Fund Fees: How Might the Supreme Court Decide?

In closing, how do you think the case will come out, and what will that mean, if anything, for mutual fund investors and mutual fund fees?

Birdthistle: I don't know how it's going to come out. I think it will be a close case. I think business cases typically are immune from some of the more profound political differences that separate the court, that split the court, in obvious constitutional contexts. And this year we're going to see a very heavy corporate/business term. There are a lot of cases up there that are involving business law.

But if I had to wager, I would wager that probably the four more left-leaning justices on the court will probably side with the plaintiffs, and the four more conservative justices would probably side with the defendants, even though Easterbrook and Posner are both somewhat conservative libertarian judges.

So I think, like many disputes, it may come down to the particular feelings of Justice Kennedy. I think that the two options that are viably on the table are Gartenberg, as it has been applied over the last quarter century, versus a Gartenberg-plus in which they vigorously look for a comparison between institutional and retail [fees].

I think what that suggests is that the possible outcomes are if it's a pro-plaintiff decision. And by that, one has to take into account the fact that these aren't just up or down decisions. There are many, many pages, often 60-, 80-, 100-page decisions. And there's a lot of emotion and language that can go into that that will inform lower court judges about how to proceed.

So I think you could end up with a possibly very pro-plaintiff finding that would, I think, impose some price discipline on the market, or I think you could end up with a status quo of Gartenberg.

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But I think status quo is different when the Supreme Court ratifies the status quo. And I think it would be troubling, because I think to the extent that there are fund complexes that do not feel bound to impose the lowest possible cost on their shareholders that this would be a carte blanche to raise them higher.

I think it is also possible that in a pro-defendant finding, ruling, by the Supreme Court that the issue would probably make its way to Congress before very long.

Leggio: Professor Coates, do you agree that it's more likely than not that the Supreme Court will end up codifying some type of Gartenberg standard?

Coates: Yes. I think there is probably more chance than Professor Birdthistle does that the court might uphold perhaps a modified version of Judge Easterbrook's approach to this test.

We didn't really ever talk about it much in this conversation, but just to state it, Easterbrook took the position that if the board is there, and the board is independent, and the board gets good information and has a good process, then courts ought to take a very careful--they ought to be very reluctant to then intervene in a fee case.

And I could imagine the court maybe not going quite as far as Judge Easterbrook did, but taking into account that factor more heavily than prior courts had done.

I also think that another option on the table is Gartenberg-plus, but a different plus. Not to necessarily focus, as I think could be misleading on the institutional-retail comparison, although I think that ought to be part of the mix, but rather to allow lower courts to put more weight on the competitive forces that I firmly believe are very present.

And I will say one more thing. I think the Supreme Court will and should take into account something that we have not talked about, which is that there are costs imposed on fund investors by these cases. These cases are not run by investors. They are run by lawyers. They are run by lawyers who have their own interests. They are run by lawyers who face less competitive pressure than the fund advisors that they are attacking. They are run by lawyers who do not have to submit their plan for the litigation, or even get approval for the litigation to investors before they bring the litigation, after the litigation, anywhere along the way.

And to pretend that the court system here is sort of a cost-free check for investors is wrong. And so I do think the Supreme Court will and should take into account the possibility that if they greatly loosen the standard and sort of encourage more cases of this kind, that in the end might actually worsen results for investors. It might lower fees slightly, but it also might lower performance, because in the end, the costs of the litigation are ultimately going to be borne by the investors themselves.

Leggio: Professor Birdthistle, I think that's an important point. If there is your type of Gartenberg-plus analysis where the profit levels or the fees of retail funds need to come closer in line with institutional funds, but then all that means is additional litigation, are shareholders really going to see a reduction in fees, even in the best-case scenario?

Birdthistle: Well, I think the boogeyman of increased litigation is almost a standard part of every defendant in front of the Supreme Court. Every time you are a defendant in front of the Supreme Court, you can say, "If we lose this case, more litigation will come."

I think it's equally plausible, or it's also plausible, that if they win this case, the costs will go up also. I don't know exactly. I don't think anyone knows exactly what the difference numerically will be.

But I think the judicial system has plenty of ways already of dismissing cases that are without foundation. And that happens all the time. Can you guarantee that you'll have a ruling in which no frivolous lawsuits will be brought? Of course you can't. People will bring them all the time.

But if, in fact, the fees do come down and there is no basis for a lawsuit, then the lawyers will lose. And after losing one or two, they won't bring many more.

So I don't think the possibility of a floodgate of litigation will be there unless of course they start winning, in which case it would suggest that there was something wrong.

Leggio: Well great. Professor Coates, Professor Birdthistle, thank you so much for joining us today.

Birdthistle: Thank you very much, Ryan.

Coates: Thanks for the invitation.

Leggio: And thank you for joining us. This is Ryan Leggio for Morningstar.