Mutual Fund Advisory Fees: An Objective Fiduciary Standard

Abstract

Mutual funds are structurally different from other corporations. The corporation or trust is controlled by an external entity, an investment management firm that profits from fees charged to manage the fund’s portfolio. Recognizing this fundamental conflict of interest, in 1970 Congress made investment management firms fiduciaries with respect to fees charged their captive funds. By doing so, it signaled a desire for fairer advisory fees. However, in the Senate report it simultaneously endorsed the status quo. In the nearly fifty years since then, the courts have interpreted fiduciary duty so narrowly that no plaintiff has met the judicially established fiduciary standard. One interpretation is that federal courts established this extreme and subjective fiduciary standard out of self-interest and a reluctance to enforce what could be interpreted as a rate making statute.

Utilizing commonly available data and statistics, this paper develops and applies an objective fiduciary standard. For a very large sample of mutual funds it demonstrates that most advisory fees are well outside of the range of fees determined by arm’s length bargaining as measured by the 95 percent confidence interval around average sub-advisory fees. Application of this objective fiduciary standard to an actual case leads to the conclusion that courts and independent mutual fund directors have been willfully blind to the realities that investors have been systematically overcharged billions of dollars per year in excess advisory fees.

Keywords: Mutual Funds, Securities Law, Financial Institutions

JEL Classification: G23, K22