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Mutual fund industry may be too quick in declaring victory on the Supreme Court Decision

The standard is upheld but the people-with-muscle caveat is a true victory for investors, according to Tamar Frankel

Wednesday, March 31, 2010 – 6:24 AM by Elizabeth MacBride
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Tamar Frankel says the Supreme Court Decision on mutual funds fees surprised and delighted her because of the pressure it puts on mutual fund boards of directors

The Supreme Court handed down a highly-anticipated decision on mutual fund fees yesterday and a strange thing happened.

Both the mutual fund industry and the people who are seeking leverage in bringing down fees declared victory.

At least one renowned expert — Tamar Frankel, a Boston University School of Law professor – doesn’t believe that the mutual fund industry should be putting the champagne on ice.

The mutual-fund-fee decision handed down yesterday by the Supreme Court puts more onus on mutual fund boards of directors to investigate advisors’ fees, she said.

It likely will mean that fund advisors must offer the boards more information about how much they charge clients such as pension funds for the same services, Frankel added.

Surprised and delighted

She said the ruling “surprised and delighted me,” because it requires boards of directors to compare the fees the mutual funds are being charged with those that are being paid to companies that have more negotiating power.

“If people with muscle can get better deals, that means the little guy should get the same deals,” she said.

The little guy is the consumer and generally RIAs ally themselves with this constituency. Some RIAs, however, also advise mutual funds.

In fact the court case was originally brought by three investors in the Oakmark family of funds against its advisor Harris Associates L.P.

Discrepancies are typical

The issue was that Harris was charging the mutual funds much more in fees than it was charging pension fund clients. Such discrepancies are typical in the industry, though why they exist is a matter of debate.

Under the Investment Company Act of 1940, mutual fund shareholders are allowed to sue mutual funds over excess fees. The courts then subject the fees to what’s known as the 1982 Gartenberg standard.

The courts deciding the case ask whether the mutual fund directors or trustees had considered factors such as costs of other mutual funds, fallout benefits, economies of scale.

No investor has ever won a case against a mutual fund company, but some have probably been settled, according to legal writings about the standard.

“People with muscle”

Yesterday’s unanimous decision endorsed the standard, but also added a new factor to the list: whether the advisor is charging “people with muscle” — i.e. institutional investors — less money, Frankel said.

The court ordered the the U.S. Court of Appeals for the Seventh Circuit to re-examine the case, known as Jones v. Harris Associates L.P.

Frankel also placed the decision in the context of new and stronger questions that are being raised about mutual fund fees in general.

RIABiz has covered the rise of ETFs, which are increasing in popularity in part because of high mutual fund fees. Read: Four hot topics in compliance from the IAA conference

Great for the ETF business

“High mutual fund fees have been great for the ETF business and this ruling should continue to push disenchanted investors toward ETFs, especially if the courts will give deference to fees agreed upon by independent boards and their advisors,” said one advisor who asked not to be named.

Frankel agreed that there’s an emerging awareness of high fees.

“They are expensive, too expensive,” she said. “People have had enough. And when did they have enough? When the market crashed.”

Keith Mitchell

Keith Mitchell

March 31, 2010 — 9:26 PM

As an independent Director on a series of open end mutual funds, and as someone whose has spent 30+ years around the mutual fund industry, I think the Supreme Court decision is very good news. Independent Directors, at least in all the Boards I have served on (4), are provided with more than adequate information to make decisions relating to fees and have every opportunity to discuss them in a robust setting. Anything else is failing to adequately oversee the fund operations. It is not, however, just a volume based decision as to fee comparisons between different types of accounts. Services, required communications, liquidity and pricing on a daily basis, etc are all part of the equation as well. Profitability of the advisor is a key element.

Mutual Funds continue to innovate, tinker and improve. There are many strategies consumers can elect to use, some of which have been described in this thread, but few have survived the test of time as have open end mutual funds. Very few people could afford the investment management services that are provided at such a high standard that are available thru mutual funds for literally pennies.

I look forward to the ongoing dialogue in our industry and to serving the thousands of shareholders on whose fund board I serve.


Brooke Southall

Brooke Southall

March 31, 2010 — 4:24 PM

Good question, Skip. I think there’s a general sense out there that mutual funds are overpriced and that anything that brings their expenses down is a positive. I think the difference between automobiles and mutual funds may lie in the fact that even sophisticated investors can’t keep up with how much their mutual fund company is charging them.

Though, I have to say, when I go to the car dealer I’m pretty baffled by all the numbers the salesman is throwing at me.


Skip Schweiss

Skip Schweiss

March 31, 2010 — 12:21 PM

Whom do you think pays less for a car, me as an individual buyer or Avis as a fleet buyer? What’s wrong with pricing breaks for volume? Should this standard be applied across all industries?

Stephen Winks

Stephen Winks

March 31, 2010 — 4:12 PM

Like every other industry, the financial services industry is simply embracing modernity in the best interests of the consumer which by definition will routinely outdate many tried and true approaches to advisory services with faster, better and cheaper solutions.

The client centric innovations in investment products and portfolio construction take the advisor far beyond the constraints of the limited investment mandate of a prospectus. It is what you do with investment products, or process, that adds value not investment products in and of themselves. Turn key asset management programs (TAMPs) and UMAs are a step in the right direction, but trust companies have taken the lead with the use of overlay management and the use of real time buy/sell manager research (cost 25 bps) which can incorporate all a clients holdings just as they are which is not possible in a TAMP or UMA (which are not capable of being held to a fiduciary standard of care).

When you look at investment performance over this past lost decade of investment, the active management of passive vehicles has resulted in DFA generating a 58% return when the market lost 9%. This establisheds the importance of process and is perfectly aligned with a prudent process resulting in fiduciary standing [if DFA serves as an outsourced CIO function incorporated in an audited prudent investment process (asset/liability study, investment policy, portfolio construction and management) with an audit path to statutory documentation to prove fiduciary standing].

The mutual fund industry needs to find a way to generate a faster, better, cheaper result for the advisor and the consumer acting as an outsourced CIO function as their intellectual capital is becoming a high cost, low value added option for advisors.

It should be noted that cost is but one of a number of considerations in the consumer’s best interests, it is just the easiest to understand. There are extraordinary innovations in portfolio construction and management which are very important to advisors who wish to act in the best interests of the consumer. The question is essentially, will fund companies find a way to become part of the solution.


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