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American Funds Win Means Loss for Shareholders

Plus, American Century gets a new CIO.

Morningstar Analysts, 02/22/2010

American Funds shareholders missed millions of dollars in potential fees savings because of a recent court decision.

On Dec. 28, 2009, Capital Research and Management Company, the investment advisor to the American Funds since 1931, became the latest advisor to prevail in an excessive fee lawsuit.

The decision is important because the investment community is just weeks away from the Supreme Court's decision in a similar excessive fee case: Jones v. Harris Associates. (Harris is the investment advisor to the Oakmark Funds.) Depending on that ruling, Capital Research may find itself in court yet again.

The recent decision in federal district court not only highlights how much money is at stake for fund shareholders and the mutual fund industry, but it also touches on the due diligence (or lack thereof) of mutual fund boards.

The case provided a rare look inside the largest privately held investment management company. Capital Research advises more than $880 billion in mutual fund assets as of Jan 1, 2010. The only other closely held advisor that comes close to Capital Research's size is Fidelity, which manages more than $700 billion.

The 105-page decision penned by U.S. District Court Judge Gary Feess sided with Capital Research but had some interesting observations about the family's mutual fund board and profit levels.

The profit levels at Capital Research would make most CFOs envious. In fiscal year 2008, combined net income for various Capital entities increased to more than $1.2 billion from roughly $361 million in fiscal 2003. Operating profit margins were consistently above 30% over the past few years. See Page 50 of the decision.

While Feess ultimately sided with Capital Research because the plaintiffs did not meet their burden of proof, he did not let the performance of the independent directors, who help set the level of mutual fund fees, slide.

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