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Court to look at mutual fund fees

March 10, 2009|Walter Hamilton

NEW YORK — Critics have long complained that mutual fund fees are too high, wrongfully enriching Wall Street at the expense of ordinary Americans.

On Monday, the U.S. Supreme Court said it would take on the contentious issue.

The court agreed to hear a case in which individual investors have accused their fund company of charging excessive fees.

At issue is the legal standard that small investors must meet to bring lawsuits against fund companies. The court will consider whether a ruling last year sets too high a bar for investors to challenge the annual levies.

Fees have become a highly charged subject in recent years as Americans have come to rely on 401(k) plans to finance retirement, and they've taken on greater relevance as the stock market has tumbled during the financial crisis.

"It's very significant because mutual funds are now the investment vehicle of choice for most American investors. They're the vehicle for planning for our retirements," said James Cox, a Duke University law professor.

Critics say the fund industry reaps big profits by not passing along economies of scale achieved through decades of growth.

As proof, the critics say, investment firms charge much higher fees to individual mutual fund investors than to pension funds and other institutional investors for essentially the same services.

The court decided to review a case in which three investors sued Harris Associates, which manages the Oakmark funds.

The investors alleged that Oakmark's average fees as a percentage of assets rose from 1993 to 2003 even though the company's assets under management jumped 40-fold to more than $11.7 billion.

Critics say that -- unlike industries such as manufacturing, which must hire workers and buy extra raw materials to service new customers -- mutual fund companies incur few additional costs when adding investors.

Thus, the levies charged to newcomers "represent almost pure profit" to fund managers, the investors said in their suit.

"We think the issue is important to a broad group of investors and we're gratified the court has taken the case," said David C. Frederick, the suing investors' attorney.

Average fund fees have declined slowly over the last decade, to 1.24% of assets last year from 1.34% in 1998, according to Morningstar Inc.

An Oakmark spokesman did not return a phone call seeking comment.

"This is an important case for the mutual fund industry and fund boards," said Rachel McTague, a spokeswoman for the Investment Company Institute, the fund industry's main trade group. "We will certainly continue to follow it closely."

The case the high court agreed to hear is an appeal of a ruling last year that made it more difficult for individual investors to challenge fund fees.

Until that ruling, courts relied on a 1982 legal standard known as Gartenberg, which itself sets high hurdles for plaintiffs to prevail in fee-related cases.

Last year's ruling laid down even tougher standards, which some experts said would make it virtually impossible for investors to bring fee cases.

The appeals court concluded that the fund industry was a competitive business and that dissatisfied investors could move to lower-cost funds, Cox said.

Critics dismiss that reasoning, saying investors in 401(k)s and other retirement plans are essentially stuck with funds (and, therefore, fund managers) chosen by their employers.

Both decisions spring from an attempt by Congress in 1970 to force mutual fund directors to charge fees that are fair.

The ability of investors to sue, and the willingness of fund companies to lower fees, will depend largely on the Supreme Court ruling, experts said.

Even if the court nullifies the more stringent standards, investors might not benefit significantly unless the justices also dispense with Gartenberg in favor of a more lenient standard.

Gartenberg is "still a very tough standard for people to meet," said Deborah Zuckerman, an attorney at retiree organization AARP.


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