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Could the Court Look to the SEC to Regulate Advisory Fees?

Below, Stanford Law School’s Connor Williams recaps yesterday’s oral argument in Jones v. Harris Associates. Connor’s preview of the case is available here, and Howe & Russell’s Kevin Russell analyzes the argument here. See the Jones v. Harris Associates (08-586) SCOTUSwiki page for additional updates.

As noted in Kevin Russell’s earlier post, all three of the attorneys (representing the petitioner, the federal government, and the respondent) who took to the podium during the oral argument yesterday in Jones v. Harris Associates urged the Court to adopt the Gartenberg standard for determining whether an investment advisor had breached the fiduciary duty established by Section 36 of the Investment Company Act. They disagreed, however, on the narrower issue of how exactly the standard should be articulated to determine when fees charged to mutual fund shareholders by their advisers violate the law. Although the three advocates shared the load of hauling Gartenberg toward the finish line, members of the Court appeared to struggle to find a workable rule that would not anoint the judicial branch as the designated fee regulator.

One exchange during Monday’s argument could signal that at least two Justices were willing to look beyond the standards proposed by the parties and the United States. First, Chief Justice Roberts raised questions the proper role of the Securities and Exchange Commission (SEC) in regulating the investment fees issue. He asked Assistant to the Solicitor General Curtis Gannon whether “[i]t makes a lot more sense to have the SEC regulate rates than to have the courts do it, doesn’t it?” However, the idea of the SEC as the chief defender of mutual fund shareholders was not fully developed in the respondent’s brief, but appeared instead in an amicus brief filed by the Mutual Fund Directors Forum on behalf of the respondent. The brief (which also embraces Gartenberg) highlights guidelines that the SEC has issued within the last decade with the intent to promote the independence of board members and protect shareholders.

Gannon declined to fully concede the Chief Justice’s point. Instead, he responded that such a regime might make sense in the abstract, and he noted that the SEC does have the authority to file suit under Section 36. When asked by Justice Ginsburg whether the SEC had in fact filed any such suits, Gannon answered that none have been filed since 1980. Justice Ginsburg’s question perhaps suggests skepticism of the SEC’s interest in robustly regulating this area (and, in so doing, highlights the potential free-for-all that could ensue if the Court leaves the question of the appropriate standard for the SEC to resolve).

Justice Scalia concluded the exchange by advancing another argument found principally in the Forum’s amicus brief. After asking whether the SEC was aware of the divergence in fees that investment advisers charge to their “captive” clients versus other clients, Justice Scalia noted that the SEC has not embraced Jones’s suggestion that the fees charged to “captive” investors should be compared with those charged to independent investors. That lack of support, Justice Scalia posited, “suggests . . . that the SEC may think that this is indeed a self-contained industry and that the comparison with investment advice given to other entities is – is not a fair one.” The Forum’s brief quotes a 2004 SEC guideline that requires disclosure when a board relies on a comparison to fees paid under other investment advisory contracts, but it then notes: “[T]he amended disclosure requirements implemented by the release do not require this kind of comparison. Rather, they merely provide that, if the board in its discretion conducts the comparison, that fact must be disclosed.”

It is, of course, impossible to draw firm conclusions from this colloquy. At most, it signals the impact made by a particular amicus brief, and a reluctance by the Chief Justice and Justice Scalia to insert courts into fee determinations. At the very least, it further highlights the fact that even when both parties and the federal government outwardly agreed on the Gartenberg standard, the Court is nevertheless tasked with a difficult line-drawing exercise.