U.S. Supreme Court

Supreme Court Accepts Consensus Standard for Investment Adviser Suits


The U.S. Supreme Court has accepted a standard formulated by a federal appeals court more than 25 years ago to evaluate shareholder suits for breach of fiduciary duty by mutual fund investment advisers.

The unanimous opinion by Justice Samuel A. Alito Jr. said that “something of a consensus” had developed around the standard set out in a federal appeals opinion, Gartenberg v. Merrill Lynch Asset Management Inc.

“We conclude that Gartenberg was correct in its basic formulation,” Alito wrote in the opinion (PDF). To face liability, “an investment adviser must charge a fee that is 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.”

The Chicago-based 7th U.S. Circuit Court of Appeals had rejected the Gartenberg standard, instead requiring the plaintiffs to prove that the adviser had misled the board of directors that approved the fee.

“By focusing almost entirely on the element of disclosure, the 7th Circuit panel erred,” Alito wrote.

Industry groups praised the decision, saying its reliance on a long-standing framework brings stability and certainty to mutual funds, Reuters reports.

But Chicago-Kent law professor William Birdthistle says the opinion is a loss for the investment industry, despite claims to the contrary, because of a discussion that begins on page 13 of the opinion.

In that section, the Supreme Court says courts may consider differences in rates that investment advisers charge institutional and retail investors, giving the differences “the weight they merit” in light of similarities and differences between services provided. Industry-wide, retail investors pay twice the rate that institutions pay, says Birdthistle, who wrote an amicus brief supporting cert in the case, Jones v. Harris Associates.

“In my mind, that’s bad news for the industry and it’s terrific news for investors,” Birdthistle told the ABA Journal.

The decision was based on an interpretation of Section 36(b) of the Investment Company Act authorizing suits against investment advisers for breach of fiduciary duty. The plaintiffs had contended that investment adviser Harris Associates had breached its duty by charging fees that were “disproportionate to the services rendered.”

Justice Clarence Thomas wrote separately to caution that the majority opinion should not be described “as an affirmation” of the Gartenberg standard. Although courts have cited Gartenberg throughout the years, they have deferred to the decisions of disinterested boards and held plaintiffs to a heavy burden of proof, he said.

Nice try, Birdthistle responds. “I think Thomas’ opinion is terrific because it’s like a really bad tell in poker”–showing Thomas’ view didn’t carry the day with the Supreme Court, Birdthistle says.

Updated at 11:50 a.m. to include comments by Birdthistle.

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