In an era of rebellion against Wall Street pay, the Supreme Court on Monday hears arguments in a case testing whether some mutual funds are charging excessive fees.
Ninety million Americans invest in retail mutual funds. The fees charged by these funds, while they may sound small percentage-wise, add up to big money. To understand this case you have to understand that mutual funds are run by professional investment advisers. But those same advisers have outside clients — big investors like, say, Microsoft's Bill Gates, or a union pension fund — who buy and sell outside of the mutual fund.
In this case, the investment adviser group Harris Associates runs a set of mutual funds called the Oakmark funds, which invest in stocks and bonds for people like you and me. We are shareholders in the funds and, hopefully, we get a return on our investment.
Harris Associates, as it happened, did very well with Oakmark. The funds outperformed virtually all other similar funds, but the shareholders sued Harris Associates for charging excessive fees. That's because Harris Associates charged the investors in the Oakmark funds roughly twice as much as the company's other clients.
So for instance, says David Frederick, the lawyer for the mutual fund investors, "an institutional investor like a teacher pension fund comes to Harris Associates and says, 'Please manage our money in exactly the same way that you manage your mutual funds.' Harris Associates is charging that outside investor, to whom it owes no fiduciary duty, half of what it is charging investors in its mutual fund."
And that, says Frederick, violates a 1970 federal law that was enacted to protect mutual fund investors from being gouged on fees.
Not so, says Karrie McMillan, general counsel for the Investment Company Institute, the trade association for mutual funds.
When you're dealing with a mutual fund's thousands of individual investors, as opposed to other large independent investors, McMillan says, you have to comply with more regulations and provide all kinds of services — like a 24-hour call line and educational and marketing materials. What's more, she contends, the services may look the same, but they are not — just as not all cars are the same.
"A Cadillac and a Hyundai are both cars," she observes, "but they are different products and they are charged at different rates."
David Frederick counters that these are all the same investment advisers, using the same research to make investment decisions on behalf of their clients. So why, he asks, are they charging so much more to the mutual fund investors?
The lower courts threw out this lawsuit, concluding that the fees were not excessive just because they were bigger than the fees charged to Harris Associates' other clients.
The case prompted an amazing debate between two distinguished conservative judges. Judge Frank Easterbrook, writing for the majority, said that there is plenty of competition in the mutual fund industry, so there is no need for intervention from the courts because the markets will police the industry. In short, people can vote with their feet.
But in dissent, Judge Richard Posner, who usually leads the pack in deferring to market forces, said the time had come to re-examine some of those assumptions. Posner said that since the high fees charged by mutual fund advisers are industrywide, measuring Harris' fees against the norm doesn't tell you much. In other words, if everyone is charging higher fees to mutual funds, most investors in these funds can't vote with their feet. The alternative way to measure the fees, he suggested, would be to measure them against the fees charged to investors outside of mutual funds.
Endorsing that idea are the mutual fund investors, who at Harris Associates paid roughly 1 percent in fees, while Harris' other clients paid half that.
"We're talking about peoples' nest eggs here, and their ability to retire," observes Frederick.
He points to statistics from the Department of Labor showing that for every 1 percent charged in fees to a mutual fund, an investor will lose approximately 28 percent of the total value of that person's portfolio over a 35-year period. That, he contends, "is a significant amount of America's retirement savings that are potentially at issue where retail mutual funds charge excessive fees."
But McMillan has a different view. She says that if investment advisers end up having to charge the same fees to their mutual fund clients and their other clients, "a lot of advisers will say forget it, its not worth it," and average investors will have fewer choices.
A decision in the mutual fund fees case is expected later in the term.