Mutual Fund Advisory Fee Litigation : Some Analytical Clarity

Households in the U.S. invest a large proportion of wealth in mutual funds. At the end of 2014, open-end mutual fund assets were $16 trillion and annual fees exceeded $100 billion. Mutual funds have a unique corporate structure that involves a conflict of interest with the investment management firm that creates and manages the fund. In 1970, Congress passed an amendment to the Investment Company Act of 1940 and made investment managers fiduciaries with respect to fees charged to captive mutual funds. In 1982, the Federal Court for the Southern District of New York, in Gartenberg v. Merrill Lynch Asset Mgmt. Inc., established a fiduciary standard to determine if fund sponsors violated their fiduciary duty with respect to fees. Since 1982, no plaintiff has received an award under the 1970 statute. A recent U.S. Supreme Court case, Jones v. Harris Assocs. L.P, confirmed the Gartenberg standard but noted that the Gartenberg case lacked “analytical clarity.” This paper examines the issues from a new and different perspective and uses micro economic analysis to clarify the ambiguities of the decision. The Gartenberg standard imposes a very high hurdle for plaintiffs in fee cases to overcome. However, in light of the evidence presented here, the ability to demonstrate that advisory fees are “so disproportionately large that they could not have been the product of arm's length negotiation” is much enhanced