The Jones v. Harris case is attracting some popular media attention, most of which focuses on the higher rates that mutual fund advisers generally charge their captive funds versus their institutional investor clients. For example, NPR covered the case this morning and tried to present both perspectives on this particular rate issue, with comments from David Frederick, counsel for mutual fund investors, and Karrie McMillan, general counsel for the trade association for mutual funds. You can listen to the story here. Judge Posner also acknowledged this issue in his dissent, stating that “[a] particular concern in this case is the adviser’s charging its captive funds more than twice what it charges independent funds.”
An adviser’s rate structure obviously is an important factor to consider, but I think we also need to analyze factors like any difference in services provided captive funds versus institutional investor clients, the actual services provided to captive funds in exchange for the negotiated fees and the independence of the fund’s directors or trustees who negotiated the adviser’s contract. For an excellent discussion of the difference between “interestedness” and “independence” in the context of mutual fund directors/trustees, see Professor Lyman Johnson’s article titled A Fresh Look at Director “Independence”: Mutual Fund Fee Litigation and Gartenberg at 25. And yes, I think courts should have the flexibility to consider market standards and competition.
That being said, what troubles me about Judge Easterbrook’s majority opinion in Jones v. Harris is not his reference to market standards and competition, but his level of deference to those factors. Perhaps his strong opinion was necessary to call attention to an arguable imbalance in the courts’ weighing of the Gartenberg factors. Based on Gartenberg’s dicta, many courts do not consider market standards and competition; according to Professor Lyman’s article, many courts do not consider director/trustee independence. I have not conducted a review of all court decisions applying the Gartenberg test, but I suspect other factors might get more or less attention than they deserve.
At the end of the day, the mutual fund’s advisory contract needs to reflect terms negotiated in good faith and at arm’s length. If a mutual fund goes beyond the definition of interestedness and retains truly independent directors/trustees, a court might grant more deference to the actual terms of the negotiated contract. If director/trustee independence is lacking, a court might place greater emphasis on evidence regarding disclosure of conflicts and terms of fee structures, market standards, competition in the markets, profitability of the fund and the like. Although such judicial discretion and flexibility may make some uncomfortable, I think it is an appropriate standard given that markets, investors and fund practices can change and are not static concepts. It will be interesting to see the Supreme Court’s decision and whether it has any impact on the larger executive compensation debate.
In addition, I want to say how much I appreciate Professor Larry Ribstein’s post yesterday on Jones v. Harris. It highlights the utility of the case beyond the basic fee dispute and reminds us of the importance of entity form selection both as we teach the concepts to our students and as they ultimately advise their clients in practice. I also think Professor Ribstein raises an important issue regarding the use of the term “fiduciary” in the business context—again, an issue that extends beyond the case and Section 36(b) of the Investment Company Act.
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