pomtalk

Big Bucks. No Whammies?

Tick Tock. Tick Tock.  In a scenario reminscent of the classic game show Press Your Luck.  It appears Former Fannie Mae CEO Daniel Mudd  may get a reprieve  courtesy of new Dodd-Frank stopwatch.  Mudd was put on notice March 11th that he could face regulatory action for his role in misrepresenting the underwriter's subprime exposure to investors and government agencies.  But Dodd-Frank amendments enacted last year introduced a 180 day time limit compelling Commission staff  to "either file an action or provide notice to the Director of the Division of Enforcement of its intent to not file an action,” within 180 days of the Wells Notice. 

The probe centers on his time at Fannie Mae and his role in creating the subprime debacle that would shock the country and the world.  But given the radio silence, observers wonder if  new admendments that were intended to make the agency more proactive in handling such cases have backfired.   

An alternate theory is that the inaction is related to reports that the SEC is winding down its investigations of Fannie & Freddie the NY Times reported that Fannie settlement talks were underway and fraud charges would likely be dismissed.  

As we explore more in the Pomerantz Monitor this month.  Fannie & Freddie Conservator the FHFA  also announced in early September that they'll seek to recover $196 billion in new actions against 17 banks for misrepresenting CDO risks to the underwriters.

For his part, Mudd has shown little remorse.  His failure, he said, was only that he could not maintain the “delicate balance,” required to meet such expectations.   Since taking over the CEO position at Fortress Investment Group Mudd's appetite for subprime has continued unabated.  In May, the publicly traded hedgefund unveiled subprime bond Springleaf acquired from AIG.  They  even managed to secure triple A rating from S&P after that agency had downgraded US treasury securities. 

So far, for Mudd its big bucks, and no whammies. 

In Madoff Case, Second Circuit Affirms Use of “Net Investment Method” to Compensate Victims

The Second Circuit was recently called upon to evaluate how the losses of investors in the Madoff Ponzi scheme should be calculated under the Securities Investor Protection Act, 15 U.S.C. § 78aaa et seq. (“SIPA”).  When a broker-dealer, such as Madoff, fails, SIPA establishes procedures for compensating that broker-dealer’s customers out of its liquidated assets.  In particular, SIPA establishes a special fund of “customer property” for priority distribution exclusively among customers based on the “net equity” value of their investments with the broker dealer.  These provisions are designed to protect investors against financial losses arising from the insolvency of their brokers.  

The problem is determining how each investor’s “net equity” should be calculated, particularly when the broker-dealer in question was a Ponzi schemer who never carried out the stock trades investors thought they were effectuating.  Normally, net equity is calculated by reference to each customer’s account at the time of liquidation, including the growth of each customer’s investments up to that time.  But what if the customer’s funds were never actually invested in any securities?  Should an investor who entrusted his money to Madoff be given credit for the growth of his investment over time—even if that growth was an illusion created out of whole cloth by the fraudster?

In the case In re Bernard L. Madoff Inv. Sec. LLC, 2011 U.S. App. LEXIS 16884 (2d Cir. Aug. 16, 2011) certain former Madoff investors appealed a decision of the United States Bankruptcy Court for the Southern District of New York approving use of the so-called “Net Investment Method” of calculating investor losses under SIPA.  Under that method, each investor’s “net equity” is calculated as the difference between the amounts they deposited with Madoff and the amounts they eventually withdrew.  That meant that Madoff’s customers would get credit only for the money they had actually deposited, not the paper gains in their investment over time.  In other words, if an investor had ultimately withdrawn more money than they deposited with Madoff, they would have no net equity in the SIPA customer fund. 

In challenging the use of the Net Investment Method, the appealing investors argued that they were entitled to recover the market value of the securities they believed they had purchased, as reflected on their last customer statements from Madoff.  This method of calculating net equity is known as the “Last Statement Method.”  The Bankruptcy Court agreed with the SIPA Trustee that, if the Last Statement Method were used, then claimants who had withdrawn funds from their Madoff accounts in excess of their initial investments would end up taking away resources from investors who hadn’t yet been made whole.  Thus, under these circumstances, the Last Statement Method would yield an inequitable result.

The Second Circuit agreed with the Bankruptcy Court that to compensate investors who had withdrawn more than their initial investment would inequitably diminish the amount of customer property available to other investors.  The Court’s decision, however, clearly leaves open the possibility that other valuation methods may continue to be used in more conventional SIPA cases not involving fabricated customer statements.

Supreme Court's Concepcion Case Poses New Challenges For Consumers

The Supreme Court’s decision in AT&T Mobility LLC v. Concepcion, No. 09-893, 563 U.S. ___ (Apr. 27, 2011) presents a major obstacle to consumers’ ability to  seek redress for fraudulent, deceptive or otherwise illegal schemes perpetrated in the marketplace.  The decision appears to permit wrongdoers to escape class adjudication of consumers’ claims merely by including collective-arbitration waivers in their form contracts of adhesion.  Despite the broad implications of the Court’s opinion, however, the decision leaves some room for state and common law protections that may prevent the evisceration of class action procedure in the adjudication of commercial claims.

Background

In Concepcion, the Court held that the Federal Arbitration Act (“FAA”) preempts state rules conditioning the enforceability of arbitration agreements on the availability of classwide arbitration procedures.  The respondents had entered into cellphone service agreements with AT&T Mobility LLC (“AT&T”) that, inter alia, required that the parties to arbitrate disputes on an individual, rather than class, basis.  The respondents later filed a putative class action alleging that AT&T had improperly charged them sales tax for phones that were advertised as being included free of charge.  AT&T moved to compel arbitration of respondents claims, and respondents in turn challenged the motion on the grounds that the collective-action waiver in the arbitration agreement was unenforceable under the rule set forth in Discover Bank v. Superior Court, 36 Cal. 4th 148 (2005).  In Discover Bank, the California Supreme Court held that collective-action waivers are unenforceable when included in contracts of adhesion and where “it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money.”  Id. at 162. 

The Majority’s Analysis

Justice Scalia’s majority opinion purports to analyze the case largely through the lens of the legislative purpose of the FAA:  to counteract judicial hostility to arbitration agreements.  The majority notes that the FAA’s substantive provisions reflect both a liberal policy favoring arbitration, and the principle that arbitration is a matter of contract between the parties.  Slip Op. at 4.  However, Section 2 of the FAA also contains a provision permitting arbitration provisions to be declared unenforceable “upon such grounds as exist at law or in equity for the revocation of any contract.”  Respondents argued that, in accordance with this provision of the FAA, California law provided grounds in law or equity to hold the arbitration agreement unenforceable.  The majority, however, held that the Discover Bank rule, insofar as it particularly applied to agreements to arbitrate, did not present grounds for revocation of any contract.  See Slip Op. at 7–9. 

Moreover, in the majority’s view, the Discover Bank rule frustrates the overarching purpose of the FAA by interfering with arbitration.  Id. at 12.  The majority articulates several reasons why the imposition of class arbitration procedures is supposedly inconsistent with the FAA:  (1) class arbitration is slower, more costly, and more procedurally complicated than bilateral arbitration; (2) class arbitration requires procedural formality; (3) class arbitration increases risks to defendants.  Id. at 14–16.  On this last point, Justice Scalia posits that “[a]rbitration is poorly suited to the higher stakes of class litigation.”  Id. at 16.

Justice Breyer’s Dissent

In dissenting from the majority opinion, Justice Breyer argues that the Discover Bank rule is consistent with the intent of the FAA because the Discover Bank rule does precisely what Section 2 of the FAA requires by putting “agreements to arbitrate and agreements to litigate on ‘upon the same footing.’”  Dissent Op. at 5.  Justice Breyer also disputes the empirical claims that class arbitration increases the complexity of arbitration procedures and thus discourages parties from entering arbitration agreements, and that arbitration is poorly suited to the high stakes of class adjudication.  Id. at 5–8.  Finally, the dissent argues that the majority’s view usurps matters usually left to the States.  Id. at 8–10.

Reason for Hope

There are a few reasons to hope that the AT&T decision will not lead to a complete evisceration of class adjudication at the hands of any company savvy enough to build class-arbitration waivers into their boilerplate contracts.  For one thing, victims of consumer fraud can presumably still challenge arbitration agreements on the grounds that the defendant’s fraud renders the agreement unenforceable.  Similarly, plaintiffs may still have success challenging agreements on unconscionability grounds that do not rest on a blanket rule of the Discover Bank type.  The arbitration agreement at issue in AT&T was exceptionally favorable to complainants.  It provided, inter alia, that AT&T would cover the cost of all nonfrivolous claims, that arbitration take place in the complainant’s country, that complainants could elect to bring their claims in small claims court rather than arbitration, that AT&T could not seek reimbursement of its attorney fees and that, in the event an arbitration award exceeds AT&T’s last settlement offer, AT&T would pay a $7,500 minimum recovery and twice the amount of the claimant’s attorney fees.  Slip Op. at 2.  It is quite possible that plaintiffs will be able to sustain a challenge to less favorable agreements on the grounds that their terms, irrespective of any blanket requirements regarding the form of arbitration, are unconscionable.

Finally, it is possible that States will respond to the AT&T decision by requiring stricter rules for the form of a class-arbitration waiver.  A footnote to the majority opinion notes that:  “Of course States remain free to take steps addressing the concerns that attend to contracts of adhesion–for example, requiring class-action-waiver provisions in adhesive arbitration agreements to be highlighted.”  Slip Op. at 12 n.6.  There is good reason to expect that numerous states will build stronger safeguards into their regimes for the enforcement of contracts of adhesion, and that these safeguards may either discourage the use of class-arbitration waivers or otherwise render non-compliant waivers unenforceable.

From the Pages of The Pomerantz Monitor: The Supremes and U.S. Chamber of Commerce Are Reading from the Same Playbook

As Jason Cowart reports in the current issue of The Pomerantz Monitor, one of the most controversial Supreme Court decisions of 2010, Citizens United v. Federal Election Commission, fundamentally altered the way elections will be conducted in our country. The Court held that corporations and unions have the same First Amendment rights as people and therefore can spend unlimited amounts of money in elections. The U.S. Chamber of Commerce filed an amicus brief in this case that supported the extension of First Amendment rights to inanimate entities. 

As the New York Times recently reported, the Chamber is having an extraordinary degree of success at the Supreme Court these days. Indeed, Carter G. Phillips, who often epresents the Chamber, has said that “except for the solicitor general representing the United States, no single entity has more influence on what cases the Supreme Court decides and how it decides them than the [Chamber’s] National Chamber Litigation Center.”

Although hundreds of lower court decisions are appealed to the Supreme Court every year, the Court only agrees to hear a few of those cases. For average citizens, the odds of obtaining Supreme Court review are about 1 in 100. According to the Chamber’s lawyers, their odds of convincing the Court to take a case increase those odds to 30%. This state of affairs is all the more troubling because the Court sides with the Chamber a disturbingly high percentage of the time. 

Consider these facts:

■  The Chamber’s positions have prevailed 68 percent of the time since Justice Roberts became Chief Justice, compared with 56 percent in the last 11 years (with no personnel changes) of the Rehnquist court.

■  Under Justice Roberts, the Court has ruled for business interests 61 percent of the time, compared with 42 percent by all courts since 1953.

■  According to the Constitutional Accountability Center, the conservative bloc of the Court favored the Chamber position 74% of the time, compared to 43% of the time for the moderate/liberal bloc – a difference nearly triple that of the Rehnquist and Burger Courts.

■  Last term, the Chamber’s side won 13 of 16 cases. Six of those were decided with a majority vote of five justices, and five of those decisions favored the Chamber. (One of them was Citizens United.)

This year, the Court will hear a series of cases that pit shareholder interests against those of corporate managers. Want to handicap the outcome? Ask: what is the Chamber’s position?

Further reading: Why Does Business (Usually) Win in the Roberts Court?

And follow: "Fix the US Chamber"

From the Pages of The Pomerantz Monitor: Must Loss Causation be Proven at the Class Cert Stage?

As Adam Prussin opines in the current issue of The Pomerantz Monitor, few decisions have caused more members of the plaintiffs’ bar to pull their hair out than the Fifth Circuit’s 2007 decision in Oscar Private Equities. There the court held that a class could not be certified in a securities fraud case unless the plaintiff could prove, by a preponderance of the evidence, that the false statements caused the investors’ losses. This is a critical issue because the Supreme Court has held that “loss causation” is  an essential element of a securities fraud  claim, and that it requires a showing that disclosure of the true facts actually caused a drop in the market price of the company’s shares. 

Oscar caused such agita because the Fifth Circuit seemed to be saying that now plaintiff had to prove, at the class certification stage, not only that there were “common questions” concerning loss causation, but also that he was going to prevail on that merits-related issue. This is not an academic question, because experts often disagree about what may have caused the price of a stock to move on any given day. In Oscar itself, certification was denied because the company disclosed other information at the same time as it corrected its previous fraudulent statements, and plaintiff’s expert could not separate the effects of one disclosure from the effects of the other. Needless to say, companies in the position of making “corrective disclosures” have become more and more sophisticated in mixing such disclosures up with other disclosures so as to obscure the “loss causation” effects. 

This issue has enormous practical consequences, because if Oscar is upheld, an additional obstacle will be interposed in securities fraud cases. Defendants would now have three chances before trial to attack the case on the merits: at the motion to dismiss stage; at summary judgment; and, now, at the class certification stage as well. Until recently, it had been accepted that the courts were to decide issues related to the merits of the case in the course of ruling on a class certification motion.  

Luckily, no other Circuit has gone along with the Oscar decision; and now, there is a good chance that even in the Fifth Circuit the Oscar rule may bite the dust. Although Oscar never went up to the Supreme Court, the principle established in that case has finally found its way there, in another Fifth Circuit case, involving Halliburton. In that case, an institutional investor alleged that Halliburton executives deliberately misrepresented the company’s financial results, and when Halliburton subsequently disclosed the true facts, the market declined. However, the lower courts denied class certification because plaintiffs had not proven that disclosure of the fraud had caused the market price of the shares to fall.

If, as we expect (hope) that decision is reversed, Oscar will be history. 

New Proxy Rules Already Impacting Pending Litigation

The SEC’s new proxy access rules, enacted on August 25, 2010, have already found there way into court.  Based on the rule changes adopted by the SEC, the Second Circuit recently remanded Bebchuk v. Elec. Arts, Inc. to the Southern District of New York for reconsideration of its previous dismissal of the case.  We’ve previously commented on the new rules here and here.

The Electronic Arts matter arises from a proposal by Harvard law professor Lucian Bebchuk to amend the company bylaws and establish a procedure for the placement of shareholder proposals into company proxy materials.  Opponents of the proposal noted that it potentially ran afoul of the SEC proxy rules as they then existed:

Professor Bebchuk's proposal is significant, in part, because it would enable a company's shareholders to amend the bylaws to permit shareholders to submit director nominees for inclusion in the company's proxy statement, even though proposals relating to the election of directors are excludable under Rule 14a-8, the SEC's shareholder proposal rule.   Accordingly, the proposal represents an effort to gain "proxy access" – that is, access to a company's proxy statement for the purpose of nominating directors.

The District Court agreed with that reasoning and granted EA’s motion to dismiss; holding that Bebchuk’s proposal was excludable under Rule 14a-8(i)(3) as contrary to the SEC’s proxy rules.  See Bebchuk v. Elec. Arts, Inc., No. 08-5842-cv (2d Cir. Sept. 13, 2010).  Now, nearly two years after that District Court dismissal, the Second Circuit has ruled that the SEC’s changes to the its proxy rules “may bear on the issues presented in this appeal” and the case should be remanded for reconsideration.  Id.   

SDNY Issues Promising Decision Limiting Martin Act Preemption

US District Judge Victor Marrero of the Southern District of New York has issued an opinion holding that New York’s Blue Sky law, the “Martin Act,” does not preempt private common law causes of action related to the sale of securities.  The opinion in the case Anwar v. Fairfield Greenwich Ltd., No. 09 Civ. 0118 (VM) (S.D.N.Y. July 29, 2010) effectively overturns a large body of prior case law within the New York federal courts previously holding that the Martin Act, which empowers the Attorney General to prosecute fraudulent practices in the securities market, preempts private causes of action in connection with the sale of securities.  Because Martin Act claims require no showing of deceitful intent, preemption was typically limited to causes of action requiring no showing of scienter (e.g., breach of fiduciary duty, negligence, negligent misrepresentation, etc., but not common law fraud).  It appears that after Judge Marrero’s ruling, Martin Act preemption, at least within the SDNY, no longer exists.

In a methodical and scholarly opinion, Judge Marrero examined the evolution of courts’ understanding of the Martin Act and its relationship with private, common law causes of action.  Ultimately, Judge Marrero concludes that the concept of Martin Act preemption arose from various courts’ misreading of precedent out of context, and uncritical adoption of rules divorced from their original purpose.  The opinion concludes that federal courts sitting in New York have misinterpreted New York law and that “New York’s highest tribunal would hold that the Martin Act does not preclude state common law causes of action that do not derive from or rely upon the Martin Act to establish a required element of the claim.”

It remains to be seen whether this will be the final chapter in the Martin Act preemption saga.  While Judge Marrero’s decision is a truly welcome development, it could just as easily be undone should the Second Circuit or New York Court of Appeals provide a contrary view on the subject.  For the time being, it appears that wronged investors have one less obstacle to contend with.

What Comes of Free Enterprise Fund v. PCAOB?

Yesterday’s Supreme Court decision concerning the constitutionality of the Public Company Accounting Oversight Board (“PCAOB”) is perhaps most important for what it didn’t hold.  Many have noted that the decision—striking down a provision of the Sarbanes-Oxley Act (“SOX”) that provided PCAOB members could only be removed for cause—will have little practical effect in the business world (the Wall Street Journal quotes Office Max’s CFO going so far as to say “[w]hat happens as a consequence of the rulings today is frankly not important”).  In a nutshell, the majority held that, because PCAOB members can only be removed by the SEC for cause, and SEC members can themselves only be removed by the President for cause, the “dual for-cause limitations” withdraw from the President the power to determine whether good cause for such removals exists.  This, the Court held, “contradicts Article II’s vesting of the executive power in the President.”  Thus, as the New York Times puts it, the PCAOB “survived a constitutional challenge on Monday, emerging only with its members having a little less job security.”  The decision is significant, however, in that it did not question the overall constitutionality of SOX and, in particular, held that it could sever the unconstitutional PCAOB tenure positions without having to throw out the entire Act.  This means not only that SOX has survived a significant constitutional challenge, but also that in the event other vulnerable provisions of the Act are held unconstitutional, SOX can potentially shed those offending provisions as well without dissolving completely.

NASCAT Reacts to Court of Appeals Ruling in Refco Fraud Case (Full Text Follows...)

FEDERAL APPEALS COURT PANEL TOSSES INVESTOR CLAIMS AGAINST CONVICTED ENABLER OF REFCO, INC. FRAUD SCHEME;  SECOND CIRCUIT RULING REJECTS SEC’S POSITION IN DENYING REMEDY FOR DEFRAUDED SHAREHOLDERS AND BONDHOLDERS

Ruling Highlights Need for Congress to Restore Accountability to Investors for Those who Knowingly Aid and Abet Securities Fraud

WASHINGTON, DC, April 28, 2010 – The National Association of Shareholder and Consumer Attorneys (NASCAT) expressed dismay with the April 27 decision in PIMCO Funds, et al v. Mayer Brown LLP, et al by a three-judge panel of the U.S. Court of Appeals for the Second Circuit, which continued a pattern of rigid and overly technical interpretations of investors’ rights under the federal securities laws.  Indeed, the Court tossed the clearly meritorious claims brought by shareholders and bondholders of bankrupt Refco, Inc. against that derivatives dealers’ outside counsel who has been criminally convicted of the fraud alleged by investors and is serving a seven year sentence in federal prison. 

“This disheartening decision rejects the common-sense approach taken by the U.S. Securities and Exchange Commission (SEC), one fully supported by the relevant statute, Section 10 of the Securities Exchange Act of 1934, that investors do have a right of action against these defendants.  Indeed, Section 10 refers generally to the prohibition of ‘any manipulative or deceptive device or contrivance in contravention’ to SEC rules, which go beyond personally uttering a misrepresentation and surely encompasses using others to knowingly make a false public statement.  Instead, the Second Circuit’s holding rendered the obvious merits of Refco’s investors’ claims irrelevant.  Indeed, unnecessarily going beyond even the two Supreme Court decisions (Central Bank in 1994 and Stoneridge in 2008) that the lower court noted were ripe for legislative re-examination, the panel granted complete immunity from lawsuits to all those who knowingly engage in securities fraud unless they are publicly identified or publicly participate in the wrongdoing,” explained Ira Schochet, Esq., NASCAT’s President.

“The Second Circuit’s decision underscores the need for Congress to restore accountability to investors for all who knowingly enable securities fraud,” Mr. Schochet continued.  “Senator Arlen Specter, a former prosecutor and senior Member of the Judiciary Committee and Chairman Barney Frank of the House Financial Services Committee have each sponsored legislation to restore the right of investors to take action against those who knowingly and substantially participate in securities fraud including gatekeepers such as accountants, lawyers and investment advisers, without whom many complex frauds such as the Refco and Lehman Brothers “book cooking” scams and the unfolding alleged Goldman Sachs derivatives’ based swindle could not have occurred.”   

The SEC had filed a friend of court brief with the Court of Appeals arguing that in cases such as Refco, so-called “secondary actors” such as consulting accountants and attorneys can be held liable as a “primary violator” of SEC Rule 10b-5’s bar against “mak[ing]” false or misleading statements to investors if that person creates and then provides the false or misleading information to another person intending that it be put into a public statement.  A flexible reading of the statute, which in prior decades the Supreme Court encouraged, readily allows the words “to make”, relating to a materially false statement, to carry that meaning (since the statute does not say “to express” or “to utter” or use similar more restrictive verbs.)   Nonetheless, the Second Circuit panel held that the “secondary actor” must be the one who publicly states the false or misleading information even if the lawyer (as in Refco) designed the sham transactions that made the fraud possible and then wrote the false statements made by other violators to investors and the public.

The underlying lawsuit brought by Refco’s shareholders and bond holders alleged that Refco’s outside attorney and its law firm (Mayer Brown, LLP) designed and helped sell to counterparties sham transactions and falsified securities offering documents to cover-up hundreds of millions of dollars in losses by Refco, Inc.  Refco, the once global, publicly traded derivatives dealer, collapsed in 2005 when its cover-up of the devastating losses unraveled.  

Although the lower court judge recognized the merits of the Refco plaintiffs’ suit, he cited the Supreme Court Central Bank and Stoneridge decisions as compelling the dismissal of the investors’ class action.  Since the lower court ruled, one of the defendants in that lawsuit, Joseph P. Collins, a partner at the law firm of Mayer Brown, and a former Refco legal adviser, has been convicted in a federal court of conspiracy to commit securities fraud and four other counts of illegal actions and is serving a seven year prison sentence.  Two others have pled guilty to fraud charges in this case.

“Private investors form a key front-line defense against financial fraud and abuse because they are in a unique position to quickly identify and take action against unlawful conduct by corporate issuers and their advisers,” Mr. Schochet continued.  “Traditionally, securities market regulation and law enforcement relied upon a ‘three legged stool’ of the SEC, federal and state attorneys general and investor actions. In recent years, however, two legs of the regulatory stool were weakened by laxity in enforcement of federal securities law and Supreme Court decisions, and lower court rulings interpreting those decisions, which have curtailed investors’ rights of action.  By immunizing fraud enablers from accountability to investors, the Courts have unwittingly encouraged  unscrupulous corporate lawyers, accountants and other gatekeepers to profit from wrongdoing.”

The National Association of Shareholder and Consumer Law Attorneys is a nonprofit organization comprised of about 100 law firms representing consumers and investors - including pension funds and individuals - in cases of securities fraud and other forms of "white collar" wrongdoing and criminal activity.

From the Pages of The Pomerantz Monitor: Supreme Court Upholds Gartenberg Standard Set By Pomerantz

As reported in the March/April issue of The Pomerantz Monitor, on March 30 the Supreme Court decided Jones v. Harris, a case concerning reasonableness of fees charged by a mutual fund advisor to its funds, and adopted a standard that was set in a case litigated by the Pomerantz firm almost three decades ago. Then, on April 5, 2010, after The Pomerantz Monitor went to press, the Supreme Court sent a lawsuit against Ameriprise Financial Inc. over alleged overcharging for mutual fund fees back to the Eighth Circuit, finding that the Gartenberg fee dispute standard that was upheld in Jones v. Harris also applies to Ameriprise.

Section 36(b) of the Investment Company Act imposes a fiduciary duty on fund advisors “with respect to the receipt of compensation,” and creates a private right of action for investors in the funds that paid those fees. This provision was enacted because Congress recognized that the fund directors who approve the fees are often not truly independent of the advisor, since the advisor created the funds in the first place and controls the appointment of the directors of the funds.

The Supreme Court in Jones v. Harris held that the Investment Company Act allows shareholders of mutual funds to challenge the reasonableness of fees charged by fund advisors, if those fees are so excessive as that they could not have been negotiated at arm’s length. The Court unanimously voted to reverse the decision of the Seventh Circuit, which had held that the marketplace, and not courts, should determine whether mutual fund fees are reasonable. The standard used by the Seventh Circuit rendered it almost impossible for shareholders to challenge fees.