WASHINGTON (CN) – In a case followed closely on Wall Street, the Supreme Court on Monday heard arguments on whether an investment adviser violated his fiduciary duty by charging exhorbitant fees. Chief Justice John Roberts asked, “It makes a lot more sense to have the Securities and Exchange Commission regulate rates than to have courts do it, doesn’t it?”
Assistant Solicitor General Curtis Gannon answered that the SEC had not acted on such a case in just under 30 years.
David Frederic, from Kellogg, Huber, Hansen, Todd, Evans & Figel, argued on behalf of investors in Oakmark Mutual Funds, and said the investors had to pay double what others paid for the same service. Noting that the investment adviser had appointed the members of the board of trustees, Frederic also suggested a conflict of interest.
John Donovan, from Ropes & Gray, argued on behalf of Harris Associates, a financial advisory firm. He agreed that the other side might have a case if there was a flaw in the process of negotiating fees or if the fee fell too far from normal. He said the price negotiations were not tainted because a majority of the fund’s independent trustees consented, and argued that the fees are difficult to compare.
“These days all you have to do is push a button and you find out exactly what the management fees are,” Roberts said, suggesting the agreement was transparent. “As an investor, you can make whatever determination you’d like.”
“He can go look at another fund. It takes 30 seconds,” Roberts added.
Frederic, in arguing against the high fees, estimated that 26 to 35 percent of mutual fund investments are from 401(K) plans, which are essentially locked into the funds. He said that this, along with tax penalties, keeps investors from switching funds.
“Using the word ‘fair fee’ in my mind is meaningless because it has to be fair in relationship to something,” Justice Sonia Sotomayor said. “As long as there has been full disclosure as required, that’s the market, so that’s fair.”
Frederick said the fees should be compared to those that the adviser charged for similar work, but were negotiated by people without a conflict of interest. He said that unfair fees would constitute a breach of fiduciary duty.
The board of trustees had approved the fees by a majority vote as mandated by the Investment Company Act of 1940.
The justices debated the role of the court in deciding such a case, with Roberts proposing that the SEC handle the problem.
The 1940 law allows the courts to give the financial agreements “such consideration that the court considers due under the circumstances.”
“Wow,” Justice Antonin Scalia said to laughter. “It’s utterly meaningless to me.”
When Donovan took the podium to argue that the fees were acceptable, Roberts asked why charging double doesn’t fall far enough out of the normal price range.
Donovan replied that every mutual fund is different and that they can’t be compared, adding that the funds the shareholders had compared were “very different.”
“Well, then you say, ‘look to see if it’s outside the bounds,’ and now you tell me there is no way to look to see if it’s outside the bounds,” Roberts said.
Sotomayor put forward a scenario where all the board members voted in favor of a fee in following the advice of a tainted insider. “Is that a process that would guarantee an arm’s-length transaction in the sense that Congress intended in this act?” she asked.
Donovan replied that the situation would be in violation of Congress’ specifications limiting conflicts of interest.
The 7th Circuit affirmed the district court’s decision in favor of Harris Associates, the adviser. The appellate court held that unless the adviser somehow misled the trustees who voted to accept the fee, it could not rule against the adviser.
It also ruled that in comparing fees, the court should compare captive funds to other captive funds, not to easily moved funds that might have lower costs.
Towards the end, Justice Stephen Breyer made a potentially telling Freudian slip, but blamed it on his laryngitis. “I think we are reviewing the district court opinion, I think we are reversing, we are reviewing, sorry,” he said in a scratchy voice to laughter among the audience.