Mutual Fund Fee Rules and E&O/D&O Coverage
May 19, 2010
By P. Noble Powell, Senior Vice President, Willis of Maryland

There has been concern as of late regarding the Supreme Court’s recent review of the Jones v. Harris Associates case and the possible impact their ruling may have on how vulnerable mutual fund boards may be to allegations of excessive fees. This is borne out of the fact that most fund managers charge their larger institutional investors less than they charge the mutual fund shareholders. While investment advisers can easily justify the need for higher fees based on the transactional costs, the need for constant advisory attention to the fund(s), etc., the plaintiff’s bar may see any ruling as an opportunity to bring action against advisers and mutual fund boards for excessive fees and /or the failure to justify those fees.

Based on the arguments and the questions that are coming out of this hearing it does appear that the court will look to keep the current Gartenberg ruling in tact with the possible additional scrutiny of comparing fee structures…. Those in the industry have been heard to refer to this as the Gartenberg-plus standard. The Gartenberg case involved Merrill Lynch Asset Management and the finding was that in order for the management fee to be considered excessive the fee would have to be “disproportionately large”.

Under many E&O/D&O insurance programs there is an exclusion for allegations of excessive fees. The fee exclusion either needs to be removed in its entirety or modified such that there are defense costs covered under a carve-back provision. Since fines, penalties, taxes and disgorgement are all excluded under E&O/D&O policies even with coverage for excessive fees the insurance company is only going to pay for defense costs so the defense carve-back is just as effective as having the exclusion removed.

Should the court look to increase the standard to what was referred to earlier as the Gartenberg-plus standard then we can look for the plaintiff’s bar to view this as new feeding grounds allowing disgruntled shareholders to simply sue because they think the fees are excessive or that the mutual fund board did not adhere to their fiduciary duty in keeping the fees down through a fee comparison process. Please make sure your E&O policy has coverage for defense costs under any excessive fees exclusion.