Supreme Court rules on mutual fund fees and fiduciary duty

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sommerfeld
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Supreme Court rules on mutual fund fees and fiduciary duty

Post by sommerfeld »

The supreme court has issued its opinion in Jones v. Harris Associates.
This is the case where John Bogle submitted an amicus brief.

The opinion is http://www.supremecourt.gov/opinions/09pdf/08-586.pdf

Looks like a mixed bag; they overturned a lower court ruling requiring plaintiffs to demonstrate that an advisor had to mislead directors.

The most relevant part to us seems to be:
The Court resolves the parties’ disagreements on several important questions. First, since the Act requires consideration of all relevant factors, §80a–35(b)(2), courts must give comparisons between the fees an investment adviser charges a captive mutual fund and the fees it charges its independent clients the weight they merit in light of the similarities and differences between the services the clients in question require. In doing so, the Court must be wary of inapt comparisons based on significant differences between those services and must be mindful that the Act does not necessarily ensure fee parity between the two types of clients. However, courts should not rely too heavily on comparisons with fees charged mutual funds by other advisers, which may not result from arm’s-length negotiations. Finally, a court’s evaluation of an investment adviser’s fiduciary duty must take into account both procedure and substance.Where disinterested directors consider all of the relevant factors, their decision to approve a particular fee agreement is entitled to considerable weight, even if the court might weigh the factors differently. Cf. Lasker, 441 U. S., at 486. In contrast, where the board’s process was deficient or the adviser withheld important information, the court must take a more rigorous look at the outcome.
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LikeYouImagine
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Post by LikeYouImagine »

Looks like they are preserving the status quo.
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Post by georgewatkins »

According to the story below from ABC News, the ruling is a victory for the mutual fund industry, because it enforces the existing standard for judging excessive fees.

In order to violate that standard, "an investment adviser 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"

Supreme Court Hands Victory to Mutual Fund Industry

-George
Eric White
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Re: Supreme Court rules on mutual fund fees and fiduciary du

Post by Eric White »

sommerfeld wrote:The supreme court has issued its opinion in Jones v. Harris Associates.
This is the case where John Bogle submitted an amicus brief.

The opinion is http://www.supremecourt.gov/opinions/09pdf/08-586.pdf

Looks like a mixed bag; they overturned a lower court ruling requiring plaintiffs to demonstrate that an advisor had to mislead directors.

The most relevant part to us seems to be:
The Court resolves the parties’ disagreements on several important questions. First, since the Act requires consideration of all relevant factors, §80a–35(b)(2), courts must give comparisons between the fees an investment adviser charges a captive mutual fund and the fees it charges its independent clients the weight they merit in light of the similarities and differences between the services the clients in question require. In doing so, the Court must be wary of inapt comparisons based on significant differences between those services and must be mindful that the Act does not necessarily ensure fee parity between the two types of clients. However, courts should not rely too heavily on comparisons with fees charged mutual funds by other advisers, which may not result from arm’s-length negotiations. Finally, a court’s evaluation of an investment adviser’s fiduciary duty must take into account both procedure and substance.Where disinterested directors consider all of the relevant factors, their decision to approve a particular fee agreement is entitled to considerable weight, even if the court might weigh the factors differently. Cf. Lasker, 441 U. S., at 486. In contrast, where the board’s process was deficient or the adviser withheld important information, the court must take a more rigorous look at the outcome.
Amazing. It is truly horrific that investors, as CAPTIVE customers of these products, are not guaranteed some basic protections.

Either free us from captivity and enable real competition or at least give us some basic protection.

That's very frustrating!
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Random Musings
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Post by Random Musings »

As usual, let the buyer beware. Surprising that the financial industry, with all their deep pockets and special interest groups running around D.C., was able to pull this off.

At least some individuals, like Jack Bogle, are on our side.

RM
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sometimesinvestor
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Post by sometimesinvestor »

here is another link with the emphasis on interpretation

http://norris.blogs.nytimes.com/2010/03 ... -punts/?hp
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tfb
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Post by tfb »

And this article makes it sound like a victory for fund investors when in fact it's just the opposite.

http://moremoney.blogs.money.cnn.com/20 ... t-victory/

The standard is set so low. As long as it's within a possible range, it's a go.
Harry Sit, taking a break from the forums.
Levett
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Post by Levett »

Here's BusinessWeek's take.

http://www.businessweek.com/news/2010-0 ... ate1-.html

When the ICI is happy, I tend to get nervous. :roll: Bob U.
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Random Musings
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Post by Random Musings »

Here's BusinessWeek's take.

http://www.businessweek.com/ne....ate1-.html

When the ICI is happy, I tend to get nervous. Bob U.
Bob U.,

I didn't think it was a hostage situation (but it is close :wink: ). The link is going to a different article.

Regards,

RM
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ruralavalon
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Post by ruralavalon »

Certainly very disappointing.
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Levett
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Post by Levett »

RM,

FARC!

I'm gonna try again.

http://www.businessweek.com/ap/financia ... P0EGO0.htm

Bob U.

P.S. Link opened in preview. :D
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Post by Alex Frakt »

I read the opinion (http://www.supremecourt.gov/opinions/09pdf/08-586.pdf). It's a complete and total victory for the mutual fund industry. While technically it's a remand to the lower court for a new decision, they make it quite clear that the outcome of that decision must be in favor of the mutual fund company in question.

What the Supreme Court has done is to reaffirm* (from an earlier Circuit Court decision known as Gartenberg) the current generally accepted definition and test of fiduciary duty when it comes to setting advisor compensation by a mutual fund's board of directors.

The definition sounds reasonable enough: "whether the fee schedule represents a charge within the range of what would have been negotiated at arm’s-length in the light of all of the surrounding circumstances." But the actual test removes all hope. As the Supreme Court put it, "to face liability under §36(b), an investment adviser 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."

In another part of the opinion they stress that great deference must be given to the mutual fund's board of directors as long as they meet the statutory requirement of having at least 40% independent directors and have not been deliberately mislead by the fund advisors:

Where disinterested directors consider all of the relevant factors, their decision to approve a particular fee agreement is entitled to considerable weight, even if the court might weigh the factors differently

and

It is also important to note that the standard for fiduciary breach under §36(b) does not call for judicial second-guessing of informed board decisions.... “[P]otential conflicts [of interests] may justify some restraints upon the unfettered discretion of even disinterested mutual fund directors, particularly in their transactions with the investment adviser,” but they do not suggest that a court may supplant the judgment of disinterested directors apprised of all relevant information, without additional evidence that the fee exceeds the arm’s-length range. Id., at 481. In reviewing compensation under §36(b), the Act does not require courts to engage in a precise calculation of fees representative of arm’s-length bargaining.

Furthermore, they specifically rejected a requirement that fees be "reasonable" on the basis that the SEC had asked that such a standard be included in the Act, but Congress declined to include it, substituting the fiduciary duty requirement instead.

*Justice Thomas' concurring opinion basically said that they they weren't merely reaffirming Gartenberg's test, they were going even further by essentially closing off all reviews of mutual fund fee decisions based on anything as squishy as mere "fairness."
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Post by Christine_NM »

The part of the opinion that says investors can and do move their money elsewhere (I think page 6, page 9 in pdf) if they think costs/fees are excessive is out of Disney fantasyland.

More typically the fund offers a kickback of some kind to advisers who put their clients' money in these funds and leave it there regardless of suitability or cost. In the fund world, the small investor who acts effectively as his own fiduciary seems limited to the people on this forum. I am probably being harsh there, but we seem to be the few who know the tyranny of compounding costs.
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Post by TheEternalVortex »

Doesn't really affect those of us that care about fees.
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Post by gkaplan »

How about those investors in lousy 401(k) plans with high fees?
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Post by woof755 »

If the American public was taught personal finance and even mutual fund investing in high school and college we wouldn't need the Supreme Court to step in. The philosophy is "Let the market decide." The market needs to be comprised of informed consumers.

In college I was required to take an art history class. I'm better for it, and once in a while I can slip a Ziggurat of Ur into conversation. Certainly, though, the average university student could trade linguistics, history of East Asian art, or golf course management for personal finance.

:roll:
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Post by LesterFreamon »

I don't have a problem with the opinion at all. If you don't like your mutual funds, move your money elsewhere. Don't like your 401(k) plan at work? You don't have to contribute. Want a new set of funds in your 401(k)? Get on the committee that negotiates with vendors and pick the one you like best.

What really needs to happen is that employers that do offer 401(k) retirement accounts should instead, and this would have to be approved by the government, offer a direct deposit to a retirement account of your choice. No reason why employers can make direct deposits to a checking account and not a retirement account. Allow all Americans to contribute to a "retirement account" with the same benefits of a 401(k) but let them choose the administrator. This could be done by creating a new type of retirement account or by changing the rules for IRAs. In order for the free market to work, the market needs to truly be free, and that requires choice on the part of employees and competition among all fund companies.
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Post by btenny »

I'm sorry but this is a complete disaster for all working people who are stuck with 401Ks for retirement. All those people have are the bad funds (in most cases) where big expenses are the norm and no alternatives exist.

Bill
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Post by LesterFreamon »

btenny wrote:I'm sorry but this is a complete disaster for all working people who are stuck with 401Ks for retirement. All those people have are the bad funds (in most cases) where big expenses are the norm and no alternatives exist.

Bill
Maybe, but that's not what legal analysis entails.
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Post by btenny »

Lester you need to go try to get on some committee to change a 401K at your work place. You will find those committees have closed membership to rank and file member or do not exist in most cases. Companies can do what they want to in setting up 401K and choosing vendors (mutual funds) and those choices are driven by management needs, not workers needs. So most people cannot do anything about their 401K choices.

Same goes for opting out of their 401Ks. If an employee chooses to not contribute to his/her 401K then he/she does not get to make any other outside tax deductable contributions. So tax laws screw the small guy who wants to save for retirement and now the Supreme Court screws his as well.

These kinds of laws were what started the feudal land revolts in old Europe.

Bill
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Post by LesterFreamon »

btenny wrote:These kinds of laws were what started the feudal land revolts in old Europe.

Bill
Don't be silly, the 401(k) didn't go into effect until January 1, 1980.

And just because something doesn't seem fair to you or me doesn't mean that there is a rational legal basis for overturning something. If you're not happy with the law, write to your Congressman and have him work on legislation to change the 401(k).

The fact that the opinion was written for a unanimous court speaks volumes.
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Post by LikeYouImagine »

I believe there was 401k reform legislation floating around the house last year. Some googling seems to indicate it is dead at this point.

edit:

Here is a thread about it:

http://www.bogleheads.org/forum/viewtop ... highlight=
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Post by Wagnerjb »

btenny wrote:Companies can do what they want to in setting up 401K and choosing vendors (mutual funds) and those choices are driven by management needs, not workers needs.
Bill: the choices are driven by "shareholder" needs, not those of a particular type of worker. In order to be competitive, some companies choose to let the mutual fund company handle the 401k administration. This saves money for the shareholders, and serves to preserve jobs for employees. The drawback is that the mutual fund company must charge the employees for the 401k administration, and this is evidenced by higher mutual fund fees.

The alternative just might be the company says "no" to a 401k plan.

An educated investor is the best we can do. The educated investor will lobby the company to offer at least one or two low-cost passive funds. If that doesn't succeed, we need educated investors to "just say no" to the 401k plan. If enough employees skip the plan, the committee will begin to pay attention.

Best wishes.
Andy
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Post by Alex Frakt »

LesterFreamon wrote:And just because something doesn't seem fair to you or me doesn't mean that there is a rational legal basis for overturning something. If you're not happy with the law, write to your Congressman and have him work on legislation to change the 401(k).

The fact that the opinion was written for a unanimous court speaks volumes.
I'm going to have to agree with Lester here. The problem is a bad law, not a bad interpretation of the law. We need to keep in mind that our law is a combination of statutory language and the body of legal decisions made over the years and that sometimes words or phrases acquire a legal definition that does not match the common definition. Congress apparently knew what it was doing when it drafted the act, whatever the members' motives.

Thankfully we have Vanguard funds and a decent range of ETFs to hold in our personal accounts. But the only universal fix for poor captive accounts is new legislation. Since proposed legislation is an OT subject, I'll stop here.
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Post by Alex Frakt »

Wagnerjb wrote:
btenny wrote:Companies can do what they want to in setting up 401K and choosing vendors (mutual funds) and those choices are driven by management needs, not workers needs.
Bill: the choices are driven by "shareholder" needs, not those of a particular type of worker. In order to be competitive, some companies choose to let the mutual fund company handle the 401k administration. This saves money for the shareholders, and serves to preserve jobs for employees. The drawback is that the mutual fund company must charge the employees for the 401k administration, and this is evidenced by higher mutual fund fees.

The alternative just might be the company says "no" to a 401k plan.

An educated investor is the best we can do. The educated investor will lobby the company to offer at least one or two low-cost passive funds. If that doesn't succeed, we need educated investors to "just say no" to the 401k plan. If enough employees skip the plan, the committee will begin to pay attention.

Best wishes.
There are low-cost independent administrators. If a company chooses one of these, the cost is utterly trivial. And if having a superior 401(k) plan will result in retaining one superior employee per decade who would otherwise leave (or attracting one who would otherwise go elsewhere), then the cost benefit swings completely in favor of the better plan.

No, the only reasons for a company to choose a poor plan is managerial incompetence (e.g., not knowing any better and not seeking out the knowledge to make the correct decision) or managerial malfeasance (i.e., deliberately putting his or her self-interest before the owner's interest).
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Post by 3CT_Paddler »

LesterFreamon wrote: What really needs to happen is that employers that do offer 401(k) retirement accounts should instead, and this would have to be approved by the government, offer a direct deposit to a retirement account of your choice. No reason why employers can make direct deposits to a checking account and not a retirement account. Allow all Americans to contribute to a "retirement account" with the same benefits of a 401(k) but let them choose the administrator. This could be done by creating a new type of retirement account or by changing the rules for IRAs. In order for the free market to work, the market needs to truly be free, and that requires choice on the part of employees and competition among all fund companies.
Well said LesterFreamon... couldn't say it any better myself! The problem is not the Supreme Court's decision... it is a law that does not allow the free market to work for employees in 401k plans.
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Post by LesterFreamon »

LesterFreamon wrote:And just because something doesn't seem fair to you or me doesn't mean that there is a rational legal basis for overturning something. If you're not happy with the law, write to your Congressman and have him work on legislation to change the 401(k).

The fact that the opinion was written for a unanimous court speaks volumes.
Alex Frakt wrote:I'm going to have to agree with Lester here. The problem is a bad law, not a bad interpretation of the law. We need to keep in mind that our law is a combination of statutory language and the body of legal decisions made over the years and that sometimes words or phrases acquire a legal definition that does not match the common definition. Congress apparently knew what it was doing when it drafted the act, whatever the members' motives.
Thanks. You nailed the issue; it is a bad law, not a poor interpretation of the law. People are acting like the Supreme Court screwed mutual fund investors or that the Supreme Court doesn't understand the severity of the situation. The real culprits here are the bastards in the House and Senate.
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Post by LesterFreamon »

LesterFreamon wrote:What really needs to happen is that employers that do offer 401(k) retirement accounts should instead, and this would have to be approved by the government, offer a direct deposit to a retirement account of your choice. No reason why employers can make direct deposits to a checking account and not a retirement account. Allow all Americans to contribute to a "retirement account" with the same benefits of a 401(k) but let them choose the administrator. This could be done by creating a new type of retirement account or by changing the rules for IRAs. In order for the free market to work, the market needs to truly be free, and that requires choice on the part of employees and competition among all fund companies.
3CT_Paddler wrote:Well said LesterFreamon... couldn't say it any better myself! The problem is not the Supreme Court's decision... it is a law that does not allow the free market to work for employees in 401k plans.
Thank you.
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