Court Adopts Flexible Gartenberg Standard
Below, Connor Williams of Stanford Law School recaps Tuesday’s opinion in Jones v. Harris Associates. Connor covered the oral arguments in the case last November, and his preview and recap of the proceedings are available here and here. Check the Jones v. Harris (08-586) SCOTUSwiki page for additional updates.
On Tuesday the Court issued its opinion in No. 08-586, Jones v. Harris Associates. In a unanimous opinion by Justice Alito, the Court held that Gartenberg v. Merrill Lynch Asset Management, Inc. applied the correct standard for determining when an investment adviser has breached the fiduciary duty owed to captive mutual fund shareholders established under Section 36(b) of the Investment Company Act of 1940 (ICA). Under Gartenberg, Section 36(b) is violated when advisers' fees are "so disproportionately large" that they "bear no reasonable relationship to the services rendered."
Ultimately, the Court concluded, although Gartenberg "may lack sharp analytical clarity," it has "provided a workable standard for nearly three decades." The Court noted that the "fiduciary duty" standard established by the ICA represents a "delicate compromise," protecting investors from fee arrangements not negotiated at arm's length, but simultaneously shifting the burden of proof to the party claiming the breach of duty.
At oral argument, the petitioners, the respondent, and the United States all urged the Court to adopt the Gartenberg standard, even while quibbling over just what proper application of the standard would entail. Petitioners and respondent differed over whether Gartenberg should allow captive shareholders to compare fees charged to independent investors when claiming a breach of duty. In its opinion, the Court indicated that such evidence may be considered, but it declined to set a hard rule, noting that although comparisons should be granted "the weight that they merit in light of the similarities and differences between the services that the clients in question require, . . . courts must be wary of inapt comparisons" due to the differences in services provided. The Court was similarly wary of comparisons to fees charged by other advisers, but did not categorically reject such evidence.
In a respondent-friendly move, the Court accorded great deference to the decision of a mutual fund board to accept a particular fee structure: "[I]f the disinterested directors considered the relevant factors, their decision to approve a particular fee agreement is entitled to considerable weight, even if a court might weigh the factors differently." This maneuver appears to follow Justice Scalia's concerns at oral arguments that courts could be required to constantly review adviser fees. The Court flatly stated: "It is also important to note that the standard for fiduciary breach under §36(b) does not call for judicial second-guessing of informed board decisions." However, even here the Court provided something of an "out clause": any finding of deficiency in board's decision-making process will trigger heightened judiciary scrutiny.
Justice Thomas authored a brief concurring opinion in which he attempted to separate the Court's approach from the potentially loose Gartenberg standard. The concurrence exhibits even more acutely the Court's concern that the judiciary will become embroiled in fee-setting disputes. Thomas expressed discomfort with Gartenberg's "fairness" language, worrying that such a lenient test "could be read to permit the equivalent of the judicial rate regulation," even though most courts purporting to apply Gartenberg (including this Court in this case) have nevertheless "correctly declined its invitation to stray beyond statutory bounds."