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Supreme Court Plays Solomon with 401k Fiduciaries on Mutual Fund Fees

March 30
16:59 2010

Today, in a unanimous opinion, the Supreme Court offered a mixed ruling on the Jones v. Harris mutual fund fee case. (Click here for the ruling.) On one hand, it reversed the dismissal of the case by the Seventh Circuit Court. On the other, it 1038828_68900425_supreme_court_building_stock_xchng_royalty_free_300ruled the Seventh Circuit Court of Appeals must use the Gartenberg standard. The District Court – a still lower court – had previously used the Gartenberg standard to throw out the case. The Seventh Circuit Court, in the appeal of the District Court decision, also dismissed Jones v. Harris, but on different grounds.

According to the opinion written by Justice Samuel Alito, the Gartenberg case stated, “The Seventh Circuit erred in focusing on disclosure by investment advisers rather than the Gartenberg standard”

Wade Eaton, Partner at Chamberlain D’Amanda in Rochester, New York who represents investors in individual and class actions cases and former Assistant Attorney General at NYS Attorney General’s Office said the ruling doesn’t affect New York jurisdictions, just those covered by the Seventh Circuit. He notes the Supreme Court emphasized mutual fund directors should take all references into account when determining whether a financial advisor’s proposed fee schedule is reasonable, specifically mentioning the wide disparity between the fees charged to the captive mutual fund (a fund set up by the investment adviser) and independent pension fund (where the fund is unrelated to the investment adviser).

On the issue of comparing the fees of mutual funds versus those of pension plans, the ruling says “courts may give such comparisons the weight that they merit in light of the similarities and differences between the services that the clients in question require, but courts must be wary of inapt comparisons.” It further goes on to say, “there may be significant differences between the services provided by an investment adviser to a mutual fund and those it provides to a pension fund which are attributable to the greater frequency of shareholder redemptions in a mutual fund, the higher turnover of mutual fund assets, the more burdensome regulatory and legal obligations, and higher marketing costs.”

Eaton concludes, “It’s not open season on mutual funds.” He believes the Supreme Court’s decision resolves the different interpretations by the different Courts of Appeal by firmly establishing that there exists some limit which can be placed on the fees a mutual fund adviser charges, even where there is full disclosure. Furthermore, Eaton states, the decision protects the board of the mutual fund by delineating the appropriate actions such boards must undertake to fulfill their fiduciary responsibilities.

Where does this ruling leave the 401k fiduciary? Some may certainly feel the Supreme Court has just encouraged plan participants to sue plan fiduciaries. However, by maintaining the Gartenberg standard, the Supreme Court keeps the bar high, making it more difficult for plaintiffs to succeed. Indeed, although the Jones v. Harris case must now go back to the appeals court, experts expect Harris – and the mutual fund industry in general – to prevail. Most interesting, though, may loom the warning of Justice Alito: When is comes to fiduciary duty, disclosure isn’t enough. One wonders if the Department of Labor is listening.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA


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