Error in SCOTUS Jones v. Harris Opinion
A misleading error appears in today’s unanimous Supreme Court opinion in Jones v. Harris, written by Justice Samuel Alito. The Court endorses a longstanding interpretation of a 1970 federal statute requiring mutual fund adviser fees to meet a standard of fiduciary duty. The Court carefully directs that federal courts reviewing challenged fees be cautious about second-guessing fund judgments.
On the interpretation issue, the Court accurately reviews its prior opinions to summarize what it has said of the legislative history. An alternative to the fiduciary duty standard ultimately appearing in the statute would have given the Securities and Exchange Commission power to review fees for reasonableness. Accurately citing Daily Income Fund, Inc. v. Fox, 464 U.S. 523 (1984), page 4 of today’s opinion says: “Industry representatives, however, objected to this proposal, fearing that it ‘might in essence provide the Commission with ratemaking authority.’” (emphasis added) (citing and quoting Daily Income Fund, 464 U.S., at 538).
On the direction the Court gives federal judges applying this statute, the Court cautions against excessive propensity to second-guess fee decisions. True, the statute requires testing fees by a fiduciary standard but judges should exert judicial restraint, at least when set by independent and informed fund directors. But then the Court, on page 16 of today’s opinion, inaccurately cross-references its own opinion and inaccurately cites Daily Income Fund, when writing: “As recounted above, Congress rejected a ‘reasonableness’ requirement that was criticized as charging the courts with rate-setting responsibilities.” (emphasis added) (citing Daily Income Fund, at 538–540—I’ve copied these pages below for readers to compare).
Nowhere in the previous parts of today’s opinion does the Court “recount” that Congress rejected the reasonableness requirement as “charging the courts with rate-setting responsibilities.” The objection concerned providing the SEC with ratemaking authority. Nor does the accompanying citation to Daily Income Fund support the assertion. It likewise recounts that industry objected that giving the SEC reasonableness power would provide it with ratemaking authority. The Daily Income Fund opinion nowhere says anything about objections that anything proposed would “charge the courts with rate-setting responsibilities.”
It is possible that this erroneous statement and citation in today’s Supreme Court opinion are harmless errors. But they appear in paragraphs directing federal courts on how to apply the statute and cautioning against second-guessing. Courts should not fear that exercising their legislatively-granted and Supreme Court-ordained authority will threaten to “charge them with rate-setting responsibilities.” But inaccurate statements and citations like these could induce that.
Excerpts from pages in the Daily Income Fund opinion quoted by today’s opinion in Jones v. Harris (emphasis added and citations omitted):
Page 538: Some of the proposals Congress ultimately adopted were intended to make the fund’s board of directors more independent of the adviser and to encourage greater scrutiny of adviser contracts. The SEC had, however, determined that approval of adviser contracts by shareholders and independent directors could not alone provide complete protection of the interests of security holders with respect to adviser compensation. Accordingly, the Commission also proposed amending the Act to require “reasonable” fees. As initially considered by Congress, the bill containing this proposal would have empowered the SEC to bring actions to enforce the reasonableness standard and to intervene in any similar action brought by or on behalf of the company.
Representatives of the investment company industry, led by amicus Investment Company Institute (ICI), expressed concern that enabling the SEC to enforce the fairness of adviser fees might in essence provide the Commission with rate-making authority. Accordingly, ICI proposed an alternative to the SEC bill which would have provided that actions to enforce the reasonableness standard “be brought only by the company or a security holder thereof on its behalf.” The version that the Senate finally passed, however, rejected the industry’s suggestion that the investment company itself be expressly authorized to bring
suit. Instead, the Senate bill required a security holder to make demand on the SEC before bringing suit and provided that, if the Commission refused or failed to bring an action within six months, the security holder could maintain a suit against the adviser in a “derivative” or representative capacity. Like the original SEC proposal, however, the Senate bill provided that the SEC could intervene in any action brought by the company or by a security holder on its behalf.
After the bill was reintroduced in the 91st Congress, further hearings and consultations with the industry led to the present version of [Section] 36(b). The new version adopted “a different method of testing management compensation.” Instead of containing a statutory standard of “reasonableness,” the new version imposed a “fiduciary duty” on investment advisers. The new bill further provided that “either the SEC or a shareholder may sue in court on a complaint that a mutual fund’s management fees involve a breach of fiduciary duty.” The reference in the previous bill to the derivative or representative nature of the security holder action was eliminated, as was the earlier provision for intervention by the SEC in actions brought by the investment company itself.
In short, Congress rejected a proposal that would have expressly made the statutory standard governing adviser fees enforceable by the investment company itself and adopted in its place a provision containing none of the indications in earlier drafts that the company could bring such a suit. This legislative history strongly suggests that, in adopting [Section] 36(b), Congress did not intend to create an implied right of action in favor of the investment company. That conclusion is further supported by the purposes of the statute. As noted above, the SEC proposed the predecessor
to [Section] 36(b) because of its concern that the structural requirements for investment companies imposed by the Act would not alone ensure reasonable adviser fees. Indeed, the Commission concluded that the Act’s provisions for independent directors and approval of adviser contracts had actually frustrated effective challenges to adviser fees.
In particular, the Commission noted that in the three fully litigated cases in which security holders had attacked such fees under state law, the courts had relied on the approval of adviser contracts by security holders or unaffiliated directors to uphold the fees. For this reason, the Senate Report proposing the final version of the statute noted that, while shareholder and directorial approval of the adviser’s contract are entitled to serious consideration by the court in a [Section] 36(b) action, “such consideration would not be controlling in determining whether or not the fee encompassed a breach of fiduciary duty.” In contrast to its approach in other aspects of the 1970 amendments, then, Congress decided not to rely solely on the fund’s directors to assure reasonable adviser fees, notwithstanding the increased disinterestedness of the board