In a significant move that has ramifications for the investment industry, the United States Court of Appeals for the Seventh Circuit has departed from long-used standards regarding the setting and approval of advisory fees by providing alternative, and less stringent, standards. In Jones v. Harris Associates L.P., No. 07-1624 (7th Cir. 2008), the Court of Appeals recently provided new insight into excessive advisory fee claims under Section 36(b) of the Investment Company Act of 1940 (the "1940 Act").  Prior to this decision, Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982) had been the leading authority on the evaluation of advisory fees. Gartenberg provided a list of specific factors that Boards of Trustees should apply in considering whether advisory fees are excessive. These factors have been applied to the evaluation of investment advisory fees for more than 25 years.

Jones offers a different approach than Gartenberg for analyzing whether an advisory fee is excessive and violates Section 36(b). For details on the differences between the former set of standards and those determined most recently by the Seventh Circuit, click here.

Although Jones provides a fresh and modern perspective for trustees concerned with the evaluation of advisory fees, Gartenberg is still in effect and thus should not be overlooked or disregarded, particularly outside of the Seventh Circuit. Moreover, trustees should continue to apply the Gartenberg approach because it provides a methodical and precise way for Boards of Trustees to address Section 15(c) renewals and to demonstrate that they have fulfilled their duties in renewing advisory and sub-advisory agreements. Indeed, although some may embrace the Seventh Circuit’s rejection of Gartenberg's approach, which appears to lack flexibility and may hint at an earlier era's view of the oversight animating the 1940 Act, Gartenberg's list of factors will nonetheless continue to be helpful in preventing imprecise or incomplete analyses. Therefore, Boards of Trustees would be prudent to consider Jones in their analysis of advisory fees, but still to rely on the Gartenberg approach in the assessment of whether such fees are excessive.

For more information on how the Seventh Circuit’s decision in Jones v. Harris Associates L.P. may affect your fund, or on general investment advisory fee issues, please contact Ballard Spahr's Steven B. King at 215.864/8604 or kings@ballardspahr.com.


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