Seventh circuit "disapproves" Gartenberg, but is this new approach fundamentally different?

Abstract

Purpose--The purpose of this paper is to analyze the implications of the May 19, 2008 decision by the US Court of Appeals for the Seventh Circuit in Jones v Harris Associates.

Design/methodology/approach--The paper reviews the 1982 decision of the US Court of Appeals for the Second Circuit in Gartenberg v. Merrill Lynch Asset Management, summarizing the Harris Associates opinion of the Seventh Circuit Court of Appeals, the paper also discusses the criticisms by the Seventh Circuit Court of Appeals of the earlier Gartenberg decision, and makes observations on why other courts may not be persuaded by the Harris Associates decision, and provides guidance to mutual funds and their directors and advisers in light of the Harris Associates opinion.

Findings--The findings in the paper are that the Harris Associates opinion suggests that a court need only determine whether the adviser to a mutual fund negotiated its advisory fee in a manner consistent with its fiduciary duty to that fund. However, the paper also finds that it would be premature for directors and advisers to conclude that they should abandon or substantially lessen the processes they have implemented to satisfy the Gartenberg standard, including requesting and evaluating such information as may reasonably be necessary to evaluate the terms of an advisory contract and reviewing an adviser's performance and compensation carefully. In addition, their opinion does not relieve mutual funds of their obligations to discuss--in their shareholder reports and proxy statements--the material factors considered and the conclusions reached in approving advisory contracts.

Originality/value--The paper is a practical guidance by experienced securities lawyers.

Keywords United States of America, Courts of appeal, Fund management, Financial control

Paper type Technical paper

**********

On May 19, 2008, the United States Court of Appeals for the Seventh Circuit issued an opinion in the Harris Associates case that purports to "disapprove" the standard under which most federal courts have considered whether the advisory fees paid by mutual funds violate Section 36(b) of the Investment Company Act of 1940 [1].

The Harris Associates opinion suggests that a court need only determine whether the adviser negotiated the advisory fee in a manner consistent with its fiduciary duty to the fund. If, according to the Court of Appeals, …