BulletProofBlog the blog on crisis communications

In this regular feature, Bulletproof interviews top plaintiffs' attorneys for their perspective on the crises likely to affect businesses in the near future. Today we talk to William A. Birdthistle, Assistant Professor of Law at Chicago-Kent College of Law who filed an amicus brief for more than 20 law professors supporting the plaintiffs in Jones v. Harris Associates.

That 2004 case is now before the Supreme Court. Plaintiffs are challenging the common practice whereby fund advisers charge significantly larger fees to individual versus institutional investors. Based on that discrepancy, the Jones shareholders claim the fees are excessive.

Last year, federal appeals judge Frank Easterbrook ruled that these fees are determined by market forces, so there’s no need for "judicial price-setting." But his Seventh Circuit colleague Richard Posner dissented, arguing that excessive compensation can indicate breach of fiduciary duty. Meanwhile, defense counsel has virtually disavowed Easterbrook’s position.

As the Supreme Court ponders the role of the judiciary in curbing marketplace excesses, the mutual funds industry faces what some warn could be pandemic litigation if the plaintiffs prevail in this case.

What is the overall significance of the Supreme Court’s willingness to hear the case?

William Birdthistle: Narrowly, the trigger was possibly the disagreement between Judges Easterbrook and Posner. They’re usually fellow travelers, so Posner’s sharp dissent grabbed a lot of attention.

Broadly, the Supreme Court may have seen a historic opportunity to weigh in on the momentous concerns raised by the recent financial crisis. This case is no small part of the financial system when you consider that mutual funds are a $10 trillion industry involving 96 million investors and $100 billion in annual adviser fees.

Even for more conservative justices on the Court, who may not be looking to address the financial crisis through judicial means, this case could be a prime vehicle for reaffirming their laissez-faire disposition. The case is particularly interesting coming at a time when the Supreme Court is the last remaining conservative bastion amongst the branches of federal government. Not since the 1930s has the high court been in such conservative opposition to financial regulation promulgated by the political branches.

How do you interpret the unwillingness of opposing counsel to argue Judge Easterbrook’s position that the fees here were a legitimate marketplace phenomenon?

William Birdthistle: Judge Easterbrook’s decision was notable for its aggressive embrace of deregulation, beyond even what the investment adviser sought or what Judge Posner found acceptable.  The industry has won victory after victory on this issue in the four decades since the law at issue was passed by Congress in 1970, yet Easterbrook’s opinion created an even more industry-friendly standard.

Mutual fund advisers may have rejoiced when he handed down his decision but, just weeks later, the current financial crisis burst forth. Then Posner published his dissent. Then the Supreme Court agreed to hear the case. So here was a ruling by Easterbrook that was trying to fix a situation that, from the industry’s practical standpoint, wasn’t exactly broken. Indeed, his remarkable ruling may have done the industry no favors by attracting heightened judicial scrutiny. 

So at oral argument before the justices, the defendants were content to appear reasonable by giving up Easterbrook and asking instead for a standard under which they have never lost a verdict.

What would be the impact if the plaintiffs prevail at the end of the day? Would the door be open, as some maintain, to an examination of virtually all fund advisory agreements?       

William Birdthistle: Defense lawyers frequently tell the Supreme Court, ‘If you don’t rule for my client, the result will be torrential litigation.’ Rarely do they discuss what will happen if they win: If the investment adviser wins this case, it’s very likely we’ll see an increase in fees from an industry that will have learned that fund advisers are legally invulnerable on high fees.

But the threat of future litigation if the plaintiffs win is far more limited, provided that the industry complies with the Supreme Court’s new standard.  First, the statute of limitations is only one year, so the exposure does not go back very far.  Bear in mind that the Supreme Court litigation will likely take more than a year, so the industry has had plenty of notice that courts may soon be looking at unjustifiable discrepancies between retail and institutional rates. Conscientious advisers could reasonably decide to be more conservative today and be shielded from all practical liability in future. 

Or, if advisers would rather gamble on future litigation, they can continue to be aggressive on fees as a measurable risk they’re willing to take ahead of next year’s final ruling. So whether we’ll see greater litigation in future is largely a decision for the industry itself to make

Larry Smith is Senior Vice President of Levick Strategic Communications, the nation's top crisis communications firm, and a contributing author to Bulletproof Blog. Connect with Levick on Twitter: @Levick.