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Judge Posner Opinion Questions Fund Compensation Ruling

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  • John M. Baker
    The U.S. Court of Appeals for the Seventh Circuit has declined to grant rehearing en banc of its ruling that mutual fund investment advisers are not subject to
    Message 1 of 1 , Aug 11, 2008
      The U.S. Court of Appeals for the Seventh Circuit has declined to
      grant rehearing en banc of its ruling that mutual fund investment
      advisers are not subject to a fiduciary cap on their compensation.
      Jones v. Harris Associates, No. 07-1624 (7th Cir. Aug. 8, 2008) (per
      curiam). In a strongly-worded and thoroughly-researched dissenting
      opinion, Judge Posner argued that the case merited the attention of
      the full court. Four judges concurred with Judge Posner, and the
      motion for rehearing en banc failed on a 5 - 5 vote, a majority being
      required for rehearing; one judge, who did not participate,
      potentially could have changed the result.

      Judge Posner's dissent from the original panel's economic analysis is
      all the more striking for his own role as a leading exponent of the
      law and economics movement. In criticizing the panel's rejection of
      the excessive-fee approach taken in Gartenberg v. Merrill Lynch Asset
      Management, 694 F.2d 923 (2d Cir. 1982), he writes, "The panel bases
      its rejection of Gartenberg mainly on an economic analysis that is
      ripe for reexamination on the basis of growing indications that
      executive compensation in large publicly traded firms often is
      excessive because of the feeble incentives of boards of directors to
      police compensation." He argues that competition in product and
      capital markets can't be counted on to solve the problem of excessive
      compensation because the same structure of incentives operates on the
      entire industry. Coming as this does from the author of Economic
      Analysis and Law, a leading text now in its seventh edition, this may
      perhaps be seen as a shot over the bow for corporate compensation
      generally and a possible precursor of more aggressive judicial review
      in this area.

      Posner writes that a particular concern in this case is the adviser's
      charging its captive funds (the mutual funds it founded and manages)
      more than twice what it charges independent funds (third-party
      pension funds that it is paid to manage). "The governance structure
      that enables mutual fund advisers to charge exorbitant fees is
      industry-wide, so the panel's comparability approach would if widely
      followed allow those fees to become the industry's floor. And in this
      case there was an alternative comparison, rejected by the panel on
      the basis of airy speculation — comparison of the fees that Harris
      charges independent funds with the much higher fees that it charges
      the funds it controls." He notes that courts do not review corporate
      salaries for excessiveness, but says that "misses the point, which is
      that unreasonable compensation can be evidence of a breach of
      fiduciary duty."

      Posner cites the Stradley Ronon Fund Alert that I co-authored, as
      well as other law firm publications, to demonstrate that the original
      panel opinion created a split in the circuits, another factor
      militating for a rehearing en banc. He acknowledges that the outcome
      of the case may be correct, but says that the creation of a circuit
      split, the importance of the issue to the mutual fund industry, and
      the one-sided character of the panel's analysis warranted a hearing
      before the full court.

      Judge Posner and Judge Easterbrook, the author of the panel opinion,
      are the first and second most frequently cited Federal Circuit
      Judges, respectively, in active service. In the face of the circuit
      split, Judge Posner's opinion, and the closely-divided vote on
      rehearing en banc, it seems certain that the plaintiffs will seek
      review before the U.S. Supreme Court. In addition, a remarkably
      similar case, including the same law firms on both sides, is
      currently pending before the Eighth Circuit, where oral argument was
      heard April 17. Gallus v. Ameriprise Financial, No. 07-2945.
      Predictably, the opinions by Judges Easterbrook and Posner have
      already been brought to the Gallus panel's attention.

      For the opinions and oral argument in Jones v. Harris Associates, see


      My earlier post, with a link to the Stradley Ronon Fund Alert, is at


      John M. Baker <JMB@...>
      Stradley Ronon Stevens & Young, LLP http://www.stradley.com
      1220 19th Street NW, Suite 600
      Washington DC 20036
      202.822.0140 fax
      FundLaw Listowner http://groups.yahoo.com/group/fundlaw
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