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In the Supreme Court of the United States
JERRY N. JONES, ET AL., PETITIONERS
HARRIS ASSOCIATES L.P.
ON WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
BRIEF FOR THE UNITED STATES
AS AMICUS CURIAE SUPPORTING PETITIONERS
Counsel of Record
MALCOLM L. STEWART
Deputy Solicitor General
CURTIS E. GANNON
Assistant to the Solicitor
Department of Justice
Washington, D.C. 20530-0001
DAVID M. BECKER
MARK D. CAHN
Deputy General Counsel
JACOB H. STILLMAN
Assistant General Counsel
TRACEY A. HARDIN
Securities and Exchange
Washington, D.C. 20549
Whether a security holder's claim that a mutual fund's investment adviser breached its fiduciary duty by charging an excessive fee-more than twice the fee it charged to clients with which it was not affiliated-is cognizable under Section 36(b) of the Investment Com pany Act of 1940, 15 U.S.C. 80a-35(b), even if the secu rity holder does not show that the adviser misled the mutual fund directors who approved the fee.
In the Supreme Court of the United States
JERRY N. JONES, ET AL., PETITIONERS
HARRIS ASSOCIATES L.P.
ON WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
BRIEF FOR THE UNITED STATES
AS AMICUS CURIAE SUPPORTING PETITIONERS
INTEREST OF THE UNITED STATES
The United States, through the Department of Jus tice and the Securities and Exchange Commission (Com mission or SEC), administers and enforces the federal securities laws. This case concerns Section 36(b) of the Investment Company Act of 1940, 15 U.S.C. 80a-35(b), which provides that the investment adviser to a mutual fund "shall be deemed to have a fiduciary duty with re spect to the receipt of compensation for services." Be cause an action under Section 36(b) may be brought ei ther by a security holder or by the Commission, see ibid ., the United States has a substantial interest in this Court's resolution of the question presented.
1. For decades, Congress has recognized that in vestment companies (such as mutual funds) require spe cial regulation, different from that applying to other corporations under federal securities laws. See H.R. Rep. No. 1382, 91st Cong., 2d Sess. 2 (1970) ("At least as early as 1935, it was recognized by Congress that mu tual funds * * * present special features which require attention beyond simply the disclosure philosophy of the Securities Act of 1933."). "[A]n investment company is typically created and managed by a pre-existing exter nal organization known as an investment adviser," which "generally supervises the daily operation of the fund and often selects affiliated persons to serve on the com pany's board of directors." Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 536 (1984). As a result, "the relation ship between investment advisers and mutual funds is fraught with potential conflicts of interest." Ibid. (inter nal quotation marks omitted).
Congress's concerns about "the potential for abuse inherent in the structure of investment companies" (Burks v. Lasker, 441 U.S. 471, 480 (1979)) led to the en actment of the Investment Company Act of 1940 (Act or ICA), ch. 686, 54 Stat. 789 (15 U.S.C. 80a-1 et seq.). The ICA initiated regulation of "most transactions between investment companies and their advisers," placed limits on "the number of persons affiliated with the adviser who may serve on the fund's board of directors," and required both "the directors and the shareholders of the fund" to approve the fees that the adviser receives "for investment advice and other services." Daily Income Fund, 464 U.S. at 536-537 (citing 15 U.S.C. 80a-17, 80a-10, and 80a-15). Section 36 of the ICA authorized the Commission to bring an action for injunctive relief against any officer, director, board member, or adviser who committed an act of "gross misconduct or gross abuse of trust." 54 Stat. 841.
This Court has previously recounted the years of study and effort-by academics, the SEC, the mutual- fund industry, and congressional committees-that cul minated in the Investment Company Amendments Act of 1970, Pub. L. No. 91-547, 84 Stat. 1413. See Daily Income Fund, 464 U.S. at 537-541. In brief, the enor mous growth of mutual funds in the 1950s and 1960s prompted concerns that the ICA was not sufficiently protecting investors in mutual funds. A 1962 report commissioned by the SEC found that investment advis ers tended to charge mutual funds "substantially high er" rates than they charged other clients and that mu tual funds lacked effective bargaining power in the es tablishment of advisers' fees. A Study of Mutual Funds Prepared for the Securities and Exchange Commission by the Wharton School of Finance and Commerce, H.R. Rep. No. 2274, 87th Cong., 2d Sess. 29, 30, 34, 66-67 (1962) (Wharton Report). In 1966, the Commission is sued its own study, which concluded that lawsuits chal lenging excessive advisory fees had been largely ineffec tive because courts had applied an unduly permissive standard (relying on ratification by the board and share holders and asking only whether a waste of corporate assets had occurred). Report of the Securities and Ex change Commission on the Public Policy Implications of Investment Company Growth, H.R. Rep. No. 2337, 89th Cong., 2d Sess. 134-138, 141 (1966) (1966 SEC Re port). The SEC concluded that board and shareholder approval could not protect shareholder interests with respect to advisory compensation because mutual funds could not, as a practical matter, terminate their relation ships with their advisers. Id. at 148.
Between 1967 and 1970, Congress considered legislation to address those concerns. See Daily Income Fund, 464 U.S. at 538-539. The resulting amendments to the ICA attempted to make mutual-fund boards "more independent of the adviser" and encouraged the boards to exercise "greater scrutiny of adviser con tracts." Id. at 538 (citing 15 U.S.C. 80a-10(a), 80a-15(c)). But Congress also concluded "that the shareholders should not have to rely solely on the fund's directors to assure reasonable adviser fees, notwithstanding the increased disinterestedness of the board." Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 108 (1991) (in ternal quotation marks omitted). Accordingly, in amen ding the ICA in 1970, Congress added Section 36(b), 15 U.S.C. 80a-35(b), which created a "new" and "unique right" by giving security holders and the SEC an "inde pendent check on excessive fees." Daily Income Fund, 464 U.S. at 535, 536, 541.
2. Section 36(b) provides in pertinent part as fol lows:
For the purposes of this subsection, the invest ment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services * * * paid by such registered investment company or by the security holders thereof, to such investment ad viser or any affiliated person of such investment ad viser. An action may be brought under this subsec tion by the Commission, or by a security holder of such registered investment company * * * for breach of fiduciary duty in respect of such compensa tion[.]
15 U.S.C. 80a-35(b). In an action under Section 36(b), the "approval" of "compensation" by the investment com pany's board or shareholders "shall be given such con sideration by the court as is deemed appropriate under all the circumstances." 15 U.S.C. 80a-35(b)(2). The stat ute authorizes an award of "actual damages resulting from the breach of fiduciary duty," while providing that damages are not "recoverable for any period prior to one year before the action was instituted" and may not "exceed the amount of compensation or payment re ceived" by the defendant from the investment company. 15 U.S.C. 80a-35(b)(3).
3. a. Petitioners are shareholders of three funds in the Oakmark complex of mutual funds. Pet. App. 16a; J.A. 562-563. Each of those funds is a part of a Massa chusetts business trust registered with the SEC under the ICA as an open-end management investment com pany.1 J.A. 563. Respondent serves as the investment adviser to the funds in the Oakmark complex pursuant to separate advisory agreements with each fund, which are negotiated with, and approved annually by, a single board of trustees representing the shareholders of the funds. JA. 563-564. Under the fee schedules accompa nying the agreements, respondent receives an advisory fee that is calculated as a percentage of each fund's net assets at the end of the preceding month. Ibid.
b. In August 2004, petitioners initiated this suit, alleging that respondent had breached its fiduciary duty under Section 36(b) by receiving advisory fees that were disproportionate to the services provided, and by im permissibly retaining savings it realized from economies of scale as the funds grew. J.A. 1, 52-53. Respondent moved for summary judgment, arguing that its advisory fees fell within the "range" of reasonable fees that could result from arm's-length bargaining, pursuant to the standard set out in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982), cert. denied, 461 U.S. 906 (1983). See Pet. App. 27a, 29a-30a. In opposing that motion, petitioners contended, inter alia, that the fees at issue were excessive because they were approximately twice as large as the fees that re spondent charged its unaffiliated institutional clients for comparable services. Id. at 6a-7a, 30a, 39a.2
c. The district court granted respondent's motion for summary judgment. Pet. App. 15a. Invoking Gar tenberg, the court found that petitioners had failed to raise a triable issue of fact as to "whether the fees charged to the [Oakmark] Funds were so disproportion ately large that they could not have been the result of arm's-length bargaining between [respondent] and the board." Id. at 29a. The court "assum[ed] for the mere sake of comparison that the services [respondent's unaf filiated] institutional clients received were indistinguish able from those the [Oakmark] Funds received." Id. at 30a. The court found more relevant, however, that "the amounts paid by different parties establish a range of prices that investors were willing to pay" for investment advice. Ibid. That broad range extended from "a low- end figure below what the institutional clients were pay ing" all the way to "a high-end figure beyond the fees that other mutual fund clients paid" their advisers. Ibid. Because respondent's fees fell within this spectrum of fees paid by both mutual funds and unaffiliated institu tional clients, the court concluded they were not exces sive. Ibid.
4. The court of appeals affirmed, concluding that respondent had not breached the fiduciary duty imposed by Section 36(b). Pet. App. 1a-14a.
The court of appeals expressly "disapprove[d] the Gartenberg approach," based on its view that "[a] fidu ciary duty differs from rate regulation." Pet. App. 8a. The court explained that Congress's use of the term "fiduciary duty" in Section 36(b) "summon[s] up the law of trusts." Ibid. The court found that "the rule in trust law is straightforward: A trustee owes an obligation of candor in negotiation, and honesty in performance, but may negotiate in his own interest and accept what the settlor or governance institution agrees to pay." Ibid.; see ibid. ("A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensa tion."). The court stated that "when the settlor or the persons charged with the trust's administration make a decision, it is conclusive." Id. at 9a. It stated as well that "[f]ederal securities laws * * * work largely by requiring disclosure and then allowing price to be set by competition in which investors make their own choice." Id. at 13a. The court of appeals concluded that respon dent had satisfied its fiduciary obligations because it had not "pulled the wool over the eyes of the disinterested trustees or otherwise hindered their ability to negotiate a favorable price for advisory services." Id. at 14a.
While generally eschewing substantive reasonable ness review of the fees charged by investment advisers, the court of appeals found it "possible to imagine com pensation so unusual that a court will infer that deceit must have occurred, or that the persons responsible for decision have abdicated." Pet. App. 9a. The court con cluded, however, that no such deviation from the norm could be established in this case because the fees that respondents charge the Oakmark funds "are roughly the same * * * as those that other funds of similar size and investment goals pay their advisers." Id. at 6a. Peti tioners contended that, because "investment advisers create mutual funds" and "[f]ew mutual funds ever change advisers," the fees paid by other mutual funds typically are not the product of arm's-length bargaining and therefore do not provide a suitable benchmark for determining whether the fees respondent received from the Oakmark funds were excessive. See ibid. The court of appeals rejected that contention, stating that mutual funds have a strong incentive to keep fees low in order to attract investors. See id. at 7a. The court acknowl edged that "beliefs about the structure of the mutual- fund market" were different when Section 36(b) was enacted in 1970. Id. at 11a. It concluded, however, that "[a] lot has happened in the last 38 years" and that the mutual fund market is now a competitive one where in vestors "can and do 'fire' advisers cheaply and easily by moving their money elsewhere." Id. at 11a-12a.
The court of appeals rejected petitioners' contention (see Pet. App. 6a, 13a) that the fees respondent charged the Oakmark funds were excessive because they were substantially greater than the fees it charged unaffili ated institutional clients. The court stated that "[d]if ferent clients call for different commitments of time. Pension funds have low (and predictable) turnover of assets. Mutual funds may grow or shrink quickly and must hold some assets in high-liquidity instruments to facilitate redemptions." Id. at 13a. The court did not identify any record evidence in this case bearing on the comparability of the services that respondent provides to its affiliated and unaffiliated clients.
5. The court of appeals denied rehearing en banc, with five judges dissenting. Pet. App. 34a-35a. Judge Posner's opinion for the dissenters (id. at 34a-43a) con cluded that the panel had erred in rejecting the Gar tenberg standard based "mainly on an economic analysis that is ripe for reexamination." Id. at 37a. The dissent ers identified as a "particular concern" that respondent "charg[es] its captive funds more than twice what it charges independent funds." Id. at 39a. They noted as well that, while the panel had suggested possible justifi cations for that disparity, those "suggestions are offered purely as speculation, rather than anything having an evidentiary or empirical basis." Ibid.
In the dissenters' view, the disparity between the fees that respondent charged its mutual-fund and unaf filiated clients called into question the panel's conclusion that competition among mutual funds for investors acts as a sufficient check on the compensation their advisers can charge. Pet. App. 40a-41a. For similar reasons, the dissenters disagreed with the panel's view that any ex cessiveness inquiry must be conducted "solely by com paring the adviser's fee with the fees charged by other mutual fund advisers." Id. at 41a. The dissenters ex plained that "[t]he governance structure that enables mutual fund advisers to charge exorbitant fees is industry-wide, so the panel's comparability approach would if widely followed allow those fees to become the industry's floor." Ibid. The dissenters instead endorsed "the Gartenberg approach," under which courts consid ering the possible excessiveness of fees may consider a broader range of evidence, including petitioners' pro posed "alternative comparison" to the fees respondent charges its independent clients. Ibid.
SUMMARY OF ARGUMENT
The special "fiduciary duty" in Section 36(b) of the ICA, 15 U.S.C. 80a-35(b), was enacted out of concern that the non-arm's-length relationship between invest ment advisers and their affiliated investment companies could cause mutual funds to agree to excessive compen sation. See Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 540-541 (1984). Although Congress did not choose to impose rate regulation on advisers, it did intend to create a check on compensation that is "independent" of the requirement that adviser contracts be approved by the funds' directors. Id. at 541. The court of appeals' construction of Section 36(b) defeats that purpose and departs from the statute's text.
A. The court of appeals' focus on whether an adviser has "ma[d]e full disclosure and play[ed] no tricks" on the investment company's board (Pet. App. 8a) is inconsis tent with the plain text of Section 36(b), the structure of the ICA, the trust-law meaning of the term "fiduciary duty," and the purposes and legislative history of the statute. The statute specifies that the board's approval of compensation "shall be given such consideration by the court as is deemed appropriate under all the circum stances," 15 U.S.C. 80a-35(b)(2), which demonstrates that a court should engage in a more encompassing in quiry than the court of appeals conducted. By creating a "fiduciary duty," Congress incorporated the estab lished meaning of that term; and under trust law, an agreement about a trustee's compensation is not binding "if the agreement is unfair to the beneficiary." Restate ment (Second) of Trusts § 242 cmt. i (1957) (Second Re statement). A disclosure-only test would effectively pre vent Section 36(b) from providing the "independent check" on compensation that is needed to vindicate the essential purposes of the statute. Daily Income Fund, 464 U.S. at 541. That test is also inconsistent with con temporaneous evidence that the 1970 Congress expected Section 36(b) to prevent an adviser from overreaching in the amount of its fee even when a fully informed board consented to it.
B. In a Section 36(b) case, the court should not de cide for itself (in the manner of a rate-setting agency) what compensation the adviser should receive, but should determine whether the adviser's fee is within the range of fees that arm's-length bargaining might have produced. That standard for determining the appropri ateness of a fee, articulated by the Second Circuit in Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923, 928 (1982), cert. denied, 461 U.S. 906 (1983), is consistent with the purposes of the statute, the legisla tive history, and this Court's articulation of the test for a fiduciary breach. See Pepper v. Litton, 308 U.S. 295, 306-307 (1939). In practice, Gartenberg has provided useful guidance for fund boards and has been incorpo rated into SEC regulations. The Gartenberg court's inquiry-an analysis of "all pertinent facts," potentially including the fees charged by the adviser for comparable services rendered to unaffiliated clients-provides the appropriate way to resolve Section 36(b) cases.
The court of appeals relied too extensively on a com parison between the fees at issue here and those paid by other mutual funds. In light of the structural impedi ments to arm's-length bargaining between mutual funds and their investment advisers, an adviser's fee cannot automatically be declared lawful simply because it is comparable to fees paid by similar mutual funds. Al though the court of appeals cited one study finding that advisory fees are constrained by competition among mu tual funds for investors, that conclusion is a matter of ongoing debate. The weight to be given to a comparison with the fees paid by other mutual funds should depend on the evidence introduced in, and surrounding circum stances of, any particular case.
The court of appeals also erred by giving no effect to petitioners' allegations that respondent charges unaffili ated institutional clients half of what it charges mutual- fund clients for comparable services. An evaluation un der Section 36(b) of "all the circumstances" should in clude consideration of any fees the adviser receives for providing comparable services to unaffiliated clients, such as pension funds and other institutional investors. Boards are encouraged to consider such information by industry best practices and SEC regulations, and courts appropriately may consider the same information. In this case, the parties appear to dispute whether the ser vices respondent provides to its unaffiliated clients are comparable to those it provides to its affiliated mutual funds. On remand, the lower courts should determine whether petitioners have presented sufficient evidence to create a genuine issue of material fact and so to sur vive respondent's motion for summary judgment.
TO DETERMINE WHETHER AN INVESTMENT ADVISER HAS BREACHED ITS FIDUCIARY DUTY UNDER SECTION 36(b), A COURT MUST CONSIDER "ALL THE CIRCUM STANCES," INCLUDING FEES RECEIVED FOR PROVIDING COMPARABLE SERVICES TO UNAFFILIATED CLIENTS
The court of appeals committed two fundamental errors in applying Section 36(b) of the ICA to the record in this case. First, the court viewed the investment ad viser's "fiduciary duty" under the statute as limited to the provision of full and accurate information to the mu tual fund's board. Second, the court indicated that, as suming Section 36(b) contemplates an inquiry into the substantive reasonableness of an adviser's fee in ex treme cases, the fees paid by comparable mutual funds provide the only suitable benchmark for evaluating the fee. Because both of those propositions are wrong, the judgment of the court of appeals should be vacated, and the case should be remanded for further proceedings under the appropriate legal standards.
A. A Mutual Fund's Investment Adviser Violates Its "Fidu ciary Duty With Respect To The Receipt Of Compensa tion" If It Negotiates And Receives An Excessive Fee, Even If It Has Fully Disclosed The Relevant Facts To The Fund's Board
The court of appeals held that an investment ad viser's fiduciary duty to a mutual fund is satisfied when ever the adviser has made "full disclosure and play[ed] no tricks" on the board. Pet. App. 8a. The court indi cated that, so long as such disclosure occurs, the board's approval is "conclusive" and Section 36(b) imposes no "cap" on the amount of compensation that the adviser may receive. Id. at 8a, 9a. The court of appeals' dis closure-only approach reflects an unduly limited view of the fiduciary duty created by Section 36(b). The text of Section 36(b) and complementary statutory provisions strongly indicates that a fully informed board's approval of compensation does not guarantee against a fiduciary breach. The statute's trust-law background, purposes, and legislative history reinforce that conclusion.
1. Section 36(b) of the ICA imposes on an invest ment adviser "a fiduciary duty with respect to the re ceipt of compensation for services." 15 U.S.C. 80a-35(b). For purposes of any suit to enforce that duty, Section 36(b)(2) specifies that "approval by the [mutual fund's] board of directors * * * of such compensation or pay ments * * * shall be given such consideration by the court as is deemed appropriate under all the circum stances." 15 U.S.C. 80a-35(b)(2). Thus, when an invest ment adviser is alleged to have breached his fiduciary duty to the mutual fund by negotiating and receiving a particular fee, the court should consider "all the circum stances" in determining whether a fiduciary breach has occurred. The court of appeals' approach contradicts the statute by making "conclusive" (Pet. App. 9a) the presence of a single "circumstance"-i.e., that the board was apprised of all relevant information before it ap proved the adviser's fee. The text of Section 36(b) makes clear that Congress intended courts to engage in a fuller inquiry.
Moreover, other provisions of the Act and its com panion statute oblige investment advisers to make dis closures and prohibit them from engaging in fraud. See 15 U.S.C. 80a-15(c), 80b-6. Under the court of appeals' disclosure-only approach, Section 36(b) requires no more of the investment adviser than compliance with those other provisions. To be sure, Section 36(b) estab lished new enforcement mechanisms, and so would not be wholly superfluous if the fiduciary duty it established merely tracked other statutory requirements. But if Congress had intended only to provide a new cause of action and additional remedies to enforce obligations established by other parts of the statutory scheme, it could have accomplished that purpose much more clear ly and directly by authorizing damages suits for viola tions of the disclosure and anti-fraud provisions.
The language that Congress instead employed- which imposes on an investment adviser "a fiduciary duty with respect to the receipt of compensation for ser vices" provided to a mutual fund, and instructs a court to consider "all the circumstances" in determining whe ther a breach has occurred-strongly indicates that Sec tion 36(b) expands the substantive obligations imposed on investment advisers. That inference is buttressed by Section 36(b)(1), which states that, in a suit alleging that an investment adviser has breached its fiduciary duty, "[i]t shall not be necessary to allege or prove that any defendant engaged in personal misconduct." 15 U.S.C. 80a-35(b)(1). Failure to disclose all relevant facts to the board could reasonably be regarded as "personal mis conduct," particularly when other parts of the statutory scheme require investment advisers to make such disclo sures. Section 36(b)(1) thus also suggests that the ad viser's fiduciary duty extends further than disclosure.
2. The court of appeals observed that the statute's use of the word "fiduciary" invokes the "law of trusts." Pet. App. 8a. The court of appeals understood general trust-law principles to provide that "[a] trustee owes an obligation of candor in negotiation, and honesty in per formance, but may negotiate in his own interest and ac cept what [compensation] the settlor * * * agrees to pay." Pet. App. 8a (citing Second Restatement § 242 & cmt. f (1957)). The court was correct that Section 36(b) should be construed to incorporate generally applicable trust-law principles. See, e.g., Varity Corp. v. Howe, 516 U.S. 489, 502 (1996) (looking to "the common law, which, over the years, has given to terms such as 'fiduciary' * * * a legal meaning to which, we normally presume, Congress meant to refer"); NLRB v. Amax Coal Co., 453 U.S. 322, 329 (1981) (explaining that the presumption that Congress intends "to incorporate the established meaning" of terms of art applies to "terms that have ac cumulated settled meaning under either equity or the common law"). The court, however, misunderstood the trust-law rules that apply to a fiduciary's periodic nego tiation of his own compensation.
The annual fee negotiation between a mutual fund and its investment adviser is properly analogized not to the arm's-length negotiation between the settlor and a potential fiduciary at the outset of the relationship, but rather to agreements that the trustee reaches with the trust's beneficiaries after the trust has been established. In that context, a trustee's compensation may "be en larged or diminished by an agreement between the trustee and the beneficiary," but the agreement will not be binding "if 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." Second Restatement § 242 cmt. i (emphasis added); see also id. § 216(3) & cmt. n. As one prominent commentator explained the underlying prin ciple, the beneficiary's consent does not guarantee the validity of a transaction in which the trustee deals with trust property on his own behalf, because "the transac tion is not like one between persons dealing with each other at arm's length." 2 Austin Wakeman Scott, The Law of Trusts § 170, at 1298 (3d ed. 1967). As a result, such a transaction is "voidable if, but only if, the trustee failed to disclose to the beneficiaries the material facts which he knew or should have known, or if he used the influence of his position to induce the consent, or if the transaction was not in all respects fair and reasonable." Ibid. (emphasis added). In other words, proof of full disclosure will not prevent a court from making a fur ther inquiry into the substantive terms of the transac tion.
Although the Second Restatement reflects the state of trust law at the time Congress enacted Section 36(b), the same principle obtains today. "An agreement en larging the trustee's compensation" will not "bind a con senting beneficiary if the trustee failed to disclose all the relevant circumstances that the trustee knew or should have known, or if the agreement is unfair to the benefi ciary." Restatement (Third) of Trusts § 38 cmt. f (2003). Indeed, the current rule is that even when the amount of compensation is established by the terms of a trust-the example invoked by the court of appeals-a court can alter that amount upon finding it to be unreasonably high or low. See id. § 38 cmt. e ("If the amount of com pensation provided by the terms of the trust is or be comes unreasonably high or unreasonably low, the court may allow a smaller or larger compensation[.]"); id. § 38 cmt. e illus. 2 ("The court's authority to modify or disre gard a compensation provision is not limited to situa tions involving unanticipated developments[.]"); Na tional Conference of Commissioners, Uniform Trust Code § 708(b)(2) (2005) (providing that a trustee is enti tled to be compensated as specified by the terms of the trust unless "the compensation specified by the terms of the trust would be unreasonably low or high").
In certain respects, Congress departed from gener ally applicable trust-law principles in crafting the new cause of action established by Section 36(b). Although a trustee normally bears the burden of establishing the fairness of a transaction that is alleged to violate the duty of loyalty,3 Section 36(b)(1) provides that "the plaintiff shall have the burden of proving a breach of fiduciary duty." 15 U.S.C. 80a-35(b)(1). Congress also imposed limits on recovery, capping "actual damages" at the amount of compensation the investment adviser re ceived, and providing that "[n]o award of damages shall be recoverable for any period prior to one year before the action was instituted." 15 U.S.C. 80a-35(b)(3).4 Sec tion 36(b) does not, however, contain any language that would preclude the usual inquiry into whether a trus tee's compensation agreement is "unfair to the benefi ciary." Second Restatement § 242 cmt. i. Thus, con trary to the court of appeals' conclusion (Pet. App. 8a- 9a), the law of trusts strongly supports the proposition that courts may consider whether an investment ad viser's annual fee is excessive, above and beyond deter mining that the adviser made full disclosure to the board.
3. The court of appeals' disclosure-only approach is also inconsistent with the purposes and legislative his tory of Section 36(b). As this Court has previously ex plained, Congress intended the new fiduciary duty im posed by Section 36(b) to be a "check on excessive fees" that was "independent" of "directorial approval of adviser contracts." Daily Income Fund, 464 U.S. at 541. That new, independent check would have added very little if it required only "full disclosure" and the absence of "tricks" on the board (Pet. App. 8a), since other provi sions of the ICA and its companion statute require dis closure and prohibit investment advisers from engaging in fraudulent conduct. See pp. 14-15, supra.
The legislative history also reveals a contemporane ous understanding-shared by the SEC and the entity representing investment companies and their advisers -that the fiduciary duty imposed by Section 36(b) would extend beyond an obligation to provide full and accurate information to the board. During the House Committee hearings about the bill that became the 1970 ICA amendments, Subcommittee Chairman Moss re quested that both the SEC and the private-sector In vestment Company Institute (ICI) (whose members held approximately 97.8% of the assets held by all open-end investment companies) provide written submissions about the "legal meaning" of the relevant statutory lan guage. See Mutual Fund Amendments: Hearings on H.R. 11995, S. 2224, H.R. 13754, and H.R. 14737 Before the Subcomm. on Commerce and Fin. of the House Comm. on Interstate and Foreign Commerce, 91st Cong., 1st Sess., Pt. 1, at 186, 187, 440 (1969). The mem orandum submitted by the SEC concluded that a breach of Section 36(b)'s fiduciary duty "would occur when com pensation to the adviser for his services is excessive in view of the services rendered-where the fund pays what is an unfair fee under the circumstances." Id. at 190. The memorandum submitted by Robert L. Augen blick, the President and General Counsel of the ICI, was to the same effect:
Many words have been used in attempting to de scribe how far a fiduciary may go in negotiating his fee without violating his fiduciary relationship. A good way to put it is that he may not overreach in the amount of his fee even though the other party to the transaction, in full possession of all the facts, does not believe the fee is excessive.
Id. at 441 (emphasis added). That contemporaneous understanding, held by both the regulator and the regu latees, is directly contrary to the court of appeals' view (Pet. App. 8a-9a) that the board's approval of an ad viser's fee is "conclusive" so long as "full disclosure" has occurred.
B. An Investment Adviser's Compensation Should Be Within The Range Of Fees That Might Have Been Nego tiated Through Arm's-Length Bargaining, And A Com parison With The Fees The Adviser Charges Unaffiliated Clients For Comparable Services Is Relevant To The Section 36(b) Inquiry
For the foregoing reasons, an investment adviser's fiduciary duty under Section 36(b) extends beyond the obligation to disclose all relevant facts to the board, and includes the duty to refrain from charging an excessive fee. Although the court in a Section 36(b) case is not authorized to decide for itself (in the manner of a rate- setting administrative agency) what the appropriate fee should be, the court should determine whether the com pensation received by the adviser is within the range of fees that arm's-length bargaining might have produced. In conducting that inquiry, the court should consider not only fees paid by other mutual funds, but also fees that the adviser charges unaffiliated clients, so long as the services provided to the adviser's unaffiliated clients and its mutual-fund clients are shown to be comparable.
1. Section 36(b) prohibits an investment adviser from charging fees so disproportionately large that they could not have been negotiated through arm's-length bargaining
a. Before the court of appeals' decision in this case, the seminal case interpreting Section 36(b) was the Sec ond Circuit's decision in Gartenberg, supra. The court in Gartenberg held that, "[t]o be guilty of a violation of [Section] 36(b), * * * the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services ren dered and could not have been the product of arm's- length bargaining." 694 F.2d at 928; see ibid. ("[T]he test is essentially whether the fee schedule represents a charge within the range of what would have been nego tiated at arm's-length in the light of all the surrounding circumstances."). Consistent with the statute's refer ence to "all the circumstances" and with the statute's legislative history, the court in Gartenberg stressed that "all pertinent facts must be weighed" in making that determination.5 Id. at 929; see S. Rep. No. 184, 91st Cong., 1st Sess. 15 (1969) (Senate Report) ("[I]t is in tended that the court look at all the facts in connection with the determination and receipt of such compensation * * * in order to reach a decision as to whether the adviser has properly acted as a fiduciary in relation to such compensation."); H.R. Rep. No. 1382, 91st Cong., 2d Sess. 37 (1970) (House Report) (same).
The core of Gartenberg's standard can be traced di rectly back to Pepper, supra, in which this Court ob served that "[t]he essence of the test [for a fiduciary breach] is whether or not under all the circumstances the transaction carries the earmarks of an arm's length bargain." 308 U.S. at 306-307; see id. at 306 (noting that the transaction is to be examined for its "inherent fair ness"). Indeed, that line from Pepper was quoted in the district court opinion that the Second Circuit affirmed in Gartenberg. See Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 528 F. Supp. 1038, 1047 (S.D.N.Y. 1981), aff'd, 694 F.2d 923 (2d Cir. 1982), cert. denied, 461 U.S. 906 (1983). And the Court in Pepper drew that standard from "certain cardinal principles of equity jurispru dence." 308 U.S. at 306. It is accordingly part of the "accumulated settled meaning under * * * equity" that Congress "incorporate[d]" into Section 36(b) by using the term fiduciary. Amax Coal Co., 453 U.S. at 329.
The Gartenberg standard also furthers Congress's core purpose in enacting Section 36(b). Congress recog nized that, because of the inherently close relationships between mutual funds and their investment advisers, "the forces of arm's-length bargaining do not work in the mutual fund industry in the same manner as they do in other sectors of the American economy." Senate Re port 5; House Report 7 (same); see Gartenberg, 694 F.2d at 928 (quoting Senate Report). By requiring that the adviser's fee fall within the range that arm's-length bar gaining might have produced, the Gartenberg standard advances Congress's objective of reducing the potential harm to investors of these non-competitive conditions.6 Moreover, some of the specific factors that the Garten berg court identified as relevant (see note 5, supra) were mentioned, along with other possible considerations, in the congressional committee reports or the SEC's 1966 report. See Senate Report 15; House Report 37; 1966 SEC Report 144-145.
b. The SEC's regulations have recognized, and for malized, Gartenberg-like factors. In a 2004 rulemaking, the Commission amended several forms to require a specific discussion in proxy statements and shareholder reports of certain factors relevant to the board's ap proval of advisory fees and other amounts payable to an investment adviser. See Disclosure Regarding Ap proval of Investment Advisory Contracts by Directors of Investment Companies, 69 Fed. Reg. 39,807-39,809 (2004) (amending Schedule 14A and Forms N-1A, N-2, and N-3).7 In listing the factors to be discussed, the re lease accompanying the amendments cited Gartenberg and noted that "[c]ourts have used similar factors in determining whether investment advisers have met their fiduciary obligations under section 36(b)." Id. at 39,801 n.31. The SEC's regulations require, inter alia, a discussion of any "comparison of the services to be rendered and the amounts to be paid under the contract with those under other investment advisory contracts, such as contracts of the same and other investment ad visers with other registered investment companies or other types of clients (e.g., pension funds and other insti tutional investors)." 17 C.F.R. 240.14a-101, Sched. 14A, Item 22, para. (c)(11)(i); 69 Fed. Reg. at 39,807-39,809.
The Gartenberg standard-along with its non-exclu sive list of potentially relevant factors-has provided useful guidance to fund boards fulfilling their obligation under Section 15(c) of the ICA of evaluating advisers' compensation. See, e.g., Federal Regulation of Securi ties Committee, ABA, Fund Director's Guidebook 31-35 (3d ed. 2006); Mutual Fund Directors Forum, Best Prac tices and Practical Guidance for Mutual Fund Direc tors 44-47 (July 2004) (Best Practices) <http://www. mfdf.com/site/documents/best_pra.pdf>. It also pro vides guidance for advisers in proposing fees. More over, the extent to which the adviser and the board ex change and reflect upon information of this kind helps a court to evaluate how much "consideration" to give a board's approval of an adviser's fee proposal. 15 U.S.C. 80a-35(b)(2). Although a board's approval is not "con trolling" (Senate Report 15), the board's receipt of nec essary information and its careful consideration of the Gartenberg factors prior to approving compensation can be strong probative evidence that the adviser has com plied with its fiduciary obligation.
c. The Gartenberg approach provides the appropri ate framework for resolving claims that an adviser has breached its fiduciary duty with respect to compensa tion. That approach is faithful to the statutory language and purposes, and it is consistent with the traditional trust-law standard for evaluating the conduct of fiducia ries dealing on their own account with entities to which they owe a duty.
Although this Court need not address the potential relevance of each "circumstance" that should be evalu ated under Section 36(b)(2), two factors warrant further discussion in light of the court of appeals' rationale for rejecting petitioners' claims. As discussed below, in de termining whether respondent's fees were consistent with those that could have been the product of arm's- length bargaining, the court of appeals gave too much weight to one factor (the fees paid by other mutual funds to their investment advisers) and too little to another (the fees paid to respondent by unaffiliated institutional clients for portfolio management).
2. In light of the structural impediments to arm's- length bargaining between mutual funds and their investment advisers, an adviser's fee cannot be de clared lawful simply because it is comparable to fees paid by similar mutual funds
To the extent the court of appeals looked beyond the board's purportedly "conclusive" approval of respon dent's fees, it treated the comparison between respon dent's fees and other mutual funds' fees as effectively dispositive. Pet. App. 9a-13a. This comparison is surely relevant to the Section 36(b) analysis. Indeed, such an analysis was identified as one potential consideration (among others) in the SEC's 1966 Report. See 1966 SEC Report 144 (listing among "all relevant factors" the "fees paid for comparable services by other financial institu tions with pools of investment capital of like size and purpose such as * * * other investment companies"). But the SEC and courts have long understood that com parisons of compensation among mutual funds should be treated with some caution. As the Gartenberg court ex plained, "the existence in most cases of an unseverable relationship between the adviser-manager and the fund it services tends to weaken the weight to be given to rates charged by advisers of other similar funds." 694 F.2d at 929 (citing 1966 SEC Report 148). "Competition between money market funds for shareholder business does not support an inference that competition must therefore also exist between adviser-managers for fund business." Ibid.
The question of whether competition among mutual funds for investors keeps advisory fees in check remains the subject of lively debate. The court of appeals cited "[a] recent, careful study" to support its conclusion that investors subject advisory fees to "competitive pres sure" by shopping among thousands of mutual funds. Pet. App. 12a (citing John C. Coates IV & R. Glenn Hub bard, Competition in the Mutual Fund Industry: Evi dence and Implications for Policy, 33 J. Corp. L. 151 (2007)). Other studies, however, have reached the oppo site conclusion. See id. at 40a-41a (Posner, J., dissent ing from denial of reh'g en banc) (citing John P. Free man & Stewart L. Brown, Mutual Fund Advisory Fees: The Cost of Conflicts of Interest, 26 J. Corp. L. 609 (2001)); see also, e.g., John P. Freeman, Stewart L. Brown, and Steve Pomerantz, Mutual Fund Advisory Fees: New Evidence and a Fair Fiduciary Duty Test, 61 Okla. L. Rev. 83, 106-122 (2008) (responding to the Coates and Hubbard study). After surveying the aca demic literature about mutual fund expenses, the De partment of Labor recently concluded "that the avail able research provides an insufficient basis to confi dently determine whether or to what degree [ERISA plan] participants pay inefficiently high investment pric es," but still concluded that "there is a strong possibility that at least some participants, especially IRA beneficia ries, pay inefficiently high investment prices."8 Invest ment Advice-Participants and Beneficiaries, 74 Fed. Reg. 3842 (2009); see also id. at 3840-3842 & nn. 24-31 (citing various articles and briefly describing their dif fering conclusions). Although not reaching a conclusion on the question, the SEC has similarly recognized that the level of fees charged by investment advisers to mutual-fund clients has become a subject of significant debate. 69 Fed. Reg. at 39,799.9
Given that ongoing debate, the weight to be given to a comparison with the fees paid by other mutual funds should depend on the circumstances and evidence in each individual case. One factor to consider is the na ture and amount of other probative evidence in the case (such as evidence concerning the fees the investment adviser received from unaffiliated clients for comparable services, see pp. 29-32, infra). In addition, case-specific evidence may indicate that competition is a more effec tive check on excessive advisory fees for the specific fund at issue (e.g., because comparable funds are avail able and investors face minimal barriers in shifting their assets to those funds). The probative value of evidence concerning the fees paid by other mutual funds will also depend in part on how similar those funds are to the fund at issue in the lawsuit, and whether the services provided by their investment advisers are comparable. A court focusing on the concrete circumstances of an actual case could more confidently assess the extent to which competition for investor dollars provided ade quate incentives for a particular adviser to reduce his fees, and thus counteracted the structural hindrances to arm's-length bargaining between the adviser and the mutual fund.
That less sweeping approach would be more faithful to Congress's purposes in enacting and retaining Section 36(b). The court of appeals remarked that "[a] lot has happened" in the mutual-fund market since Section 36(b) was enacted in 1970. Pet. App. 11a. But one thing that has not happened is any change in Section 36(b)'s statement of fiduciary duty. Congress's imposition of that duty was largely predicated on the assumption that disclosure and the pressures of the marketplace were not fully adequate to protect investors from "the poten tial for abuse inherent in the structure of investment companies." Daily Income Fund, 464 U.S. at 536 (quot ing Burks v. Lasker, 441 U.S. 471, 480 (1979)). If ap plied globally, the court of appeals' finding that mutual funds' costs are effectively constrained by competition threatens to "eviscerate [Section] 36(b)." Gallus v. Ameriprise Fin., Inc., 561 F.3d 816, 823 (8th Cir. 2009); see Pet. App. 41a (Posner, J., dissenting from denial of reh'g) ("The governance structure that enables mutual fund advisers to charge exorbitant fees is industry-wide, so the panel's comparability approach would if widely followed allow those fees to become the industry's floor.").
3. An evaluation under Section 36(b) of "all the circum stances" should include consideration of any fees the adviser receives for providing comparable services to unaffiliated clients
Just as a comparison with the fees paid by other mu tual funds may be a relevant circumstance in evaluating an adviser's compensation under Section 36(b), so too may be a comparison with the fees that an adviser re ceives from clients with which it is not affiliated. Be cause negotiations for such fees typically occur between independent parties, each of which is subject to competi tive pressures, they may provide better evidence of the prices that arm's-length bargaining would produce for the relevant services. For these reasons, such compari sons have played a major role in the debate about whe ther mutual fund fees are excessive. See Daily Income Fund, 464 U.S. at 537 (describing the Wharton Report's finding "that investment advisers often charged mutual funds higher fees than those charged the advisers' other clients"). The 1966 SEC report-which initiated the legislative proposals that culminated in the enactment of Section 36(b)-expressly contemplated that the bench marks for evaluating the reasonableness of investment advisers' fees could include "the costs of investment management services provided to pension and profit- sharing plans and other large nonfund clients." 1966 SEC Report 145.
Current industry practice itself recognizes the poten tial relevance of this factor. The Mutual Fund Directors Forum recommended in 2004 that fund directors request and evaluate "meaningful information on the adviser's fee structures for any other comparable investment ve hicles, both public and private, and an explanation of any differences from fees charged to the fund." Best Prac tices 45. And for the last several years, the SEC's regu lations and forms have required boards to disclose in proxy statements and periodic reports to shareholders the consideration they give to the fees that their advis ers charge to other clients. See 69 Fed. Reg. at 39,807- 39,809. It would make little sense to preclude courts from considering for purposes of Section 36(b) the same kind of data that boards often consider for purposes of Section 15(c).
Of course, the fees an investment adviser charges unaffiliated clients will be relevant to the Section 36(b) analysis only to the extent that the adviser performs sufficiently comparable services in the two contexts. Here, petitioners claim to have presented evidence that respondent charged its unaffiliated institutional clients approximately half of what it charged the Oakmark funds for comparable advisory services. Pet. Br. 9-10, 48-49; Pet. App. 6a-7a, 30a, 39a. The district court as sumed arguendo that the services were in fact compara ble, but discounted this evidence, treating as dispositive the similarity between respondents' fees from Oakmark and advisory fees paid by other mutual funds. See id. at 30a.10 The court of appeals similarly slighted the com parison to unaffiliated clients, stating that "[d]ifferent clients call for different commitments of time," and sug gesting that the provision of advisory services to mutual funds may be more difficult or time-consuming than the rendering of advice to unaffiliated clients. Id. at 13a. But that analysis is flawed on two different levels. First, the court offered no "evidentiary or empirical basis," id. at 39a (Posner, J., dissenting from denial of rehearing en banc), even for the generalization that advisory services to mutual funds are more difficult or costly to perform than advisory services to unaffiliated clients. Second, the appropriateness of the benchmark that petitioners advocate does not depend on whether investment advis ers typically provide comparable services to their mutual-fund and unaffiliated clients. Rather, if petition ers can show that respondent provides comparable ser vices to the two types of clients, a substantial disparity between the fees respondent charges in the two contexts should be given significant weight in the Section 36(b) analysis, whether or not such comparability of services is characteristic of prevailing industry practices.
On remand, the lower courts therefore should con sider whether petitioners-who bear the burden of proof, 15 U.S.C. 80a-35(b)(1)-have presented sufficient evidence about the comparability of services respondent provides to mutual-fund clients and unaffiliated clients to defeat respondent's motion for summary judgment.
The judgment of the court of appeals should be va cated and the case remanded for further consideration under the appropriate standards.
MALCOLM L. STEWART
Deputy Solicitor General
CURTIS E. GANNON
Assistant to the Solicitor
Department of Justice
Washington, D.C. 20530-0001
DAVID M. BECKER
MARK D. CAHN
Deputy General Counsel
JACOB H. STILLMAN
Assistant General Counsel
TRACEY A. HARDIN
Securities and Exchange
1 An "open end" company is required "to redeem its securities on demand at a price approximating their proportionate share of the fund's net asset value at the time of redemption." United States v. National Ass'n of Secs. Dealers, Inc., 422 U.S. 694, 698 (1975).
2 Petitioners also filed a cross-motion for summary judgment. The district court denied that motion (Pet. App. 22a-26a), and the court of appeals affirmed in relevant part (id. at 2a-4a). In this Court, petition ers do not request a ruling that summary judgment should be entered in their favor. Rather, they argue (Pet. Br. 19) that their "evidence warrants a trial on the merits."
3 See Pepper v. Litton, 308 U.S. 295, 306 (1939) (noting the burden on a fiduciary to "show [a challenged transaction's] inherent fairness from the viewpoint of the [beneficiary]"); 2 Scott § 170.1, at 1304 ("[T]he burden of proof is upon the trustee to show that he did not take advan tage of his position[.]").
4 Cf. Second Restatement §§ 205 and 206 (containing no such limits).
5 The Gartenberg court itself considered the following non-exclusive series of factors: (1) the nature and quality of services provided to the fund and shareholders; (2) the profitability of the fund to the adviser; (3) fall-out benefits (including collateral benefits other than advisory fees that accrue to the adviser by virtue of its business with the fund and its shareholders); (4) economies of scale (including whether the ad viser fairly shares with the fund and its shareholders any decreases in marginal operating costs owing to increased size); (5) comparative fee structure (meaning a comparison of the fees with those paid by similar funds); and (6) the independence, expertise, care, and conscientiousness of the board in evaluating the contract. See 694 F.2d at 930-931.
6 This is not to say that Congress intended for the SEC to engage in "rate regulation" or for courts to engage in "[j]udicial price-setting." Pet. App. 8a, 10a. Indeed, the legislative history disclaims such a pur pose. See Senate Report 6. Determining what outcomes fall outside the range that could result from an arm's-length negotiation is not the same as independently setting rates or prescribing a particular standard to produce prices, like a cost-plus model.
7 A board is permitted to omit any particular factor it concludes is irrelevant to its evaluation of the investment advisory contract, as long as it explains why. 69 Fed. Reg. at 39,801 & n.32.
8 Mutual-fund advisers' fees have been the subject of litigation under the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. 1001 et seq. Plaintiffs in such cases have alleged that plan fidu ciaries breached their fiduciary duties under ERISA, see 29 U.S.C. 1104(a)(1), by allowing plans (or plan participants in individual-account plans) to pay excessive fees by purchasing certain mutual funds at retail rates. See, e.g., Young v. General Motors Inv. Mgmt. Corp., No. 08-1532-CV, 2009 WL 1230350, at *1 (2d Cir. May 6, 2009). Because Section 36(b) and ERISA have different statutory language, histories, and purposes, the resolution of this case should not establish the legal standard that should apply to excessive-fee claims against plan fidu ciaries under ERISA.
9 In its brief opposing certiorari (at 28), respondent quoted a docu ment prepared by the SEC's staff as stating that "empirical evidence suggest[s] that there is significant competition based on costs in the fund industry." Memorandum from Paul F. Roye, Div. of Inv. Mgmt., to William H. Donaldson, Chairman 6 (June 11, 2003) <http://financial services.house.gov/media/pdf/061803kanememo.pdf>. That staff-auth ored paper made clear that "the views expressed in this memorandum may not necessarily reflect [the] views" of the Chairman or other Com missioners. Id. at 1. In addition, the staff's treatment was far from conclusive, noting that "it is difficult to measure the extent to which cost-based competition exists in the mutual fund industry," id. at 3, and that "the degree to which investors understand mutual fund fees and expenses remains a significant source of concern," id. at 12.
10 Both the comparison to the fees that respondent charged its unaf filiated institutional clients and the comparison to fees paid by other mutual funds reflect attempts to identify the range of compensation that could have resulted from an arm's-length negotiation. Those com peting benchmarks are potentially subject to different infirmities. Compensation paid by other mutual funds provides an imperfect meas ure of what arm's-length bargaining would have produced because other mutual funds are also related to their investment advisers in ways that may suppress such bargaining. The comparison to fees paid by unaffiliated institutional clients eliminates that concern, but raises the question whether the services provided to different kinds of entities were in fact comparable.