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Jones v. Harris Associates LP

U.S. Supreme Court Allows People to Protect Their Retirement Investments

The U.S. Supreme Court vacated a lower court ruling that set a very high standard for establishing that a mutual fund investment adviser's compensation constitutes a breach of fiduciary duty. AARP had asked the Court to hear this dispute, had briefed the case in lower court consideration, and had filed a "friend of the court" brief with the Supreme Court noting that millions of people are investing in mutual funds, either on their own or through 401(k)s or IRAs, and that excessive fees jeopardize their retirement security.


A mutual fund is an investment company that pools money from many people and invests the money in stocks, bonds, short-term money-market instruments, other securities, or some combination of these instruments. Mutual funds do not have employees, and while they do have a board of directors, the board primarily plays an oversight role but is not involved in the fund's day-to-day operations. That role is played by an investment adviser who decides which securities to buy and sell in order to meet the fund's specified financial goals. Because investment advisers simultaneously direct and are compensated by the funds they manage, they may have interests other than maximizing investors' returns, and the typical relationship between the fund and its adviser is fraught with potential conflicts of interest.

In order to minimize such conflicts, Congress passed the Investment Company Act of 1940, which established a system to regulate transactions between funds and their advisers. In the years that followed, however, conflicts that harmed investors remained, and studies showed that the mutual fund industry "even as regulated by the Act, had proven resistant to efforts to moderate adviser compensation." To further address the inherent conflicts, Congress passed the Investment Company Amendments Act of 1970, which, in part, imposed a fiduciary duty on investment advisers with respect to their compensation and gave investors the right to sue when advisers breached that duty.

The Dispute

Owners of shares in several of the Oakmark family of mutual funds sued the Fund's investment adviser, Harris Associates, contending that the Funds paid excessive fees in violation of Harris's fiduciary duty under the federal law. A federal trial court dismissed the case, finding that the fees were typical for the industry and the investors' challenge did not meet the threshold to make a claim that was set out by the U.S. Court of Appeals for the Second Circuit in the 1982 Gartenberg case. Gartenberg established that in order to constitute a compensation-related breach of fiduciary duty, a fee must be "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."

On the investors' appeal, the U.S. Court of Appeals for the Seventh Circuit agreed that the compensation in this case was not excessive, but rejected the Second Circuit's Gartenberg test, setting an even higher threshold to permit a claim to go forward. The Seventh Circuit adopted a test that requires only that investment advisers make "full disclosure" to the fund's board of directors and "play no tricks" in negotiating their compensation. The investors here had not claimed that "Harris Associates pulled the wool over the eyes" of the board of directors and therefore, the court said, they could not establish a breach of fiduciary duty.

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