In the Supreme Court of the United States

No. 08-586

In the Supreme Court of the United States

JERRY N. JONES, ET AL., PETITIONERS

v.

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

DAVID M. BECKER

General Counsel

MARK D. CAHN

Deputy General Counsel

JACOB H. STILLMAN

Solicitor

MARK PENNINGTON

Assistant General Counsel

TRACEY A. HARDIN

Senior Counsel

Securities and Exchange

Commission

Washington, D.C. 20549

ELENA KAGAN

Solicitor General

Counsel of Record

MALCOLM L. STEWART

Deputy Solicitor General

CURTIS E. GANNON

Assistant to the Solicitor

General

Department of Justice

Washington, D.C. 20530-0001

(202) 514-2217

QUESTION PRESENTED

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 Company Act of 1940, 15 U.S.C. 80a-35(b), even if the security holder does not show that the adviser misled the

mutual fund directors who approved the fee.

(I)

TABLE OF CONTENTS

Page

Interest of the United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Summary of argument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Argument:

To determine whether an investment adviser has

breached its fiduciary duty under Section 36(b), a court

must consider “all the circumstances,” including fees

received for providing comparable services to

unaffiliated clients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

A. A mutual fund’s investment adviser violates its

“fiduciary duty with respect to the receipt of

compensation” if it negotiates and receives an

excessive fee, even if it has fully disclosed the

relevant facts to the fund’s board . . . . . . . . . . . . . . . . . 13

B. An investment adviser’s compensation should be

within the range of fees that might have been

negotiated through arm’s-length bargaining, and

a comparison with the fees the adviser charges

unaffiliated clients for comparable services is

relevant to the Section 36(b) inquiry . . . . . . . . . . . . . . 20

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 . . . . . . . . . . . . . . . . . . . . . . 21

2. In light of the structural impediments to arm’slength bargaining between mutual funds and

their investment advisers, an adviser’s fee cannot

be declared lawful simply because it is

comparable to fees paid by similar mutual

funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

(III)

IV

Table of Contents—Continued:

Page

3. An evaluation under Section 36(b) of “all the

circumstances” should include consideration of

any fees the adviser receives for providing

comparable services to unaffiliated clients . . . . . . . 29

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

TABLE OF AUTHORITIES

Cases:

Burks v. Lasker, 441 U.S. 471 (1979) . . . . . . . . . . . . . . . . 2, 29

Daily Income Fund , Inc. v. Fox, 464 U.S. 523

(1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . passim

Gallus v. Ameriprise Fin., Inc., 561 F.3d 816 (8th Cir.

2009) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

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) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

694 F.2d 923 (2d Cir. 1982), cert. denied,

461 U.S. 906 (1983) . . . . . . . . . . . . . . . . . 6, 11, 21, 22, 26

Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90 (1991) . . . 4

NLRB v. Amax Coal Co., 453 U.S. 322 (1981) . . . . . . 16, 22

Pepper v. Litton, 308 U.S. 295 (1939) . . . . . . . . . . . 11, 18, 22

United States v. National Ass’n of Secs. Dealers, Inc.,

422 U.S. 694 (1975) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Varity Corp. v. Howe, 516 U.S. 489 (1996) . . . . . . . . . . . . . 16

Young v. General Motors Inv. Mgmt. Corp., No.

08-1532-CV., 2009 WL 1230350 (2d Cir. May 6,

2009) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

V

Statutes and regulations:

Page

Employee Retirement Income Security Act of 1974,

29 U.S.C. 1001 et seq. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

29 U.S.C. 1104(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Investment Company Act of 1940, ch. 686, 54 Stat. 789 . . . 2

§ 36, 54 Stat. 841 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Investment Company Act of 1940, 15 U.S.C. 80a-1

et seq. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

15 U.S.C. 80a-10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

15 U.S.C. 80a-10(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

15 U.S.C. 80a-15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

15 U.S.C. 80a-15(c) (§ 15(c)) . . . . . . . . . . . . . . . . . . 4, 14

15 U.S.C. 80a-17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

15 U.S.C. 80a-35(b) (§ 36(b)) . . . . . . . . . . . . . . . passim

15 U.S.C. 80a-35(b)(1) (§ 36(b)(1)) . . . . . . . . . 15, 18, 32

15 U.S.C. 80a-35(b)(2) (§ 36(b)(2)) . . . . 5, 10, 14, 24, 25

15 U.S.C. 80a-35(b)(3) (§ 36(b)(3)) . . . . . . . . . . . . . 5, 18

Investment Company Amendments Act of 1970,

Pub. L. No. 91-547, 84 Stat. 1413 . . . . . . . . . . . . . . . . . . . 3

15 U.S.C. 80b-6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

17 C.F.R. 240.14a-101, Sched. 14A, Item 22,

para. (c)(11)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Miscellaneous:

John C. Coates & R. Glenn Hubbard, Competition in

the Mutual Fund Industry: Evidence and

Implications for Policy, 33 J. Corp. L. 151 (2007) . . . . 26

VI

Miscellaneous—Continued:

Page

Disclosure Regarding Approval of Investment

Advisory Contracts by Directors of Investment

Companies, 69 Fed. Reg. (2004):

p. 39,799 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

p. 39,801 n.31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

p. 39,801 n.32 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

pp. 39,807-39,809 . . . . . . . . . . . . . . . . . . . . . . . . 23, 24, 30

Investment Advice—Participants and Beneficiaries,

74 Fed. Reg. (2009):

pp. 3840-3842 & nn. 24-31 . . . . . . . . . . . . . . . . . . . . . . 27

p. 3842 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Federal Regulation of Securities Committee, ABA ,

Fund Director’s Guidebook (3d ed. 2006) . . . . . . . . . . . 24

John P. Freeman & Stewart L. Brown, Mutual Fund

Advisory Fees: The Cost of Conflicts of Interest,

26 J. Corp. L. 609 (2001) . . . . . . . . . . . . . . . . . . . . . . . . . . 26

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 (2008) . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

H.R. Rep. No. 1382, 91st Cong., 2d Sess. (1970) . . . 2, 22, 23

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. (1962) . . . . . . . . . . . . . . . . . . . . . 3, 30

Report of the Securities and Exchange Commission

on the Public Policy Implications of Investment

Company Growth, H.R. Rep. No. 2337, 89th Cong.,

2d Sess. (1966) . . . . . . . . . . . . . . . . . . . . . 3, 4, 23, 25, 26, 30

VII

Miscellaneous—Continued:

Page

Memorandum from Paul F. Roye, Div. of Inv. Mgmt.,

to William H. Donaldson, Chairman, (June 11,

2003) <http://financialservices.house.gov/media/

pdf/061803kanememo.pdf> . . . . . . . . . . . . . . . . . . . . 27, 28

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 (1969) . . . . . . . . . . . . . . . . . . . 19, 20

Mutual Fund Directors Forum, Best Practices and

Practical Guidance for Mutual Fund Directors

(July 2004) <http://www.mfdf.com/site/

documents/best_pra.pdf> . . . . . . . . . . . . . . . . . . . . . 24, 30

National Conference of Commissioners, Uniform

Trust Code (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Restatement (Second) of Trusts (1957) . . . . . . . . . . 11, 16, 18

Restatement (Third) of Trusts (2003) . . . . . . . . . . . . . . 17, 18

S. Rep. No. 184, 91st. Cong., 1st Sess. 15

(1969) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22, 23, 24

2 Austin Wakeman Scott, The Law of Trusts (3d ed.

1967) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17, 18

In the Supreme Court of the United States

No. 08-586

JERRY N. JONES, ET AL., PETITIONERS

v.

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 Justice and the Securities and Exchange Commission (Commission 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 respect to the receipt of compensation for services.” Because an action under Section 36(b) may be brought either 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)

2

STATEMENT

1. For decades, Congress has recognized that investment companies (such as mutual funds) require special 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 mutual 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 external organization known as an investment adviser,” which

“generally supervises the daily operation of the fund and

often selects affiliated persons to serve on the company’s board of directors.” Daily Income Fund, Inc. v.

Fox, 464 U.S. 523, 536 (1984). As a result, “the relationship between investment advisers and mutual funds is

fraught with potential conflicts of interest.” Ibid . (internal 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 enactment 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

3

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 mutualfund industry, and congressional committees—that culminated 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 enormous 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 advisers tended to charge mutual funds “substantially higher” rates than they charged other clients and that mutual funds lacked effective bargaining power in the establishment 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 issued its own study, which concluded that lawsuits challenging excessive advisory fees had been largely ineffective because courts had applied an unduly permissive

standard (relying on ratification by the board and shareholders and asking only whether a waste of corporate

assets had occurred). Report of the Securities and Exchange 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 Report). The SEC concluded that board and shareholder

approval could not protect shareholder interests with

respect to advisory compensation because mutual funds

4

could not, as a practical matter, terminate their relationships 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 contracts.” 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) (internal quotation marks omitted). Accordingly, in amending 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 “independent check[] on excessive fees.” Daily Income

Fund, 464 U.S. at 535, 536, 541.

2. Section 36(b) provides in pertinent part as follows:

For the purposes of this subsection, the investment 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 adviser or any affiliated person of such investment adviser. An action may be brought under this subsection by the Commission, or by a security holder of

such registered investment company * * * for

5

breach of fiduciary duty in respect of such compensation[.]

15 U.S.C. 80a-35(b). In an action under Section 36(b),

the “approval” of “compensation” by the investment company’s board or shareholders “shall be given such consideration by the court as is deemed appropriate under

all the circumstances.” 15 U.S.C. 80a-35(b)(2). The statute 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 received” 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 Massachusetts business trust registered with the SEC under

the ICA as an open-end management investment company.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 accompanying 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 .

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).

6

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 impermissibly 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 respondent 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 Gartenberg, 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 disproportionately 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 unaffiliated] institutional clients received were indistinguishable from those the [Oakmark] Funds received.” Id . at

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, petitioners 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.”

7

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 lowend figure below what the institutional clients were paying” 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 institutional clients, the court concluded they were not excessive. 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] fiduciary 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 compensation.”). 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 respondent had satisfied its fiduciary obligations because it had

8

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 reasonableness review of the fees charged by investment advisers,

the court of appeals found it “possible to imagine compensation 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 concluded, 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. Petitioners 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 acknowledged that “beliefs about the structure of the mutualfund 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 investors “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

9

substantially greater than the fees it charged unaffiliated institutional clients. The court stated that “[d]ifferent 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) concluded that the panel had erred in rejecting the Gartenberg standard based “mainly on an economic analysis

that is ripe for reexamination.” Id . at 37a. The dissenters 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 justifications 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 unaffiliated 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 excessiveness inquiry must be conducted “solely by comparing the adviser’s fee with the fees charged by other

mutual fund advisers.” Id . at 41a. The dissenters explained that “[t]he governance structure that enables

10

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 considering the possible excessiveness of fees may consider a

broader range of evidence, including petitioners’ proposed “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 investment advisers and their affiliated investment companies

could cause mutual funds to agree to excessive compensation. 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 inconsistent 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 circumstances,” 15 U.S.C. 80a-35(b)(2), which demonstrates

11

that a court should engage in a more encompassing inquiry than the court of appeals conducted. By creating

a “fiduciary duty,” Congress incorporated the established 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.” Restatement (Second) of Trusts § 242 cmt. i (1957) (Second Restatement). A disclosure-only test would effectively prevent 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 contemporaneous 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 decide 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 appropriateness 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 legislative 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 incorporated into SEC regulations. The Gartenberg court’s

inquiry—an analysis of “all pertinent facts,” potentially

including the fees charged by the adviser for comparable

12

services rendered to unaffiliated clients—provides the

appropriate way to resolve Section 36(b) cases.

The court of appeals relied too extensively on a comparison between the fees at issue here and those paid by

other mutual funds. In light of the structural impediments 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. Although the court of appeals cited one study finding that

advisory fees are constrained by competition among mutual 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 circumstances of, any particular case.

The court of appeals also erred by giving no effect to

petitioners’ allegations that respondent charges unaffiliated institutional clients half of what it charges mutualfund clients for comparable services. An evaluation under Section 36(b) of “all the circumstances” should include 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 services 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 survive respondent’s motion for summary judgment.

13

ARGUMENT

TO DETERMINE WHETHER AN INVESTMENT ADVISER

HAS BREACHED ITS FIDUCIARY DUTY UNDER SECTION

36(b), A COURT MUST CONSIDER “ALL THE CIRCUMSTANCES,” 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 adviser’s “fiduciary duty” under the statute as limited to

the provision of full and accurate information to the mutual fund’s board. Second, the court indicated that, assuming Section 36(b) contemplates an inquiry into the

substantive reasonableness of an adviser’s fee in extreme 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 “Fiduciary Duty With Respect To The Receipt Of Compensation” 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 adviser’s fiduciary duty to a mutual fund is satisfied whenever the adviser has made “full disclosure and play[ed]

no tricks” on the board. Pet. App. 8a. The court indicated 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-

14

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 investment adviser “a fiduciary duty with respect to the receipt 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 payments * * * shall be given such consideration by the

court as is deemed appropriate under all the circumstances.” 15 U.S.C. 80a-35(b)(2). Thus, when an investment 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 circumstances” 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 approved 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 companion statute oblige investment advisers to make disclosures 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-

15

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 clearly and directly by authorizing damages suits for violations 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 services” provided to a mutual fund, and instructs a court

to consider “all the circumstances” in determining whether a breach has occurred—strongly indicates that Section 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 misconduct,” particularly when other parts of the statutory

scheme require investment advisers to make such disclosures. Section 36(b)(1) thus also suggests that the adviser’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 performance, but may negotiate in his own interest and accept what [compensation] the settlor * * * agrees to

16

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 accumulated settled meaning under either equity or the

common law”). The court, however, misunderstood the

trust-law rules that apply to a fiduciary’s periodic negotiation 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 enlarged 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 principle, 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 transaction is not like one between persons dealing with each

17

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 further inquiry into the substantive terms of the transaction.

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 enlarging the trustee’s compensation” will not “bind a consenting 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 beneficiary.” 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 compensation provided by the terms of the trust is or becomes 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 disregard a compensation provision is not limited to situations involving unanticipated developments[.]”); National Conference of Commissioners, Uniform Trust

Code § 708(b)(2) (2005) (providing that a trustee is entitled to be compensated as specified by the terms of the

18

trust unless “the compensation specified by the terms of

the trust would be unreasonably low or high”).

In certain respects, Congress departed from generally 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 received, 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 Section 36(b) does not, however, contain any language that

would preclude the usual inquiry into whether a trustee’s compensation agreement is “unfair to the beneficiary.” Second Restatement § 242 cmt. i. Thus, contrary to the court of appeals’ conclusion (Pet. App. 8a9a), the law of trusts strongly supports the proposition

that courts may consider whether an investment adviser’s annual fee is excessive, above and beyond determining 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 history of Section 36(b). As this Court has previously ex3

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 advantage of his position[.]”).

4

Cf. Second Restatement §§ 205 and 206 (containing no such limits).

19

plained, Congress intended the new fiduciary duty imposed 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 provisions of the ICA and its companion statute require disclosure and prohibit investment advisers from engaging

in fraudulent conduct. See pp. 14-15, supra.

The legislative history also reveals a contemporaneous 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 requested that both the SEC and the private-sector Investment 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 language. 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 memorandum submitted by the SEC concluded that a breach

of Section 36(b)’s fiduciary duty “would occur when compensation 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-

20

blick, the President and General Counsel of the ICI, was

to the same effect:

Many words have been used in attempting to describe 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 regulatees, is directly contrary to the court of appeals’ view

(Pet. App. 8a-9a) that the board’s approval of an adviser’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 Negotiated Through Arm’s-Length Bargaining, And A Comparison 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 ratesetting administrative agency) what the appropriate fee

should be, the court should determine whether the compensation 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

21

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 Second 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 rendered and could not have been the product of arm’slength 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 negotiated at arm’s-length in the light of all the surrounding

circumstances.”). Consistent with the statute’s reference 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

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 adviser 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

22

Cong., 1st Sess. 15 (1969) (Senate Report) (“[I]t is intended 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 directly back to Pepper, supra, in which this Court observed 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 fairness”). 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 jurisprudence.” 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 recognized 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

funds); and (6) the independence, expertise, care, and conscientiousness

of the board in evaluating the contract. See 694 F.2d at 930-931.

23

in other sectors of the American economy.” Senate Report 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 bargaining 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 Gartenberg 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 formalized, 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 approval of advisory fees and other amounts payable to an

investment adviser. See Disclosure Regarding Approval 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 re6

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 purpose. 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.

24

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 advisers with other registered investment companies or

other types of clients (e.g., pension funds and other institutional 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-exclusive 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 Securities Committee, ABA, Fund Director’s Guidebook 31-35

(3d ed. 2006); Mutual Fund Directors Forum, Best Practices and Practical Guidance for Mutual Fund Directors 44-47 (July 2004) (Best Practices) <http://www.

mfdf.com/site/documents/best_pra.pdf>. It also provides guidance for advisers in proposing fees. Moreover, the extent to which the adviser and the board exchange 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 “controlling” (Senate Report 15), the board’s receipt of necessary information and its careful consideration of the

Gartenberg factors prior to approving compensation can

be strong probative evidence that the adviser has complied with its fiduciary obligation.

25

c. The Gartenberg approach provides the appropriate framework for resolving claims that an adviser has

breached its fiduciary duty with respect to compensation. 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 fiduciaries 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 evaluated 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 determining whether respondent’s fees were consistent

with those that could have been the product of arm’slength 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’slength bargaining between mutual funds and their

investment advisers, an adviser’s fee cannot be declared 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 respondent’s fees, it treated the comparison between respondent’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

26

Report 144 (listing among “all relevant factors” the “fees

paid for comparable services by other financial institutions with pools of investment capital of like size and

purpose such as * * * other investment companies”).

But the SEC and courts have long understood that comparisons of compensation among mutual funds should be

treated with some caution. As the Gartenberg court explained, “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 pressure” by shopping among thousands of mutual funds.

Pet. App. 12a (citing John C. Coates IV & R. Glenn Hubbard, Competition in the Mutual Fund Industry: Evidence and Implications for Policy, 33 J. Corp. L. 151

(2007)). Other studies, however, have reached the opposite conclusion. See id . at 40a-41a (Posner, J., dissenting from denial of reh’g en banc) (citing John P. Freeman & 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

27

Coates and Hubbard study). After surveying the academic literature about mutual fund expenses, the Department of Labor recently concluded “that the available research provides an insufficient basis to confidently determine whether or to what degree [ERISA

plan] participants pay inefficiently high investment prices,” but still concluded that “there is a strong possibility

that at least some participants, especially IRA beneficiaries, pay inefficiently high investment prices.”8 Investment 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 differing 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

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 fiduciaries 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 fiduciaries under ERISA.

9

In its brief opposing certiorari (at 28), respondent quoted a document 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-authored paper made clear that “the views expressed in this memorandum

28

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 nature 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 effective check on excessive advisory fees for the specific

fund at issue (e.g., because comparable funds are available 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 adequate 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

may not necessarily reflect [the] views” of the Chairman or other Commissioners. 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.

29

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 potential for abuse inherent in the structure of investment

companies.” Daily Income Fund, 464 U.S. at 536 (quoting Burks v. Lasker, 441 U.S. 471, 480 (1979)). If applied 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 circumstances” 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 mutual 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 receives from clients with which it is not affiliated. Because negotiations for such fees typically occur between

independent parties, each of which is subject to competitive 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-

30

sons have played a major role in the debate about whether 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 benchmarks for evaluating the reasonableness of investment

advisers’ fees could include “the costs of investment

management services provided to pension and profitsharing plans and other large nonfund clients.” 1966

SEC Report 145.

Current industry practice itself recognizes the potential 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 vehicles, both public and private, and an explanation of any

differences from fees charged to the fund.” Best Practices 45. And for the last several years, the SEC’s regulations and forms have required boards to disclose in

proxy statements and periodic reports to shareholders

the consideration they give to the fees that their advisers charge to other clients. See 69 Fed. Reg. at 39,80739,809. 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

31

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 assumed arguendo that the services were in fact comparable, 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 comparison to unaffiliated clients, stating that “[d]ifferent

clients call for different commitments of time,” and suggesting 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 advisers typically provide comparable services to their

10

Both the comparison to the fees that respondent charged its unaffiliated 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 competing benchmarks are potentially subject to different infirmities.

Compensation paid by other mutual funds provides an imperfect measure 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.

32

mutual-fund and unaffiliated clients. Rather, if petitioners can show that respondent provides comparable services 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 consider 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.

CONCLUSION

The judgment of the court of appeals should be vacated and the case remanded for further consideration

under the appropriate standards.

Respectfully submitted.

DAVID M. BECKER

General Counsel

MARK D. CAHN

Deputy General Counsel

JACOB H. STILLMAN

Solicitor

MARK PENNINGTON

Assistant General Counsel

TRACEY A. HARDIN

Senior Counsel

Securities and Exchange

Commission

JUNE 2009

ELENA KAGAN

Solicitor General

MALCOLM L. STEWART

Deputy Solicitor General

CURTIS E. GANNON

Assistant to the Solicitor

General