check out William Birdthistle's article, Investment Indiscipline: A Behavioral Approach to Mutual Fund Jurisprudence, where he writes, among other things, "As every law student knows, the term 'fiduciary duty' describes a broad range of obligations, from the most minimal requirements of a bailee to the far more onerous responsibilities of an executor.")

Of course, in this case, the term "fiduciary" was used by Congress in §36(b) of the Investment Company Act of 1940: "the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services." Thus, we could just view this as an exercise statutory interpretation, though "fiduciary" is not a defined term in the statute, so it's not clear how this change in perspective helps things. In the end, it appears that Congress was leaning on the common law to give content to the term.

Where do we start? William Birdthistle surely is correct in asserting, "Any argument that market forces are and ought to be the only restraints on the fees that investment advisors charge fund shareholders – and that courts are ill-suited to this task – must first acknowledge that Congress has already decided otherwise in its enactment of Section 36(b)." Of course, this is a bit of straw man because even Judge Easterbrook did not hold that "market forces are and ought to be the only restraints on the fees." Instead, he held that investment advisors are subject to a fiduciary duty of candor. That is a fairly minimalist understanding of fiduciary duty.

The Gartenberg case has a more expansive understanding of the duty, variously framed as a duty to avoid a fee “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” and a duty to charge a fee “within the
range of what would have been negotiated at arm’s length in light of all the surrounding circumstances.” Lyman Johnson, in A Fresh Look at Director “Independence”:  Mutual Fund Fee Litigation and Gartenberg at 25, says that the first formulation looks substantive while the second looks procedural, but I disagree. They both look substantive to me. The focus is on the size of the fee, and the process is mentioned only as a guide to determining a reasonable size. Substantive tests for breach of fiduciary duty are extremely difficult for courts to assess, and courts rarely pull the trigger under a substantive test ... go read Chancellor Allen's Gagliardi case if you need more convincing on that point. Nevertheless, if the process is compromised -- and the process here looks very compromised -- courts don't have much choice but to look at substance. By the way, Judge Posner seems to embrace the substantive standard in his dissent from denial of rehearing en banc: "unreasonable compensation can be evidence of a breach of fiduciary duty."

Usha noted another option from the oral argument that made me laugh. This one came from David Frederick, who was representing the petitioners. Going back to Justice Kennedy's questions, Frederick announced:

What Judge Cardozo, when he was on the New York Court of Appeals, said [is that] a fiduciary represents the punctilio of honor, and that is contrasted with the morals of the marketplace operating at arm's-length. It surely cannot be the case that, where you are dealing with a fiduciary duty -- which is a higher standard recognized in the law -- that you can charge twice as much as what you are obtaining at arm's-length for services that you are providing.

Two points here. First, Frederick is stuck in a world in which "fiduciary" has meaning independent of context. The reason I laughed at his invocation of Meinhard v. Salmon is that this articulation of fiduciary duty stands for the proposition that the fiduciary loses. Seriously, can you live up to the "punctilio of an honor the most sensitive"? Can anyone? The standard is largely vacuous, a fun rhetorical flourish without any meaningful content. If you tried to derive content from this standard, you would be led astray because the talk is too tough.

Second, Cardozo's standard is clearly procedural. It's about how the fiduciary behaves in exercising discretion. Frederick slides from that straight into Gartenberg's substantive standard. Apples and oranges.

So where does this leave us? I think Brett McDonnell got it right: "Gartenberg [is] the worst alternative available, except for all of the others."

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