The Forum attended the oral argument of the Jones v. Harris Associates case yesterday in the Supreme Court. The Court’s decision in this case, which will likely determine how trial courts decide excessive fees cases, will almost certainly have far-reaching consequences for fund directors and the industry. While it isn’t possible to forecast accurately the outcome of any case before the Supreme Court based only on the oral argument, questions asked during the argument may shed some light on the issues that individual justices may find to be particularly important.
The Forum’s “friend of the court” brief focused on the central role of independent directors in the oversight of fees. In particular, the Forum’s brief, like many others in the case, broadly supported the Gartenberg framework, both in terms of how directors determine whether a fee is reasonable and as a standard that courts should look to in deciding whether to defer to the decision of the directors. In contrast, in their brief, the Jones plaintiffs purported to support Gartenberg, but, in reality, largely rejected the ability of independent directors effectively to oversee the fee-setting process. Instead, their brief urged that courts should be required to determine independently whether the fees paid by the fund are fair (and that courts look primarily at the fees paid to the adviser by non-fund, institutional clients in doing so).
In court, the Solicitor General (who argued on behalf of the United States) and the attorney for Harris Associates both expressly urged the Court to adopt the Gartenberg approach. (All sides – the plaintiffs, the defendants and the United States -- rejected the “market forces” analysis Judge Easterbrook relied upon in his opinion for the Seventh Circuit Court of Appeals.)
Because of the broad support for Gartenberg, it is not surprising that many of the justices’ questions focused on the phrasing and application of the standard, and in particular, when judicial review of a fee determination would be warranted. At one point, Justice Breyer asked specifically, “What do we do about Gartenberg?” While there was much discussion on these points, it is difficult to predict how any particular justice might resolve the issue.
There was one further exchange between Justice Scalia and the attorney for the plaintiffs that, while it arguably missed the point of how boards and advisers interact, might nonetheless suggest that the justices do recognize the potential for independent directors to oversee funds effectively. Specifically, the lawyer for the Jones plaintiffs asserted at one point that “the directors can’t fire and walk away from the adviser.” Justice Scalia questioned that assertion, saying:
I don’t understand your statement that they can’t fire the investment adviser. Maybe they can’t fire him, but they can insist that he accept a lower fee, right? Surely they can do that, can’t they?
The attorney, pursuing the argument articulated in the Jones brief, said that independent directors do not demand lower fees in practice, “[b]ecause the adviser picks the board of directors.” Justice Scalia appeared to reject that line of argument, saying:
Let’s assume you have a disinterested board of directors, which is what the statute requires. You tell me even though they are disinterested, they can’t fire the adviser. It seems to me, while they can’t fire him, they can say: We are going to cut your fee in half. Whereupon they don’t have to fire him. He will pack up and leave, and they will get a new adviser. Doesn’t that work?
A number of thoughtful commentaries have been written, discussing various facets of the oral argument, and parsing the likely views of different justices. We have collected several of these interesting pieces in the Forum’s Directors’ Resource Center, where they are available to Forum members.