March 11, 2009
Will the Supreme Court Save our Savings?
Posted by William Birdthistle

Whenever Dick Posner and Frank Easterbrook get into judicial fisticuffs, fascinating things happen.  (Think of Jordan v. Duff & Phelps, now an anchor tenant in the corporate law canon.)  This time, the spat is so good the Supreme Court has agreed to choose a winner.  Yesterday, the Court granted certiorari in Jones, et al. v. Harris Associates, L.P., thereby ensuring the case's immortality in corporate casebooks everywhere.

As I served as counsel of record for a brief of amici curiae law professors in support of the petitioners at the certiorari stage, Christine and Gordon have invited me to blog a few entries about the case.  And the timing could hardly be better or, perhaps, worse: during this disastrous economic meltdown that has shorn huge chunks (about $3 trillion) from IRAs, 401(k)s, and other investment accounts, the Supreme Court will decide whether and according to what legal standard mutual fund shareholders may sue their financial advisers for exacerbating those losses by charging excessive fees.  Since more than 90 million Americans hold (or did until recently) over $17 trillion in investment accounts, the potential impact of the case is nearly universal and the sums at issue staggering.

If one assumes cynically that this Court will simply side with the more conservative appellate jurist, we will have to find some ideological and political daylight between Easterbrook and Posner.  Or if one assumes that this Court will simply side with big business and against an increase in litigation, we need look only to last week's decision in Wyeth v. Levine, in which the Court rejected big pharma's preemption arguments and implicitly countenanced more product liability lawsuits.  So predicting how things will turn out in Jones v. Harris may require a little more digging into the statutory and jurisprudential background, as well as the competing opinions of Easterbrook and Posner.  In a short series of posts, I hope to spend a little time on each of those topics before offering a few concluding thoughts about the decision's practical and theoretical implications for the scholarly debates over classical versus behavioral law and economics, excessive executive compensation, and the Court's ability to evaluate dueling econometric analyses of market competitiveness.

But first, some background.

Jones, et al., were investors in mutual funds managed by Harris Associates, an investment adviser.  Those investors are now suing Harris for charging excessive fees to manage the funds in violation of the adviser's fiduciary duty under Section 36(b) of the Investment Company Act of 1940.  Congress added that fiduciary duty -- and a private right of action to enforce it -- in 1970, legislating that "the investment adviser of a registered investment company shall be deemed to be a fiduciary with respect to the receipt of compensation for services."  What exactly does that mean?

The Second Circuit attempted to answer that question in 1982 with its ruling in Gartenberg v. Merrill Lynch Asset Management.  The Second Circuit held that the Section 36(b) fiduciary duty is violated if the adviser charges a fee that "bears no reasonable relationship to the services rendered and could not have been the product of arm's-length bargaining."  Fund trustees -- and courts -- can make this substantive determination, according to Gartenberg, by evaluating a set of factors, including the nature of the services rendered by the adviser, the profitability of the fund to the adviser, economies of scale, the fees of similarly situated mutual funds, &c.  Since 1982, mutual fund trustees everywhere have conducted an annual review of advisory contracts following these "Gartenberg factors."

But ever since the creation of this fiduciary duty, not a single plaintiff has won a lawsuit complaining of its breach by an adviser charging excessive fees.  So what makes Jones v. Harris so interesting?  Did the plaintiffs win this one?  No, they lost badly.  But in ruling against them, Judge Easterbrook held that notwithstanding the 38-year losing streak, the Gartenberg standard was still too lenient for plaintiffs, and that the proper standard should be something a little more market-oriented and a little less regulatory.

Next up, Chief Judge Easterbrook's opinion.

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