JONES ET AL. v. HARRIS ASSOCIATES L. P.
No. 08-586
SUPREME COURT OF THE UNITED STATES
Argued November 2, 2009—Decided March 30, 2010
559 U.S. 335
David C. Frederick argued the cause for petitioners. With him on the briefs were Brendan J. Crimmins, Daniel G. Bird, Ernest A. Young, Michael J. Brickman, James C. Bradley, Nina H. Fields, Guy M. Burns, and John M. Greabe.
Curtis E. Gannon argued the cause for the United States as amicus curiae supporting petitioners. With him on the brief were Solicitor General Kagan, Deputy Solicitor General Stewart, David M. Becker, Mark D. Cahn, Jacob H. Stillman, and Mark Pennington.
John D. Donovan, Jr., argued the cause for respondent. With him on the brief were Robert A. Skinner, Benjamin S. Halasz, Brian R. Blais, Jeffrey A. Lamken, and Aaron M. Streett.*
*Briefs of amici curiae urging reversal were filed for AARP et al. by Jay E. Sushelsky and Michael Schuster; for Law Professors by William A. Birdthistle, pro se; for the National Association of Shareholder and Consumer Attorneys by Jerome M. Congress, Anna C. Dover, and Kevin P. Roddy; for the North American Securities Administrators Association, Inc., by Alfred E. T. Rusch; for John C. Bogle by James A. Feldman, Michael Woerner, and Lynn Lincoln Sarko; and for Deborah A. DeMott et al. by Ms. DeMott, pro se, and Jerome A. Broadhurst.
Briefs of amici curiae urging affirmance were filed for the Cato Institute by Ilya Shapiro and Timothy Sandefur; for the Chamber of Commerce of the United States of America by Richard D. Bernstein, Barry P. Barbash, Mary Eaton, Robin S. Conrad, and Amar D. Sarwal; for Fidelity Management & Research Co. by Stephen M. Shapiro, Andrew J. Pincus, Timothy S. Bishop, James N. Benedict, and Sean M. Murphy; for the Independent Directors Council by Theodore B. Olson and Mark A. Perry; for the Investment Company Institute by Seth P. Waxman, Paul R. Q. Wolfson, Rebecca G. Deutsch, Lori A. Martin, Paul Schott Stevens, and Karrie McMillan; for Law and Finance Professors and Scholars by Fran-
Stephen M. Tillery filed a brief for Robert Litan et al. as amici curiae.
OPINION
JUSTICE ALITO delivered the opinion of the Court.
We consider in this case what a mutual fund shareholder must prove in order to show that a mutual fund investment adviser breached the “fiduciary duty with respect to the receipt of compensation for services” that is imposed by
I
A
The
“Congress adopted the [Investment Company Act of 1940] because of its concern with the potential for abuse inherent in the structure of investment companies.” Daily Income Fund, 464 U. S., at 536 (internal quotation marks omitted). Recognizing that the relationship between a fund and its investment adviser was “fraught with potential conflicts of interest,” the Act created protections for mutual fund shareholders. Id., at 536-538 (internal quotation marks omitted); Burks, supra, at 482-483. Among other things, the Act required that no more than 60 percent of a fund‘s directors could be affiliated with the adviser and that fees for investment advisers be approved by the directors and the shareholders of the fund. See §§ 10, 15(c), 54 Stat. 806, 813.
The growth of mutual funds in the 1950‘s and 1960‘s prompted studies of the 1940 Act‘s effectiveness in protecting investors. See Daily Income Fund, 464 U. S., at 537-538. Studies commissioned or authored by the Securities and Exchange Commission (SEC or Commission) identified problems relating to the independence of investment company boards and the compensation received by investment advisers. See ibid. In response to such concerns, Congress amended the Act in 1970 and bolstered shareholder protection in two primary ways.
First, the amendments strengthened the “cornerstone” of the Act‘s efforts to check conflicts of interest, the independence of mutual fund boards of directors, which negotiate and scrutinize adviser compensation. Burks, supra, at 482. The amendments required that no more than 60 percent of a fund‘s directors be “persons who are interested persons,”1 e. g., that they have no interest in or affiliation with the investment adviser.
The “fiduciary duty” standard contained in §36(b) represented a delicate compromise. Prior to the adoption of the 1970 amendments, shareholders challenging investment adviser fees under state law were required to meet “common-law standards of corporate waste, under which an unreasonable or unfair fee might be approved unless the court deemed it ‘unconscionable’ or ‘shocking,‘” and “security holders challenging adviser fees under the [Investment Company Act] itself had been required to prove gross abuse of trust.” Daily Income Fund, 464 U. S., at 540, n. 12. Aiming to give shareholders a stronger remedy, the SEC proposed a provision that would have empowered the Commission to bring actions to challenge a fee that was not “reasonable” and to intervene in any similar action brought by or on behalf of an investment company. Id., at 538. This approach was included in a bill that passed the House. H. R. 9510, 90th Cong., 1st Sess., §8(d) (1967); see also S. 1659, 90th Cong.,
The provision that was ultimately enacted adopted “a different method of testing management compensation,” id., at 539 (quoting S. Rep., at 5; internal quotation marks omitted), that was more favorable to shareholders than the previously available remedies but that did not permit a compensation agreement to be reviewed in court for “reasonableness.” This is the fiduciary duty standard in §36(b).
B
Petitioners are shareholders in three different mutual funds managed by respondent Harris Associates L. P., an investment adviser. Petitioners filed this action in the Northern District of Illinois pursuant to § 36(b) seeking damages, an injunction, and rescission of advisory agreements between Harris Associates and the mutual funds. The complaint alleged that Harris Associates had violated §36(b) by charging fees that were “disproportionate to the services rendered” and “not within the range of what would have been negotiated at arm‘s length in light of all the surrounding circumstances.” App. 52.
The District Court granted summary judgment for Harris Associates. Applying the standard adopted in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F. 2d 923 (CA2 1982), the court concluded that petitioners had failed to raise a triable issue of fact as to “whether the fees charged ... were so disproportionately large that they could not have been the result of arm‘s-length bargaining.” App. to Pet. for Cert. 29a. The District Court assumed that it was relevant to compare the challenged fees with those that Harris Associates charged its other clients. Id., at 30a. But in light of those comparisons as well as comparisons with fees charged by other investment advisers to similar mu-
A panel of the Seventh Circuit affirmed based on different reasoning, explicitly “disapprov[ing] the Gartenberg approach.” 527 F. 3d 627, 632 (2008). Looking to trust law, the panel noted that, while a trustee “owes an obligation of candor in negotiation,” a trustee, at the time of the creation of a trust, “may negotiate in his own interest and accept what the settlor or governance institution agrees to pay.” Ibid. (citing Restatement (Second) of Trusts § 242, and Comment f). The panel thus reasoned that “[a] fiduciary duty differs from rate regulation. A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation.” 527 F. 3d, at 632. In the panel‘s view, the amount of an adviser‘s compensation would be relevant only if the compensation were “so unusual” as to give rise to an inference “that deceit must have occurred, or that the persons responsible for decision have abdicated.” Ibid.
The panel argued that this understanding of § 36(b) is consistent with the forces operating in the contemporary mutual fund market. Noting that “[t]oday thousands of mutual funds compete,” the panel concluded that “sophisticated investors” shop for the funds that produce the best overall results, “mov[e] their money elsewhere” when fees are “excessive in relation to the results,” and thus “create a competitive pressure” that generally keeps fees low. Id., at 633-634. The panel faulted Gartenberg on the ground that it “relies too little on markets.” 527 F. 3d, at 632. And the panel firmly rejected a comparison between the fees that Harris Associates charged to the funds and the fees that Harris Associates charged other types of clients, observing that “[d]ifferent clients call for different commitments of time” and that costs, such as research, that may benefit several categories of clients “make it hard to draw inferences from fee levels.” Id., at 634.
The Seventh Circuit denied rehearing en banc by an equally divided vote. 537 F. 3d 728 (2008) (per curiam). The dissent from the denial of rehearing argued that the panel‘s rejection of Gartenberg was based “mainly on an economic analysis that is ripe for reexamination.” 537 F. 3d, at 730 (opinion of Posner, J.). Among other things, the dissent expressed concern that Harris Associates charged “its captive funds more than twice what it charges independent funds,” and the dissent questioned whether high adviser fees actually drive investors away. Id., at 731.
We granted certiorari to resolve a split among the Courts of Appeals over the proper standard under §36(b).2 556 U. S. 1104 (2009).
II
A
Since Congress amended the Investment Company Act in 1970, the mutual fund industry has experienced exponential growth. Assets under management increased from $38.2 billion in 1966 to over $9.6 trillion in 2008. The number of mutual fund investors grew from 3.5 million in 1965 to 92 million in 2008, and there are now more than 9,000 open- and closed-end funds.3
During this time, the standard for an investment adviser‘s fiduciary duty has remained an open question in our Court, but, until the Seventh Circuit‘s decision below, something of a consensus had developed regarding the standard set forth
In Gartenberg, the Second Circuit noted that Congress had not defined what it meant by a “fiduciary duty” with respect to compensation but concluded that “the test is essentially whether the fee schedule represents a charge within the range of what would have been negotiated at arm‘s-length in the light of all of the surrounding circumstances.” 694 F. 2d, at 928. The Second Circuit elaborated that, “[t]o be guilty of a violation of § 36(b), ... the adviser-manager must charge a fee that 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.” Ibid. “To make this determination,” the court stated, “all pertinent facts must be weighed,” id., at 929, and the court specifically mentioned “the adviser-manager‘s cost in providing the service, ... the extent to which the adviser-manager realizes economies of scale as the fund grows larger, and the volume of orders which must be processed by the manager,” id., at 930.5 Observing that competition among advisers for
B
The meaning of § 36(b)‘s reference to “a fiduciary duty with respect to the receipt of compensation for services”7 is hardly pellucid, but based on the terms of that provision and the role that a shareholder action for breach of that duty plays in the overall structure of the Act, we conclude that
1
We begin with the language of § 36(b). As noted, the Seventh Circuit panel thought that the phrase “fiduciary duty” incorporates a standard taken from the law of trusts. Petitioners agree but maintain that the panel identified the wrong trust-law standard. Instead of the standard that applies when a trustee and a settlor negotiate the trustee‘s fee at the time of the creation of a trust, petitioners invoke the standard that applies when a trustee seeks compensation after the trust is created. Brief for Petitioners 20-23, 35-37. A compensation agreement reached at that time, they point out, “will not bind the beneficiary” if either “the trustee failed to make a full disclosure of all circumstances affecting the agreement” which he knew or should have known or if the agreement is unfair to the beneficiary. Id., at 23 (quoting Restatement (Second) of Trusts §242, Comment i). Respondent, on the other hand, contends that the term “fiduciary” is not exclusive to the law of trusts, that the phrase means different things in different contexts, and that there is no reason to believe that §36(b) incorporates the specific meaning of the term in the law of trusts. Brief for Respondent 34-36.
We find it unnecessary to take sides in this dispute. In Pepper v. Litton, 308 U. S. 295 (1939), we discussed the meaning of the concept of fiduciary duty in a context that is analogous to that presented here, and we also looked to trust law. At issue in Pepper was whether a bankruptcy court could disallow a dominant or controlling shareholder‘s claim for compensation against a bankrupt corporation. Domi-
“Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein. ... The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm‘s length bargain. If it does not, equity will set it aside.” Id., at 306-307 (emphasis added; footnote omitted); see also Geddes v. Anaconda Copper Mining Co., 254 U. S. 590, 599 (1921) (standard of fiduciary duty for interested directors).
We believe that this formulation expresses the meaning of the phrase “fiduciary duty” in §36(b), 84 Stat. 1429. The Investment Company Act modifies this duty in a significant way: It shifts the burden of proof from the fiduciary to the party claiming breach,
The Gartenberg approach fully incorporates this understanding of the fiduciary duty as set out in Pepper and reflects §36(b)(1)‘s imposition of the burden on the plaintiff. As noted, Gartenberg insists that all relevant circumstances be taken into account, see 694 F. 2d, at 929, as does § 36(b)(2), 84 Stat. 1429 (“[A]pproval by the board of directors ... shall be given such consideration by the court as is deemed appropriate under all the circumstances” (emphasis added)). And Gartenberg uses the range of fees that might result from arm‘s-length bargaining as the benchmark for reviewing challenged fees.
2
Gartenberg‘s approach also reflects §36(b)‘s place in the statutory scheme and, in particular, its relationship to the other protections that the Act affords investors.
Under the Act, scrutiny of investment-adviser compensation by a fully informed mutual fund board is the “cornerstone of the ... effort to control conflicts of interest within mutual funds.” Burks, 441 U. S., at 482. The Act interposes disinterested directors as “independent watchdogs” of the relationship between a mutual fund and its adviser. Id., at 484 (internal quotation marks omitted). To provide these directors with the information needed to judge whether an adviser‘s compensation is excessive, the Act requires advisers to furnish all information “reasonably ... necessary to evaluate the terms” of the adviser‘s contract,
In recognition of the role of the disinterested directors, the Act instructs courts to give board approval of an adviser‘s compensation “such consideration ... as is deemed appropriate under all the circumstances.”
From this formulation, two inferences may be drawn. First, a measure of deference to a board‘s judgment may be appropriate in some instances. Second, the appropriate measure of deference varies depending on the circumstances.
Gartenberg heeds these precepts. Gartenberg advises that “the expertise of the independent trustees of a fund, whether they are fully informed about all facts bearing on the [investment adviser‘s] service and fee, and the extent of care and conscientiousness with which they perform their duties are important factors to be considered in deciding whether they and the [investment adviser] are guilty of a breach of fiduciary duty in violation of § 36(b).” 694 F. 2d, at 930.
III
While both parties in this case endorse the basic Gartenberg approach, they disagree on several important questions that warrant discussion.
The first concerns comparisons between the fees that an adviser charges a captive mutual fund and the fees that it charges its independent clients. As noted, the Gartenberg court rejected a comparison between the fees that the adviser in that case charged a money market fund and the fees that it charged a pension fund. 694 F. 2d, at 930, n. 3 (noting that “[t]he nature and extent of the services required by each type of fund differ sharply“). Petitioners contend that such a comparison is appropriate, Brief for Petitioners 30-31, but respondent disagrees, Brief for Respondent 38-44. Since the Act requires consideration of all relevant factors,
By the same token, courts should not rely too heavily on comparisons with fees charged to mutual funds by other advisers. These comparisons are problematic because these
Finally, a court‘s evaluation of an investment adviser‘s fiduciary duty must take into account both procedure and substance. See
In contrast, where the board‘s process was deficient or the adviser withheld important information, the court must take a more rigorous look at the outcome. When an investment adviser fails to disclose material information to the
It is also important to note that the standard for fiduciary breach under § 36(b) does not call for judicial second-guessing of informed board decisions. See Daily Income Fund, supra, at 538; see also Burks, 441 U. S., at 483 (“Congress consciously chose to address the conflict-of-interest problem through the Act‘s independent-directors section, rather than through more drastic remedies“). “[P]otential conflicts [of interests] may justify some restraints upon the unfettered discretion of even disinterested mutual fund directors, particularly in their transactions with the investment adviser,” but they do not suggest that a court may supplant the judgment of disinterested directors apprised of all relevant information, without additional evidence that the fee exceeds the arm‘s-length range. Id., at 481. In reviewing compensation under §36(b), the Act does not require courts to engage in a precise calculation of fees representative of arm‘s-length bargaining. See 527 F. 3d, at 633 (“Judicial price-setting does not accompany fiduciary duties“). As recounted above, Congress rejected a “reasonableness” requirement that was criticized as charging the courts with rate-setting responsibilities. See Daily Income Fund, supra, at 538-540. Congress’ approach recognizes that
By focusing almost entirely on the element of disclosure, the Seventh Circuit panel erred. See 527 F. 3d, at 632 (An investment adviser “must make full disclosure and play no tricks but is not subject to a cap on compensation“). The Gartenberg standard, which the panel rejected, may lack sharp analytical clarity, but we believe that it accurately reflects the compromise that is embodied in §36(b), and it has provided a workable standard for nearly three decades. The debate between the Seventh Circuit panel and the dissent from the denial of rehearing regarding today‘s mutual fund market is a matter for Congress, not the courts.
IV
For the foregoing reasons, the judgment of the Court of Appeals is vacated, and the case is remanded for further proceedings consistent with this opinion.
It is so ordered.
JUSTICE THOMAS, concurring.
The Court rightly affirms the careful approach to §36(b) cases, see
The District Court and Court of Appeals in Gartenberg created that standard, which emphasizes fee “fairness” and proportionality, 694 F. 2d, at 929, in a manner that could be read to permit the equivalent of the judicial rate regulation the Gartenberg opinions disclaim, based on the Investment Company Act of 1940‘s “tortuous” legislative history and a handful of extrastatutory policy and market considerations, id., at 928; see also id., at 926-927, 929-931; Gartenberg v. Merrill Lynch Asset Management, Inc., 528 F. Supp. 1038, 1046-1050, 1055-1057 (SDNY 1981). Although virtually all subsequent §36(b) cases cite Gartenberg, most courts have correctly declined its invitation to stray beyond statutory bounds. Instead, they have followed an approach (principally in deciding which cases may proceed past summary judgment) that defers to the informed conclusions of disinterested boards and holds plaintiffs to their heavy burden of proof in the manner the Act, and now the Court‘s opinion, requires. See, e. g., ante, at 347 (underscoring that the Act “modifies” the governing fiduciary duty standard “in a significant way: It shifts the burden of proof from the fiduciary to the party claiming breach,
I concur in the Court‘s decision to affirm this approach based upon the Investment Company Act‘s text and our longstanding fiduciary duty precedents. But I would not say that in doing so we endorse the ”Gartenberg standard.” Whatever else might be said about today‘s decision, it does not countenance the free-ranging judicial “fairness” review