Reporting from Washington — Mutual funds that charge exorbitant fees can be sued for violating their duty of trust to investors, the Supreme Court ruled Tuesday, rejecting the view that the free market can be counted on to ensure fair fees.
But the justices also made it hard for plaintiffs and securities regulators to win such claims and warned judges against "second-guessing" the pay decisions made by an independent board of directors.
The mixed result came in one of this term's most closely watched business cases. More than 92 million Americans have money in mutual funds, and nearly $11 trillion in stocks and bonds were held by these funds at the start of this year.
Pay scales in the mutual fund industry, like those in banking and investment firms, are not strictly regulated by the government, and as the Wall Street collapse revealed, investment advisors and bankers sometimes can earn huge fees while losing money for their shareholders.
In 1970, however, Congress said mutual funds must operate with an independent board of directors. And it said the investment advisors for the funds have a "fiduciary duty," or a duty of trust, to the investors when setting fees for their services. The law also allowed suits against those suspected of violating this duty.
But investors have rarely won such claims. In Tuesday's decision, the Supreme Court gave new life to the law, ruling that investment advisors could be sued for charging excessive fees.
But the court's opinion also said such suits should fail unless there was evidence that advisors hid information from the board or that their fees were "so disproportionately large" as to suggest a cozy deal between the advisors and the supposedly independent board.
Afterward, both sides declared victory.
"This is a good day for investors," said Washington lawyer David Frederick, who represents investors who sued Chicago-based Harris Associates, which advises the Oakmark funds.
The Securities and Exchange Commission, in a statement, called it "welcome news for mutual fund investors, who can continue challenging fund fees they believe to be excessive." But leaders of the fund industry noted that the court's opinion stressed that judges should give "considerable deference" to the fees agreed upon by boards and their investment advisors.
"We're pleased the court recognized the importance of independent directors who look out for the interest of investors," said Carolyn McPhillips, counsel for the Mutual Fund Directors Forum.
The 9-0 ruling revived a lawsuit against Harris Associates. The suit contended the advisors were violating a federal duty of trust to their individual investors by charging fees that were twice as high as those paid by pension funds.
A federal judge and the U.S. Court of Appeals in Chicago had thrown out the suit before a trial two years ago on the grounds that those fees were disclosed to the board, and therefore, were appropriate.
The Supreme Court set aside that decision in Jones vs. Harris Associates and sent the case back to Chicago for the judges to decide whether the fees were so "disproportionately large" as to raise questions. The high court devoted most of its opinion to explaining why these fee decisions should be left to the mutual fund boards, and not to judges and juries.
The law relies "largely upon independent director watchdogs to protect shareholder interests," said Justice Samuel A. Alito Jr., and judges owe "considerable deference" to the fees that boards and investment advisors have agreed on.
Also, the court in a 7-2 decision barred lawsuits by whistle-blowers who sought to expose a fraud involving federal money that had already been revealed in an audit by a state or local agency.
But the decision appeared to have a quite limited effect because Congress recently changed the law in that area.
Writing for the court, Justice John Paul Stevens said the False Claims Act was designed to encourage true whistle-blowers who revealed a fraud, but not to give a windfall to "opportunistic plaintiffs" who rush to the courthouse.
The law allows the plaintiffs to claim a significant percentage of the money recouped by the federal government.
Justices Sonia Sotomayor and Stephen G. Breyer dissented, saying the law did not foreclose claims simply because a local or state agency had already revealed the facts.
Those reports are often overlooked or ignored, the two justices said.
Congress added a provision to the recently enacted healthcare reform law that bars fraud reports from whistle-blowers only when a federal agency has revealed the information.
That would permit future suits that reveal the misuse of federal funds, even if a state or local agency was aware of the misuse.