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Oakmark Wins Fee Battle: Ruling Seen as Victorious Precedent


While not exactly a national victory for the mutual fund industry, a recent court ruling regarding "excessive fees" could set a strong precedent for further disputes.

In the case Jerry N. Jones v. Harris Associates L.P., the U.S. Court of Appeals, Seventh Circuit affirmed a lower court's decision to dismiss claims that the Oakmark Funds, managed by Harris Associates, breached their fiduciary duties by charging retail investors excessive fees.

Plaintiffs contended that Harris Associates' fees for individual investors are too high compared to fees for institutional shareholders, thereby in violation of Section 36(b) of the Investment Company Act of 1940. The United States District Court for the Northern District of Illinois, Eastern Division, concluded that Harris Associates did not violate the Act and granted summary judgment in its favor.

Several lawyers at firms that specialize in mutual funds said the ruling firms up a lot of confusion over the subject of excessive fees and could set a precedent for future disputes.

There are currently about a dozen such "excessive fee" cases pending that were brought against mutual fund companies in 2003 and 2004, at the outset of the mutual fund trading scandal which later broadened out to encompass fees, conflicts of interest and questionable sales practices, particularly in 401(k)s in other defined contribution plans.

Going back as far as the 1960s, Congress first realized some unscrupulous investment advisors to equity mutual funds were gouging investors in those funds with excessive fees, particularly by not taking economies of scale into account.

In the Oakmark case, the plaintiffs alleged that Harris Associates breached its fiduciary duties by charging excessive fees for its services and by retaining excessive profits derived from economies of scale. As assets and fees have grown in size, the nature of the services rendered by the defendant has changed very little, if at all, the plaintiffs argued

Harris Associates increased its fees as a percentage of fund complex assets over the past decade when it should have decreased its fees to reflect the economies of scale achieved by extraordinary net asset growth, the litigants charged.

In making its decision, the court looked at the 1982 case Gartenberg v. Merrill Lynch Asset Management Inc. and concluded that Harris Associates fees are ordinary.

"To be guilty of a violation ... the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's-length bargaining," the 1982 case found.

Harris Associates' fees are comparable to those which other funds of similar size and investment goals pay their advisers, and the fee structure is lawful under the Investment Advisers Act, the court found.

A 2007 study by John C. Coates and R. Glenn Hubbard concludes that investors can and do protect their interests by shopping and regulating advisory fees through litigation is likely to do more harm than good.

While few mutual funds ever change advisers, investors can and do "fire" advisers by moving their money elsewhere. Investors don't necessarily do this when the advisers' fees are too high, but when they are excessive in relation to the results. Some mutual funds track market indexes and do not have investment advisers, thus avoiding advisory fees.

The court found that Harris Associates' fees are not excessive, particularly when one considers the high fees that hedge funds charge their customers.

While Harris Associates charges different fees for different clients, those clients have differing levels of risk. Pension funds have low and predictable asset turnovers, while mutual funds can grow or shrink quickly.

The court concluded that Harris Associates fees are not hidden from investors and Oakmark funds' net return has attracted new investment, rather than driving investors away.

The case also touched on the sensitive subject of independent trustees.

A provision of the '40 Act that was added in 1970 requires at least 40% of a mutual fund's trustees to be independent or disinterested in the adviser and requires the fund to reveal financial links between trustees and the adviser. Compensation for the adviser is controlled by the majority of disinterested trustees.

Plaintiffs asked the court to require Harris Associates to return the compensation it received, but the court found that such a penalty would be disproportionate to the wrong.

One of the founding principals of Harris Associates and a former chairman, Victor Morgenstern, who serves as one of the funds' current trustees, does not meet the statutory standards because Harris Associates bought out his partnership with a stream of payments that can be deferred if the fund does not satisfy performance benchmarks, the plaintiffs said.

The plaintiffs contend that this form of payments is a form of profit sharing, and are treated as securities under statutes. Because Morgenstern owns securities in Harris Associates, he is not disinterested, and Oakmark funds did not disclose these facts to the public.

The court could require Oakmark to disclose Morgenstern's post-retirement payments in their annual reports, but only a violation of the 40% independence rule could justify a settlement against Harris Associates, the court found. Even if Morgenstern is treated as an interested member, most of the funds' trustees are disinterested. During the time period covered by the suit, at least seven of the funds' nine or 10 trustees were independent.

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