In reaching its decision, the Seventh Circuit considered the “reasonableness” test originally set forth in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982). The court stated that the Gartenberg test has been expressed two different ways: (1) whether the fee represents a charge within the range of what would have been negotiated at arm’s-length in light of all surrounding circumstances; and (2) whether the fee is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining. In its decision, however, the Seventh Circuit effectively rejected both variations of this test. Instead, the court ruled that Section 36(b) requires neither that fees be “reasonable” nor that the courts engage in judicial rate regulation. To the contrary, according to the court, Section 36(b) merely states that the adviser has a fiduciary duty to its clients.
According to the Seventh Circuit, “[a] fiduciary must make full disclosure and play no tricks” on investors. The court then noted that, in the context of other fiduciary relationships, such as those with trustees and lawyers, there is no cap on compensation nor is there judicial oversight of the rates charged. The Seventh Circuit further noted that investors can “vote with their feet” and will not invest in mutual funds with excessive fees. In that respect, the trustees (particularly with the input of the disinterested trustees) are in a better position than a judge or jury to determine how much advisory services are worth.
The Court concluded that there were no allegations in the case that: “Harris pulled the wool over the eyes of the disinterested trustees or otherwise hindered their ability to negotiate a favorable price for advisory services. The fees [were] not hidden from investors – and the Oakmark funds’ net return [had] attracted new investment rather than driving investors away.” Finally, the Court held that it was irrelevant that Harris charged other institutional investors lower fees than it charged Oakmark. According to the Seventh Circuit, mutual funds are more complicated and often require more work from advisors than simply managing the investments of institutional investors. For example, the Seventh Circuit pointed out that mutual funds are often growing and shrinking rather rapidly and needing liquid assets to facilitate redemptions, complicating the advisers’ tasks and often justifying higher fees. The court, therefore, ruled that the fees charged by Harris and negotiated with the input of the disinterested trustees were not excessive under Section 36(b) and, therefore, dismissed the claims against Harris.
Plaintiffs have sought a rehearing by the Seventh Circuit en banc, which could lead to a conflict between circuits, thus making the issue ripe for consideration by the Supreme Court.
