The Supreme Court decided Jones v. Harris Associates this morning. I wrote an amicus brief in this case for the Cato Institute.
The case involves a federal statute that imposes a fiduciary duty on investment fund advisors “with respect to compensation.” The plaintiffs sued their investment fund managers on the grounds that they had paid their advisors too much. The Seventh Circuit rejected their argument, holding that the statute only requires fair and open dealing, but does not impose any kind of a reasonableness standard on the amount of pay that an investment company can pay to an advisor. In the brief I wrote, I argued that this was the correct approach—as long as everyone involved in the deal is open and honest with each other, the resulting pay is just and fair, even if it’s a lot.
The decision rejects this approach, and formally adopts the “totality of the circumstances” test applied in the Gartenberg case. It takes a restrained interpretation of the Gartenberg decision—as Justice Thomas points out in his concurring opinion: “today’s decision…does not countenance the free-ranging judicial ‘fairness’ review of fees that Gartenberg could be read to authorize…and that virtually all courts…since Gartenberg…have wisely eschewed.” But, sadly, the decision implies that a company could be liable solely because the compensation amount is very high, even though nobody was dishonest or uninformed: “This is not to deny that a fee may be excessive even if it was negotiated by a board in possession of all relevant information, but such a determination must be based on evidence that the fee ‘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 bargaining.’”
What precisely does that mean? How is one to determine whether a person is being paid “disproportionately” even though the bargaining over his salary was perfectly open and honest? The Court does not explain, adopting instead a generalized “totality of the circumstances” approach with no clear lines. The upside is that it seems unlikely that a plaintiff could meet the burden of proof of showing that the advisor’s pay is “outside the range that arm’s-length bargaining would produce” in a case where there was no dishonest bargaining. But the downside is that because it refuses to draw a clear line blocking lawsuits in the absence of evidence of dishonest dealing, today’s decision invites further lawsuits. That raises costs to consumers and investors, and keeps lawyers employed for many years to come.
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