In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 07-1624
JERRY N. JONES, M ARY F. JONES, and
A RLINE W INERMAN,
Plaintiffs-Appellants,
v.
H ARRIS A SSOCIATES L.P.,
Defendant-Appellee.
____________
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 04 C 8305—Charles P. Kocoras, Judge.
____________
A RGUED S EPTEMBER 10, 2007—D ECIDED M AY 19, 2008
____________
Before E ASTERBROOK , Chief Judge, and K ANNE and
E VANS, Circuit Judges.
E ASTERBROOK, Chief Judge. Harris Associates advises the
Oakmark complex of mutual funds. These open-end
funds (an open-end fund is one that buys back its shares
at current asset value) have grown in recent years be-
cause their net returns have exceeded the market average,
and the investment adviser’s compensation has grown
apace. Plaintiffs, who own shares in several of the
Oakmark funds, contend that the fees are too high and
thus violate §36(b) of the Investment Company Act of
2 No. 07-1624
1940, 15 U.S.C. §80a–35(b), a provision added in 1970. The
district court concluded that Harris Associates had not
violated the Act and granted summary judgment in its
favor. 2007 U.S. Dist. L EXIS 13352 (N.D. Ill. Feb. 27, 2007).
Plaintiffs rely on several sections of the Act in addition
to §36(b), and we can make short work of these. The Act
requires at least 40% of a mutual fund’s trustees to be
disinterested in the adviser, see 15 U.S.C. §80a–10(a), and
obliges the fund to reveal the financial links between
its trustees and the adviser, see 15 U.S.C. §80a–33(b).
Compensation for the adviser is controlled by a majority
of the disinterested trustees. 15 U.S.C. §80a–15(c). Plaintiffs
say that the Oakmark funds have violated all of these
rules. Because none of the funds is a party to this suit, an
order directing the funds to comply is not available as
relief. Plaintiffs say that the court could require Harris to
return the compensation it has received, but such a
penalty would be disproportionate to the wrong. That’s
not the only problem: although §36(b) creates a private
right of action, the other sections we have mentioned
do not. We need not decide whether a private right of
action should be implied, see Alexander v. Sandoval, 532
U.S. 275 (2001), or whether a sensible remedy could be
devised, as there has been no violation of §10(a) or §15(c).
Victor Morgenstern is among the funds’ trustees. Until
the end of 2000, when he retired, Morgenstern was
a partner of Harris Associates and counted among
the funds’ “interested” trustees. Since his retirement,
Morgenstern has been treated as a disinterested trustee and
has voted at the special meetings that deal with the ad-
viser’s compensation. Plaintiffs insist that Morgenstern
does not meet the statutory standards because Harris
Associates bought out his partnership with a stream
No. 07-1624 3
of payments that can be deferred if Harris does not
satisfy performance benchmarks in a given year. This
makes the payments a form of profit sharing, plaintiffs
contend, and because profit-sharing agreements are
treated as “securities” under 15 U.S.C. §80a–2(a)(36),
Morgenstern owns securities in Harris Associates and
is not disinterested. 15 U.S.C. §80a–2(a)(19)(B)(iii). More-
over, plaintiffs continue, the Oakmark funds did not
disclose these facts to the public and so are out of com-
pliance with 15 U.S.C. §80a–33(b).
Harris Associates contends that payments fixed in
amount are not “profit sharing” in the statutory sense
just because the time of payment is uncertain. Let us
assume (again without deciding) that Morgenstern held
a “security” under the Act because he was exposed to the
risk of business reverses at his old firm. Failure to dis-
close Morgenstern’s post-retirement payments from
Harris Associates might support an order directing the
funds to correct their annual reports and other official
disclosure documents but would not justify any relief
against Harris Associates. To get anywhere, even with
a private right of action, plaintiffs would have to show
the sort of violation that knocks out any valid contract
between Harris Associates and the funds. Only a viola-
tion of the 40%-independence rule or the approval-by-a-
majority-of-disinterested-trustees rule could do that. Yet
most of the funds’ trustees are disinterested even if
Morgenstern is treated as interested.
During the time covered by the suit, the funds had
nine or ten trustees, at least seven of whom are independ-
ent even if we count Morgenstern as interested. That’s
comfortably over the statutory requirement that 40% of
trustees be disinterested. And as the disinterested trustees
4 No. 07-1624
unanimously approved the contracts with Harris Associ-
ates, it makes no difference how Morgenstern is classi-
fied. Plaintiffs ask us to suppose that Morgenstern pos-
sessed some Svengali-like sway over the other trustees, so
that his presence in the room was enough to spoil their
decisions. But in 2000 and before, when Morgenstern
had been treated as interested, the disinterested trustees
met in his absence and approved Harris’s compensation.
More: although the disinterested directors initially meet
separately, the whole board ultimately discusses and
votes on the contract. 15 U.S.C. §80a–15(a)(2). Interested
directors are not silenced. So it is impossible to see
how Morgenstern’s role from 2001 through 2004 can be
treated as poisoning the deliberations.
Now for the main event: plaintiffs’ contention that the
adviser’s fees are excessive. They rely on §36(b), which
provides:
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, or of
payments of a material nature, paid by such regis-
tered 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 on behalf of such
company, against such investment adviser . . . .
With respect to any such action the following
provisions shall apply:
(1) It shall not be necessary to allege or
prove that any defendant engaged in per-
No. 07-1624 5
sonal misconduct, and the plaintiff shall
have the burden of proving a breach of
fiduciary duty.
(2) In any such action approval by the
board of directors of such investment
company of such compensation or pay-
ments, or of contracts or other arrange-
ments providing for such compensation or
payments, and ratification or approval of
such compensation or payments, or of
contracts or other arrangements providing
for such compensation or payments, by
the shareholders of such investment com-
pany, shall be given such consideration by
the court as is deemed appropriate under
all the circumstances. . . .
The district court followed Gartenberg v. Merrill Lynch Asset
Management, Inc., 694 F.2d 923 (2d Cir. 1982), and con-
cluded that Harris Associates must prevail because its
fees are ordinary. Gartenberg articulated two variations on
a theme:
[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 of the surrounding circumstances.
694 F.2d at 928. And
[t]o be guilty of a violation of §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’s-length bar-
gaining.
6 No. 07-1624
Ibid. Oakmark Fund paid Harris Associates 1% (per year)
of the first $2 billion of the fund’s assets, 0.9% of the next
$1 billion, 0.8% of the next $2 billion, and 0.75% of any-
thing over $5 billion. The district court’s opinion sets out
the fees for the other funds; they are similar. It is undis-
puted that these fees are roughly the same (in both level
and breakpoints) as those that other funds of similar
size and investment goals pay their advisers, and that
the fee structure is lawful under the Investment Advisers
Act. See 15 U.S.C. §80b–5. The Oakmark funds have
grown more than the norm for comparable pools, which
implies that Harris Associates has delivered value for
money.
Plaintiffs contend that we should not follow Gartenberg,
for two principal reasons: first, that the second circuit
relies too much on market prices as the benchmark of
reasonable fees, which plaintiffs insist is inappropriate
because fees are set incestuously rather than by competi-
tion; second, that if any market should be used as the
benchmark, it is the market for advisory services to unaffil-
iated institutional clients. The first argument stems from
the fact that investment advisers create mutual funds,
which they dominate notwithstanding the statutory
requirement that 40% of trustees be disinterested. Few
mutual funds ever change advisers, and plaintiffs con-
clude from this that the market for advisers is not competi-
tive. The second argument rests on the fact that Harris
Associates, like many other investment advisers, has
institutional clients (such as pension funds) that pay
less. For a client with investment goals similar to
Oakmark Fund, Harris Associates charges 0.75% of the
first $15 million under management and 0.35% of the
amount over $500 million, with intermediate break-
No. 07-1624 7
points. Plaintiffs maintain that a fiduciary may charge its
controlled clients no more than its independent clients.
Like the plaintiffs, the second circuit in Gartenberg
expressed some skepticism of competition’s power to
constrain investment advisers’ fees.
Competition between [mutual] funds for share-
holder business does not support an inference that
competition must therefore also exist between
adviser-managers for fund business. The former
may be vigorous even though the latter is virtually
non-existent. Each is governed by different forces.
694 F.2d at 929. The second circuit did not explain why this
is so, however. It was content to rely on the observation
that mutual funds rarely advertise the level of their man-
agement fees, as distinct from the funds’ total expenses
as a percentage of assets (a widely publicized benchmark).
Holding costs down is vital in competition, when inves-
tors are seeking maximum return net of expenses—and as
management fees are a substantial component of adminis-
trative costs, mutual funds have a powerful reason to
keep them low unless higher fees are associated with
higher return on investment. A difference of 0.1% per
annum in total administrative expenses adds up by
compounding over time and is enough to induce many
investors to change mutual funds. That mutual funds
are “captives” of investment advisers does not curtail
this competition. An adviser can’t make money from
its captive fund if high fees drive investors away.
So just as plaintiffs are skeptical of Gartenberg because
it relies too heavily on markets, we are skeptical about
Gartenberg because it relies too little on markets. And this
is not the first time we have suggested that Gartenberg
8 No. 07-1624
is wanting. See Green v. Nuveen Advisory Corp., 295 F.3d
738, 743 n.8 (7th Cir. 2002). Two courts of appeals (in
addition to the second circuit) have addressed claims
against the advisers of open-end mutual funds. One circuit
has followed Gartenberg. See Midgal v. Rowe Price–Fleming
International, Inc., 248 F.3d 321 (4th Cir. 2001). The other
has concluded that adherence to the statutory proce-
dures, rather than the level of price, is the right way to
understand the “fiduciary” obligation created by §36(b).
See Green v. Fund Asset Management, L.P., 286 F.3d 682
(3d Cir. 2002). Our own Green opinion, though it dealt
with the obligations of advisers to closed-end funds,
indicated sympathy for the third circuit’s position.
Having had another chance to study this question, we
now disapprove the Gartenberg approach. A fiduciary
duty differs from rate regulation. A fiduciary must
make full disclosure and play no tricks but is not subject
to a cap on compensation. The trustees (and in the end
investors, who vote with their feet and dollars), rather
than a judge or jury, determine how much advisory
services are worth.
Section 36(b) does not say that fees must be “reasonable”
in relation to a judicially created standard. It says
instead that the adviser has a fiduciary duty. That is a
familiar word; to use it is to summon up the law of trusts.
Cf. Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989).
And 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. Restatement (Second) of Trusts §242 & com-
ment f. When the trust instrument is silent about com-
pensation, the trustee may petition a court for an
No. 07-1624 9
award, and then the court will ask what is “reasonable”;
but when the settlor or the persons charged with the
trust’s administration make a decision, it is conclusive.
John H. Langbein, The Contractarian Basis of the Law of
Trusts, 105 Yale L. J. 625 (1995). It is possible to imagine
compensation so unusual that a court will infer that
deceit must have occurred, or that the persons respon-
sible for decision have abdicated—for example, if a uni-
versity’s board of trustees decides to pay the president
$50 million a year, when no other president of a com-
parable institution receives more than $2 million—but
no court would inquire whether a salary normal among
similar institutions is excessive.
Things work the same way for business corporations,
which though not trusts are managed by persons who
owe fiduciary duties of loyalty to investors. This does not
prevent them from demanding substantial compensa-
tion and bargaining hard to get it. Publicly traded corpora-
tions use the same basic procedures as mutual funds: a
committee of independent directors sets the top managers’
compensation. No court has held that this procedure
implies judicial review for “reasonableness” of the re-
sulting salary, bonus, and stock options. These are con-
strained by competition in several markets—firms that
pay too much to managers have trouble raising money,
because net profits available for distribution to investors
are lower, and these firms also suffer in product markets
because they must charge more and consumers turn
elsewhere. Competitive processes are imperfect but
remain superior to a “just price” system administered by
the judiciary. However weak competition may be at
weeding out errors, the judicial process is worse—for
judges can’t be turned out of office or have their
salaries cut if they display poor business judgment.
10 No. 07-1624
Lawyers have fiduciary duties to their clients but are
free to negotiate for high hourly wages or compensation
from any judgment. Rates over $500 an hour and con-
tingent fees exceeding a third of any recovery are
common. The existence of the fiduciary duty does not
imply judicial review for reasonableness; the question a
court will ask, if the fee is contested, is whether the
client made a voluntary choice ex ante with the benefit
of adequate information. Competition rather than litiga-
tion determines the fee—and, when judges must set fees,
they try to follow the market rather than demand that
attorneys’ compensation conform to the judges’ prefer-
ences. See, e.g., In re Synthroid Marketing Litigation, 325
F.3d 974 (7th Cir. 2003); In re Continental Illinois Securities
Litigation, 962 F.2d 566 (7th Cir. 1992). A lawyer cannot
deceive his client or take strategic advantage of the de-
pendence that develops once representation begins, but
hard bargaining and seemingly steep rates are lawful.
The list could be extended, but the point has been
made. Judicial price-setting does not accompany fiduciary
duties. Section 36(b) does not call for a departure from
this norm. Plaintiffs ask us to look beyond the statute’s
text to its legislative history, but that history, which
Gartenberg explores, is like many legislative histories in
containing expressions that seem to support every pos-
sible position. Some members of Congress equated fidu-
ciary duty with review for reasonableness; others did not
(language that would have authorized review of rates
for reasonableness was voted down); the Senate com-
mittee report disclaimed any link between fiduciary duty
and reasonableness of fees. See 694 F.2d at 928.
Statements made during the debates between 1968
and 1970 rest on beliefs about the structure of the mutual-
No. 07-1624 11
fund market at the time, and plaintiffs say that because
many members of Congress deemed competition inade-
quate (and regulation essential) in 1970, we must act as if
competition remains weak today. Why? Congress did not
enact its members’ beliefs; it enacted a text. A text authoriz-
ing the SEC or the judiciary to set rates would be
binding no matter how market conditions change. Section
36(b) does not create a rate-regulation mechanism, and
plaintiffs’ proposal to create such a mechanism in 2008
cannot be justified by suppositions about the market
conditions of 1970. A lot has happened in the last 38 years.
Today thousands of mutual funds compete. The pages
of the Wall Street Journal teem with listings. People can
search for and trade funds over the Internet, with negligi-
ble transactions costs. “At the end of World War II,
there were 73 mutual funds registered with the Securities
and Exchange Commission holding $1.2 billion in assets.
By the end of 2002, over 8,000 mutual funds held more
than $6 trillion in assets.” Paul G. Mahoney, Manager-
Investor Conflicts in Mutual Funds, 18 J. Econ. Perspectives
162, 162 (Spring 2004). Some mutual funds, such as
those that track market indexes, do not have investment
advisers and thus avoid all advisory fees. (Total expenses
of the Vanguard 500 Index Fund, for example, are under
0.10% of assets; the same figure for the Oakmark Fund
in 2007 was 1.01%.) Mutual funds rarely fire their invest-
ment advisers, but investors can and do “fire” advisers
cheaply and easily by moving their money elsewhere.
Investors do this not when the advisers’ fees are “too
high” in the abstract, but when they are excessive in
relation to the results—and what is “excessive” depends
on the results available from other investment vehicles,
rather than any absolute level of compensation.
12 No. 07-1624
New entry is common, and funds can attract money
only by offering a combination of service and manage-
ment that investors value, at a price they are willing to
pay. Mutual funds come much closer to the model of
atomistic competition than do most other markets. Judges
would not dream of regulating the price of automobiles,
which are produced by roughly a dozen large firms;
why then should 8,000 mutual funds seem “too few” to
put competitive pressure on advisory fees? A recent,
careful study concludes that thousands of mutual funds
are plenty, that investors can and do protect their interests
by shopping, and that regulating advisory fees through
litigation is unlikely to do more good than harm. See
John C. Coates & R. Glenn Hubbard, Competition in the
Mutual Fund Industry: Evidence and Implications for Policy,
33 Iowa J. Corp. L. 151 (2007).
It won’t do to reply that most investors are unsophisti-
cated and don’t compare prices. The sophisticated inves-
tors who do shop create a competitive pressure that
protects the rest. See Alan Schwartz & Louis Wilde,
Imperfect Information in Markets for Contract Terms, 69 Va. L.
Rev. 1387 (1983). As it happens, the most substantial and
sophisticated investors choose to pay substantially
more for investment advice than advisers subject to §36(b)
receive. A fund that allows only “accredited investors” (i.e.,
the wealthy) to own non-redeemable shares is exempt
from the Investment Company Act. See 15 U.S.C.
§80a–6(a)(5)(A)(iii). Investment pools that take advan-
tage of this exemption, commonly called hedge funds,
regularly pay their advisers more than 1% of the pool’s
asset value, plus a substantial portion of any gains from
successful strategies. See René M. Stulz, Hedge Funds: Past,
Present, and Future, 21 J. Econ. Perspectives 175 (Spring
No. 07-1624 13
2007). See also Joseph Golec & Laura Starks, Performance fee
contract change and mutual fund risk, 73 J. Fin. Econ. 93
(2004). When persons who have the most to invest, and
who act through professional advisers, place their assets
in pools whose managers receive more than Harris Associ-
ates, it is hard to conclude that Harris’s fees must be
excessive.
Harris Associates charges a lower percentage of assets to
other clients, but this does not imply that it must be
charging too much to the Oakmark funds. Different
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. That complicates an adviser’s task. Joint
costs likewise make it hard to draw inferences from fee
levels. Some tasks in research, valuation, and portfolio
design will have benefits for several clients. In competi-
tion those joint costs are apportioned among paying
customers according to their elasticity of demand, not
according to any rule of equal treatment.
Federal securities laws, of which the Investment Com-
pany Act is one component, work largely by re-
quiring disclosure and then allowing price to be set by
competition in which investors make their own choices.
Plaintiffs do not contend that Harris Associates pulled
the wool over the eyes of the disinterested trustees or
otherwise hindered their ability to negotiate a favorable
price for advisory services. The fees are not hidden from
investors—and the Oakmark funds’ net return has at-
tracted new investment rather than driving investors
away. As §36(b) does not make the federal judiciary a
rate regulator, after the fashion of the Federal Energy
14 No. 07-1624
Regulatory Commission, the judgment of the district
court is affirmed.
USCA-02-C-0072—5-19-08