ICI filed a friend-of-the-court brief supporting the respondent in Jones v. Harris Associates, a case challenging the legal framework dating from the 1982 Gartenberg decision by the 2nd U.S. Circuit Court of Appeals (see “High Court Takes on Investment Adviser Fee Dispute”).
In its brief, ICI asserted that the Gartenberg framework provides “real and substantial protection to investors” and has provided useful guidance for investment advisers, fund directors, courts, and even the Securities and Exchange Commission (SEC) for almost 30 years.
The brief explained that in Gartenberg v. Merrill Lynch Asset Management, the 2nd Circuit held that “to be guilty of a violation of Section 36(b),” a fund 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.” Under Gartenberg, a court evaluating an excessive fee claim weighs those factors most relevant to the particular case and gives appropriate weight to the independent directors’ approval of the fee, as Congress directed in the Investment Company Act.
ICI noted that, using Gartenberg, fund directors and courts have found that a central part of their analysis focuses on the nature and quality of the services investors are receiving and the price that investors could be expected to pay to other advisers that manage similar mutual funds providing comparable services. ICI argued that often petitioners are asking courts to reject a comparison of fees charged by advisers to comparable mutual funds in favor of a comparison to fees paid by a fundamentally different type of client and one that typically receives fundamentally different services from the adviser.
ICI said these disputes rest on a highly inaccurate equating of mutual funds and non-mutual fund institutional accounts, and also disregard regulatory enhancements to mutual fund governance and fee-approval decisions that Congress, the SEC, independent directors, and the industry have put in place, as well as Section 36(b)(2), which instructs courts to give appropriate consideration to the fee approval decisions of independent fund directors.
ICI contended that “mutual funds operate under a regulatory regime arguably more comprehensive than that governing any other financial product,” and that “a centerpiece of this regime is Section 15(c) of the ICA [Investment Company Act], which requires substantive scrutiny by fund boards of investment advisory contracts and their terms, and further requires that advisory fees be approved by a majority of independent directors.”
“For nearly three decades, the Gartenberg framework has provided fund boards and advisers with useful guidance, ensured investor protection, and served judicial economy by not embroiling the courts in technical disputes over business judgment,” the ICI brief stated.
Free Market Works Fine, ICI Says
In Jones v. Harris
Associates, the 7th U.S. Circuit Court of Appeals dismissed the lawsuit
by investors in Oakmark funds who claimed the fees of adviser Harris
Associates were too high and that Harris did not disclose certain
information about its pricing process. The 7th Circuit asserted that
while the fees of fund family advisers should be properly disclosed,
their level should be regulated by a free market in which dissatisfied
investors can take their business elsewhere.
In the friend-of-the-court brief to the high court, ICI supported this logic. "The mutual fund industry is virtually a textbook case of a competitive market, with many firms vying for cost-conscious investors. The industry has flourished over the past four decades because it has met these competitive challenges by providing investors with more investment choices and more services, all with declining costs," ICI said.
As an example of how competition among advisers for investors' business has supported a decades-long decline in the overall cost of investing in a mutual fund, ICI pointed out that the total cost of investing in stock mutual funds fell from 2.32% in 1980 to 0.99% in 2008—a decline of nearly 60%—despite a "massive" increase in demand. ICI pointed out that basic economics suggest that, all else equal, such a massive increase in demand normally should have led to an increase in fees.
"Fees instead declined as existing and new advisers offered more funds and as these advisers competed by seeking out and passing through cost savings, evidence that competition prevails in the fund industry," ICI said.
The brief also pointed out that as investors increasingly turned to mutual funds as their investment vehicle of choice, they demanded a greater array of services, and fund advisers competed to offer these services.
ICI contended the information that mutual funds disclose, either by law or choice, is far greater than that available for other investment products, so competition is enhanced by the amount of information available to investors about fund fees. The brief noted that survey data indicate that for a majority of investors, one of the most important factors they consider before purchasing a mutual fund is its fees.
The surest sign that investors are responsive to fund fees is to compare what they buy with what the market offers for sale, said ICI, noting that investors generally gravitate towards lower-cost funds. As an example, the brief said that in the 10-year period ending in 2008, funds with below-average prices attracted money from investors, whereas funds with above-average prices saw investors withdraw money.
Investors have also shown they will move money between advisers in response to various factors, including fees and performance. According to the brief, in any given year between 1990 and 2008, between 25% and 70% of fund advisers experienced net outflows in total across all the funds that they advised. "As a result, fund advisers feel intense pressure to offer funds with performance, services, and fees that meet investors' needs," ICI said.
Supreme Court records show a total of eight friend-of-the-court briefs filed in Harris. Justices are scheduled to hear oral arguments in the case November 2.
The ICI brief is available here.