Professor John Coates
November 06, 2009
On Monday, November 2, the Supreme Court heard oral arguments in the case of Jones v. Harris Associates. Harvard Law School Professor John Coates, who organized the filing of an amicus curiae brief on behalf of the respondents in September, debated the merits of the case in a video on Morningstar.com.
The petitioners are three shareholders in the Oakmark mutual fund family, and the respondent is Harris Associates LP, a mutual fund management company in charge of the fund involved in the case. The claim is that Oakmark charges excessive fees for its mutual fund – individual investors are charged roughly twice as much as institutional investors – and has violated the “fiduciary responsibility” set out for it by Congress under the Investment Company Act, which establishes the rules for setting mutual fund fees.
In the debate on Morningstar, Coates faced off against Professor William Birdthistle from Chicago-Kent School of Law, who filed an amicus curiae brief for the petitioners. Coates argued that the fees set by Harris Associates did not violate the Investment Company Act.
Birdthistle led the debate, explaining the impact the case might have. “It involves 93 million Americans…investing $10 trillion in mutual funds. And every year, the Investment Advisory Industry brings home $100 billion in fees,” he said.
Coates described the process of mutual fund fee setting. He explained that fees are proposed by the advisors or sponsors of mutual funds and then negotiated with independent trustees of the boards of the funds, who are unaffiliated with the fund advisors.
After the negotiation, Coates said, “the fees are disclosed…to the shareholders” of the funds. The investors have an opportunity to approve or reject the fees annually in the same manner shareholders choose the board members of the fund.
In 1970, Congress passed amendments to the Investment Company Act which state that investment advisors, like Harris in this case, “have a fiduciary duty with receipt to compensation.” Birdthistle said what exactly a fiduciary duty is or means in today’s context is up for debate and argued that mutual fund companies, such as Harris, have abused their duty.
“What I think it means, broadly speaking, is that we've got a circumstance here where the advisers have a lot of control over the fees that are originally set,” said Birdthistle. “I think we also have a circumstance, when you look at empirical data, that a lot of shareholders don't actually spend an awful lot of time figuring out what exactly they're paying and knowing what it is at any particular time. And I think what the fiduciary duties should help us do is to impose some sort of standard on advisors to treat similarly situated shareholders alike.”
“I don’t think it’s fair to say that advisors are dominant in setting the fees,” Coates responded. “In the process…there are a number of checks on advisers. But even more important…is the fact that investors of mutual funds, unlike customers of most other companies that sell them services, like auto mechanics, mutual fund investors can pull their money out at any time and reinvest somewhere else. And they can do that for any reason, no reason at all, and they do it all the time. Between 25% and 70% of the funds out there experience net outflows, meaning more investors pulling their money out than putting money in at any given year.”
Twenty-five leading academics agree with Coates and signed onto his amicus brief, including HLS Professors Robert Clark ’72, Allen Ferrell ’95 and Mark Ramseyer ’82.
On the other side, HLS Professor Jesse Fried ’92 was one of numerous law professors who signed onto Birdthistle’s brief. Fried, an expert on executive compensation, told the Wall Street Journal on October 30 that a shareholder win would encourage plaintiff lawyers “for their own selfish reasons, [to] monitor compensation structures in these firms,” filing suits when fund advisor compensation looks out of line with the fund’s performance. “That will keep compensation down,” he said. In a recent Q&A with Harvard Law Today, Fried shared his views on how executive compensation arrangements can be improved.
