Jones v. Harris Assocs. L.P.

• Decision Date: 30 March 2010
• Docket Number: No. 08–586.,08–586.
• Citation: 130 S.Ct. 1418,176 L.Ed.2d 265,559 U.S. 335
• Parties: Jerry N. JONES, et al., Petitioners, v. HARRIS ASSOCIATES L.P.
• Court: U.S. Supreme Court

559 U.S. 335

130 S.Ct. 1418

176 L.Ed.2d 265

Jerry N. JONES, et al., Petitioners,

v.HARRIS ASSOCIATES L.P.

No. 08–586.

Supreme Court of the United States

Argued Nov. 2, 2009.

Decided March 30, 2010.

David C. Frederick, Washington, D.C., for Petitioners.

Curtis E. Gannon, for United States as amicus curiae, by special leave of the Court, supporting the Petitioners.

John D. Donovan, Jr., Boston, MA, for Respondent.

Michael J. Brickman, James C. Bradley, Nina H. Fields, Richardson, Patrick, Westbrook & Brickman, LLC, Charleston, SC, Guy M. Burns, Johnson, Pope, Bokor, Ruppel, & Burns, LLP, Tampa, Florida, David C. Frederick, Brendan J. Crimmins, Daniel G. Bird, Jennifer L. Peresie, Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C., Washington, D.C., Ernest A. Young, Chapel Hill, NC, John M. Greabe, Hopkinton, NH, for Petitioners.

Jeffrey A. Lamken, Baker Botts L.L.P., Washington, D.C., Aaron M. Streett, Baker Botts L.L.P., Houston, TX, John D. Donovan, Jr., Robert A. Skinner, Benjamin S. Halasz, Brian R. Blais, Ropes & Gray LLP, Boston, MA, for Respondent.

Opinion

Justice ALITO delivered the opinion of the Court.

We consider in this case what a mutual fund shareholder must prove in order to show that a mutual fund investment adviser breached the “ fiduciary duty with respect to the receipt of compensation for services” that is imposed by § 36(b) of the Investment Company Act of 1940, 15 U.S.C. § 80a–35(b) (hereinafter § 36(b)).

I

A

The Investment Company Act of 1940 (Act), 54 Stat. 789, 15 U.S.C. § 80a–1 et seq., regulates investment companies, including mutual funds. “A mutual fund is a pool of assets, consisting primarily of [a] portfolio [of] securities, and belonging to the individual investors holding shares in the fund.” Burks v. Lasker, 441 U.S. 471, 480, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979). The following arrangements are typical. A separate entity called an investment adviser creates the mutual fund, which may have no employees of its own. See Kamen v. Kemper Financial Services, Inc., 500 U.S. 90, 93, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991); Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 536, 104 S.Ct. 831, 78 L.Ed.2d 645 (1984); Burks, 441 U.S., at 480–481, 99 S.Ct. 1831. The adviser selects the fund's directors, manages the fund's investments, and provides other services. See id., at 481. Because of the relationship between a mutual fund and its investment adviser, the fund often “ ‘cannot, as a practical matter sever its relationship with the adviser. Therefore, the forces of arm's-length bargaining do not work in the mutual fund industry in the same manner as they do in other sectors of the American economy.’ ” Ibid. (quoting S.Rep. No. 91–184, p. 5 (1969) (hereinafter S. Rep.)).

“Congress adopted the [Investment Company Act of 1940] because of its concern with the potential for abuse inherent in the structure of investment companies.” Daily Income Fund, 464 U.S., at 536, 104 S.Ct. 831 (internal quotation marks omitted). Recognizing that the relationship between a fund and its investment adviser was “fraught with potential conflicts of interest,” the Act created protections for mutual fund shareholders. Id., at 536–538, 104 S.Ct. 831 (internal quotation marks omitted); Burks, supra, at 482–483, 99 S.Ct. 1831. Among other things, the Act required that no more than 60 percent of a fund's directors could be affiliated with the adviser and that fees for investment advisers be approved by the directors and the shareholders of the fund. See §§ 10, 15(c), 54 Stat. 806, 813.

The growth of mutual funds in the 1950's and 1960's prompted studies of the 1940 Act's effectiveness in protecting investors. See Daily Income Fund, 464 U.S., at 537–538, 104 S.Ct. 831. Studies commissioned or authored by the Securities and Exchange Commission (SEC or Commission) identified problems relating to the independence of investment company boards and the compensation received by investment advisers. See ibid. In response to such concerns, Congress amended the Act in 1970 and bolstered shareholder protection in two primary ways.

First, the amendments strengthened the “cornerstone” of the Act's efforts to check conflicts of interest, the independence of mutual fund boards of directors, which negotiate and scrutinize adviser compensation. Burks, supra, at 482, 99 S.Ct. 1831. The amendments required that no more than 60 percent of a fund's directors be “persons who are interested persons,” e.g., that they have no interest in or affiliation with the investment adviser.¹ 15 U.S.C. § 80a–10(a); § 80a–2(a)(19); see also Daily Income Fund, supra, at 538, 104 S.Ct. 831. These board members are given “a host of special responsibilities.” Burks, 441 U.S., at 482–483, 99 S.Ct. 1831. In particular, they must “review and approve the contracts of the investment adviser” annually, id., at 483, 99 S.Ct. 1831, and a majority of these directors must approve an adviser's compensation, 15 U.S.C. § 80a–15(c). Second, § 36(b), 84 Stat. 1429, of the Act imposed upon investment advisers a “fiduciary duty” with respect to compensation received from a mutual fund, 15 U.S.C. § 80a–35(b), and granted individual investors a private right of action for breach of that duty, ibid.

The “fiduciary duty” standard contained in § 36(b) represented a delicate compromise. Prior to the adoption of the 1970 amendments, shareholders challenging investment adviser fees under state law were required to meet “common-law standards of corporate waste, under which an unreasonable or unfair fee might be approved unless the court deemed it ‘unconscionable’ or ‘shocking,’ ” and “security holders challenging adviser fees under the [Investment Company Act] itself had been required to prove gross abuse of trust.” Daily Income Fund, 464 U.S., at 540, n. 12, 104 S.Ct. 831. Aiming to give shareholders a stronger remedy, the SEC proposed a provision that would have empowered the Commission to bring actions to challenge a fee that was not “reasonable” and to intervene in any similar action brought by or on behalf of an investment company. Id., at 538, 104 S.Ct. 831. This approach was included in a bill that passed the House. H.R. 9510, 90th Cong., 1st Sess., § 8(d) (1967); see also S. 1659, 90th Cong., 1st Sess., § 8(d) (as introduced May 1, 1967). Industry representatives, however, objected to this proposal, fearing that it “might in essence provide the Commission with ratemaking authority.” Daily Income Fund, 464 U.S., at 538, 104 S.Ct. 831.

The provision that was ultimately enacted adopted “a different method of testing management compensation,” id., at 539, 104 S.Ct. 831 (quoting S.Rep., at 5 (internal quotation marks omitted)), that was more favorable to shareholders than the previously available remedies but that did not permit a compensation agreement to be reviewed in court for “reasonableness.” This is the fiduciary duty standard in § 36(b).

B

Petitioners are shareholders in three different mutual funds managed by respondent Harris Associates L.P., an investment adviser. Petitioners filed this action in the Northern District of Illinois pursuant to § 36(b) seeking damages, an injunction, and rescission of advisory agreements between Harris Associates and the mutual funds. The complaint alleged that Harris Associates had violated § 36(b) by charging fees that were “disproportionate to the services rendered” and “not within the range of what would have been negotiated at arm's length in light of all the surrounding circumstances.” App. 52.

The District Court granted summary judgment for Harris Associates. Applying the standard adopted in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (C.A.2 1982), the court concluded that petitioners had failed to raise a triable issue of fact as to “whether the fees charged ... were so disproportionately large that they could not have been the result of arm's-length bargaining.” App. to Pet. for Cert. 29a. The District Court assumed that it was relevant to compare the challenged fees with those that Harris Associates charged its other clients. Id., at 30a. But in light of those comparisons as well as comparisons with fees charged by other investment advisers to similar mutual funds, the Court held that it could not reasonably be found that the challenged fees were outside the range that could have been the product of arm's-length bargaining. Id., at 29a–32a.

A panel of the Seventh Circuit affirmed based on different reasoning, explicitly “disapprov[ing] the Gartenberg approach.” 527 F.3d 627, 632 (2008). Looking to trust law, the panel noted that, while a trustee “owes an obligation of candor in negotiation,” a trustee, at the time of the creation of a trust, “may negotiate in his own interest and accept what the settlor or governance institution agrees to pay.” Ibid. (citing Restatement (Second) of Trusts § 242, and Comment f ). The panel thus reasoned that “[a] fiduciary duty differs from rate regulation. A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation.” 527 F.3d, at 632. In the panel's view, the amount of an adviser's compensation would be relevant only if the compensation were “so unusual” as to give rise to an inference “that deceit must have occurred, or that the persons responsible for decision have abdicated.” Ibid.

The panel argued that this understanding of § 36(b) is consistent with the forces operating in the contemporary mutual fund market. Noting that “[t]oday thousands of mutual funds compete,” the panel concluded that “sophisticated investors” shop for the funds that produce the best overall results, “mov[e] their money elsewhere” when fees are “excessive in relation to the results,” and thus “create a competitive pressure” that generally keeps fees low. Id., at 633–634. The panel faulted Gartenberg on the ground that it “relies too little on markets.” 527 F.3d, at 632. And the panel firmly rejected a comparison between the fees that Harris Associates charged to the funds...