The Fiduciary Duty in Mutual Fund Excessive Fee Cases: Ripe for Reexamination

Abstract

This Note examines the controversy surrounding the fiduciary duty standard applied in excessive fee cases and concludes that neither the traditional Gartenberg standard nor the market-based Harris Associates standard adequately protects shareholders against excessive fees as Congress intended. To further Congress’ goals, this Note proposes that the Court should modify, but maintain, the Gartenberg standard. This proposed modification incorporates market-forces into the fiduciary duty standard by introducing a fairness proxy and by encouraging efficiency, but ultimately rejects Harris Associates’ total reliance on the market.

The Note proceeds in four Parts. Part I discusses the structure and fees of mutual funds. Part II describes both the traditional Gartenberg standard and the market-based Harris Associates standard. Part III presents criticisms of the Gartenberg standard, but maintains that the framework remains useful. It continues with an analysis of the Easterbrook opinion in Harris Associates. This analysis demonstrates that, although Chief Judge Easterbrook’s opinion tracks his view of corporate law, he is ignoring the realities of the mutual fund market and engaging in unauthorized statutory sun-setting of Section 36(b).

Finally, Part IV proposes a solution to the controversy surrounding the fiduciary duty standard applied in excessive fee cases. Gartenberg should stand, with two modifications. First, Gartenberg’s comparative fee structure factor must be broadened to include a comparison between the fees charged to captive mutual fund investors and those charged to independent institutional investors. This change would allow boards and courts to compare the fee paid by the mutual fund shareholders to a fee negotiated at arm’s length - a proxy for fairness. Second, Gartenberg’s profitability factor should be eliminated. It is counterintuitive to punish an investment advisor for being more profitable than another, if that profit comes from efficiency and not increased fees.

Keywords: mutual fund, excessive fee, fiduciary duty, Section 36(b), Posner, Easterbrook, investment company, Gartenberg, Harris Associates

JEL Classification: G23, G28, G29, G38