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BOSTON – The U.S. Supreme Court is taking a close look at a question individual investors have long asked about their mutual funds, but the courts have largely ignored: Why am I getting charged twice as much as big institutional clients?
Sure enough, the services that different classes of fund clients get aren’t the same. Institutions like pension funds and foundations may not need toll-free customer hotlines. They don’t require as many of the prospectuses and other fund reports that individuals often throw away, even though they’re printed and mailed at great expense. Individuals move relatively paltry sums in and out of a fund, piling up higher transaction costs than big clients.
Still, the investments a fund makes are often the same for both groups, and the returns similar – though individuals’ higher fees take a bigger bite from their results, regardless of whether markets are up or down.
So it can be galling for an individual to pay an expense ratio of, say, 1 percent of cash invested as an annual fee, versus 0.5 percent for an institutional client enjoying what is in effect a bulk rate.
Courts have been reluctant to consider such disparities, and have rarely sided with investors. Instead, the comparisons that courts have allowed focus on whether a fund’s fees are so far out of line from what competing funds charge as to be unreasonable.
Another key factor: Whether expenses were so out of whack that they couldn’t conceivably have been the product of honest negotiations between the investment adviser running the fund and the fund’s board of directors, which is supposed to advocate for shareholders.
But now, the Supreme Court could be on the verge of ruling that the individual-vs.-institutional disparity should be thrown into the mix of factors central to deciding a case’s outcome. The issue dominated much of the discussion in arguments presented last week in a long-running fee challenge, Jones v. Harris Associates.
Some of the court’s more liberal justices suggested the disparity shouldn’t be left out of the equation in considering the fairness of fees that the more than 52 million U.S. fund-owning households pay.
“Wouldn’t that be a normal question to ask?” Justice Stephen Breyer asked an attorney for Harris Associates, which advised the Oakmark complex of funds.
The attorney, John Donovan, agreed that such a comparison “is likely to be relevant,” although Donovan added that the disparity shouldn’t necessarily become a key consideration in every fee challenge.
The court is expected to rule sometime before June. It remains unclear what, if any, changes justices will make to a fee-setting legal standard that the fund industry says has served investors well since 1982.
Two court conservatives, John Roberts and Antonin Scalia, suggested they’re unsympathetic to having courts second-guess fund boards’ fee-approval decisions.
