We Were Wrong (About the Supreme Court)
By James Kwak
Last November, we criticized a decision by the Court of Appeals for the Seventh Circuit in Jones v. Harris Associates in which Judge Frank Easterbrook wrote that mutual fund companies can charge their mutual funds whatever they can get away with (assuming disclosure and absent fraud), because prices are set by The Market. The case was remarkable because of a dissent by Judge Richard Posner, part of his recent (partial) disavowal of his earlier free market views, arguing that markets could not be trusted to set mutual fund fees. However, we predicted that the Supreme Court would pass up the opportunity to strike a blow on behalf of mutual fund investors and against excessive mutual fund fees:
“It can take the easy way out and resolve the case on the sole question of what ‘fiduciary duty’ means. Or it could limit itself to deciding what standard should be used in reviewing mutual fund fees and then tell the 7th Circuit to hear the case again. Most likely it will either sign off on the efficient-markets myth or dodge the question in one of these ways.”
We were partially right; technically speaking, the Court (opinion here) simply clarified the standard to be used when assessing mutual fund fees. Substantively speaking, however, it went a bit further. As Jennifer Taub explains, not only did it strike down Easterbrook’s bit of outdated free market theory, it also held that courts should compare the fees that a mutual fund company charges its captive mutual funds and those it charges institutional clients who can negotiate fees directly. In Jones v. Harris Associates, Harris Associates was charging its captive mutual funds fees that were more than double those it charged institutional asset management clients.
It still doesn’t look that great for the plaintiffs–mutual fund investors who claim they were charged excessive fees. The district court that first heard the case found that, under the existing Gartenberg standard, the plaintiffs had no case. The Supreme Court in its opinion said that it was reaffirming Gartenberg, but as Taub and William Birdthistle have pointed out, it really was modifying Gartenberg slightly in a pro-plaintiff way. So what happens now is that the case goes back to the Seventh Circuit to deal with the case in a manner consistent with the Supreme Court ruling (and I think the Seventh Circuit could hand it back to the district court). But it’s still a small step.