Gartenberg, Jones, Blackrock and the Demise of § 36(B) Litigation
Vol. 43, Review of Banking and Financial Law (Forthcoming)
46 Pages Posted: 9 May 2023 Last revised: 14 Nov 2023
Date Written: November 13, 2023
It has long been recognized that the forces of arm’s length bargaining do not operate on mutual fund management fees. Beginning with the 1970 amendments to the Investment Company Act (ICA), Congress made mutual fund sponsors fiduciaries where management fees are concerned. This happened because, as the SEC pointed out and Congress recognized, mutual funds are captives of the investment management firms that bring them into existence and manage their portfolios. As a result, fund boards must purchase investment management services from monopoly sellers who are able to charge excess management fees.
Early in this century the plaintiffs’ bar had some success in extracting settlements from fund sponsors by comparing management fees to fees actually determined by arm’s length bargaining, e.g., pension and sub-advisory fees. The fiduciary standard established in Gartenberg was ambiguous about such comparisons.
This changed when the district court in Jones v. Harris Assocs. L.P. explicitly compared fees on the named fund with fees on other mutual funds. The implication was that fees on other mutual funds are determined by competitive forces and thus could not be excessive. This directly challenged the Second Circuit’s decision in Gartenberg. Jones eventually made it to the U.S. Supreme Court.
Distilled to its essence, there is disagreement about fee competition in mutual fund markets. If advisory fees respond to competitive pressures, then fee litigation is a costly and unnecessary indulgence. If competitive forces do not operate in mutual fund markets, then fund sponsors extract tens of billions of dollars annually in excess advisory fees. The competition argument has prevailed and there is currently (early 2023) no § 36(b) litigation outstanding against mutual fund investment management firms.
Soon after Jones was filed, the Investment Company Institute commissioned a study by two well-credentialled Ivy League academics purporting to demonstrate that competitive pressures are a strong force constraining investment management fees. This paper shows that the conclusions are based on misdirection and duplicity.
The Seventh Circuit in Jones gave great credence to the ICI commissioned paper and the US Supreme Court in Jones took the case to resolve differences between the Second and Seventh Circuits.
Justice Alito wrote the decision in Jones that functionally embraced the competition argument, while appearing to embrace the Gartenberg status quo. Jones effectively removed the uncertainty over comparing mutual fund fees to pension and sub-advisory fees. As a result, the industry has no incentive to settle fee cases. Subsequent case law universally favors the industry. The judicial system has successfully reduced its case load and100 million mutual fund investors continue to be overcharged tens of billions annually in excess investment management fees.
Keywords: Mutual Funds, Mutual Fund Fees, Mutual Fund Fee Litigation
JEL Classification: G23,K22,K23
Suggested Citation: Suggested Citation