It is notable from a law and economics perspective for the vigorous opinion in the Seventh Circuit Court of Appeal of Judge Frank Easterbrook and the powerful dissent of Richard Posner, regarding the necessity and market failure in respect of adviser fee regulation.

The majority of the Court of Appeals ruled against the plaintiffs citing a lack of judicial authority to regulate investment company fees.

A difference of 0.1% per annum in total administrative expenses adds up by compounding over time and is enough to induce many investors to change mutual funds.

It is possible to imagine compensation so unusual that a court will infer that deceit must have occurred, or that the persons responsible for decision have abdicated—for example, if a university’s board of trustees decides to pay the president $50 million a year, when no other president of a com- parable institution receives more than $2 million—but no court would inquire whether a salary normal among similar institutions is excessive.

Things work the same way for business corporations, which though not trusts are managed by persons who owe fiduciary duties of loyalty to investors.

Publicly traded corporations use the same basic procedures as mutual funds: a committee of independent directors sets the top managers’ compensation.

No court has held that this procedure implies judicial review for “reasonableness” of the resulting salary, bonus, and stock options.

These are constrained by competition in several markets—firms that pay too much to managers have trouble raising money, because net profits available for distribution to investors are lower, and these firms also suffer in product markets because they must charge more and consumers turn elsewhere.

However weak competition may be at weeding out errors, the judicial process is worse—for judges can’t be turned out of office or have their salaries cut if they display poor business judgment.’ [Easterbrook said lawyers fees are set in the same way, and the list could be extended to other fiduciaries.]

Judges would not dream of regulating the price of automobiles, which are produced by roughly a dozen large firms; why then should 8,000 mutual funds seem “too few” to put competitive pressure on advisory fees?

A recent, careful study concludes that thousands of mutual funds are plenty, that investors can and do protect their interests by shopping, and that regulating advisory fees through litigation is unlikely to do more good than harm.

As §36(b) does not make the federal judiciary a rate regulator, after the fashion of the Federal Energy Regulatory Commission, the judgment of the district court is affirmed.Posner, reading a dissenting judgment, argued that the majority's decision ran counter to well established principle in Gartenberg, that the market was ineffective to solve the problem and that procedurally the decision was flawed since it was not circulated prior to publication, as is required in the case of a circuit split.

Gartenberg permits a court to consider, as a factor in determining such a breach, whether 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.” 694 F.2d at 928.

A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation.” [Posner then noted that Gartenberg has express approval from every case listed on Westlaw.]

Competition in product and capital markets can’t be counted on to solve the problem because the same structure of incentives operates on all large corporations and similar entities, including mutual funds.

Mutual funds are a component of the financial services industry, where abuses have been rampant, as is more evident now than it was when Coates and Hubbard wrote their article.

“[T]he chief reason for substantial advisory fee level differences between equity pension fund portfolio managers and equity mutual fund portfolio managers is that advisory fees in the pension field are subject to a marketplace where arm’s-length bargaining occurs.

The panel opinion gives some reasons why, though one of them is weak in its unelaborated form: that the funds managed by Harris have grown faster than the industry norm.

But 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 warrant our hearing the case en banc.Jones then appealed to the Supreme Court which granted certiorari on March 9, 2009.

The Supreme Court unanimously agreed with the plaintiffs and held the Seventh Circuit erred in holding that claims alleging mutual fund management's fees were too high is not cognizable under Section 36(b) of the Investment Company Act.

Justice Alito wrote the majority opinion arguing the Seventh Circuit Court of Appeals erred in not applying the established standard from Gartenberg v. Merrill Lynch Asset Management, Inc..

The Court established that the ICA requires for a claim to be valid there must be a determination that the fee is "so disproportionately large it bears no reasonable relationship to the services rendered."