It’s a neat racket when you’re a lawyer who can file class-action suits against a corporation, supposedly on behalf of the company’s shareholders, who will end up paying themselves the judgment if they win. The whole exercise is nonsensical.
If a lawyer successfully sues a company, its value declines, meaning that the worth of its stock declines as well. So stockholders may lose money if they win the case because a chunk of the award goes to the lawyers, while their stock value drops based on the total payout. It’s like the right hand robbing the body to pay the left hand but giving part of the loot to a third party in the process.
That illogical scenario - involving mutual funds rather than individual corporations - is just a small part of the problem in the case of Jones v. Harris Associates, on which the Supreme Court hears oral arguments Monday. The case is tremendously important because it represents the trial bar’s latest attempt to find massive jackpots from the ordinary workings of a free and productive market. And the outcome of the case hits home for most Americans. Ninety-three million individuals from more than 50 million households pay investment advisers to manage their $10 trillion investments in mutual funds, an amount equivalent to nearly 20 percent of U.S. household net worth.
In this case, the plaintiffs (or their lawyers) claim that the defendants, who manage the mutual funds, charged excessive fees to serve as investment advisers for the mutual funds owned by the plaintiffs. They note that Harris Associates LP charged a rate of 0.88 percent to manage the Oakmark Funds, compared to a 0.45 percent rate to manage independent accounts such as pension funds. This difference, they say, is a breach of fiduciary duty so great that courts should step in to micromanage the fee structure of mutual funds.
That’s hard to believe. Investment advisers these days make only about 40 percent (in terms of percentage of a fund’s value) of what they made a quarter-century ago. Oakmark claims to charge 0.17 percent less than the median of its competitors while providing the best returns among 200 similar funds. There also are good reasons to charge lower fees to institutional investors such as pension funds. The pension funds do all the administrative services for their members, so the investment advisers are required to do far less work.
The bigger issue, though, exists irrespective of whether some supposedly objective third party decides Harris’ fees are reasonable: Should judges substitute their own economic analyses for those of a vibrant and increasingly transparent mutual-funds market? Opening mutual-fund advisers to such unfettered litigation could easily drive many of them out of the business, leaving individual investors with fewer choices, less economic leverage and exactly the higher fees the lawyers claim to be fighting.
There may be good reasons for judges to examine whether investment advisers have conflicts of interest or are somehow misleading investors or committing other ethical breaches. However, there is no reason to assume judges possess an economic omniscience enabling their choices to improve upon the market. Short of serious malfeasance, current law lets judges step in only when a fee is “so disproportionately large that it bears no reasonable relationship to the services rendered.” Tens of millions of small investors are well-served by that standard, and there is no good reason to modify it.
By John Solomon
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