Aaron T. Morris is a partner at Barr Law Group. This post is based on his Barr Law memorandum.
The case law on who bears the risks inherent in a mutual fund’s operations is becoming paradoxical, and may now require intervention by mutual fund boards. Investment advisors have, incredibly, convinced some federal courts that they bear enormous risks in operating their mutual funds—so much so that they’re justified in charging hundreds of millions of dollars in extra advisory fees—but, at the same time, should not be held liable if and when those risks materialize, even if the result is a catastrophic meltdown of the fund.
Two cases exemplify this state of affairs. Last year, JPMorgan was trapped in a litigation requiring it to justify charging $132 million more, annually, to certain JPMorgan-branded funds than it charged third-party funds for the same investment advice. To justify the difference, the advisor hired an economist from Ohio State University to opine about the “substantially greater risks” JPMorgan assumed as to its own funds, which JPMorgan argued “require it to charge higher fees.” [1] This was the argument, despite the fact that, like virtually every other investment advisory contract in the country, JPMorgan’s contract included provisions that immunized it for everything short of bad faith and intentional misconduct. Nonetheless, the court apparently found the argument persuasive because it copied and pasted a section of the economist’s opinion into its order, and ruled in favor of JPMorgan. [2]
