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Executive compensation makes it to the Supreme Court

By: J.P. Freire
Associate Commentary Editor
11/03/09 12:58 PM PST

Even for free-market types, there is such a thing as getting paid too much. That may be happening among mutual fund managers, which is why the Supreme Court began hearing arguments this week in Jones v. Harris. The case essentially deals with the higher rates that mutual fund advisers may charge their captive funds versus their institutional investor clients. The fund's board of trustees generally negotiates on behalf of investors to arrive at this sum.

At first blush, the libertarian approach should be simple enough: Judges should not set the rates of mutual fund advisers, and instead should allow market forces to make the call.

But the case has a twist. Two judges known for their market-based view of the law are add odds in the case. Judge Frank H. Easterbrook of the 7th Circuit ruled against the suit, saying that if investors have a problem with how much the advisors are charging in fees, they can pull their money out and go elsewhere. "It won't do to reply that most investors are unsophisticated and don't compare prices," Judge Easterbrook said in his opinion in rejecting the shareholder suit. "The sophisticated investors who do shop create a competitive pressure that protects the rest."

On the other hand, Judge Richard Posner wrote that the trustees of a mutual fund that determine compensation for advisers are too insulated from market forces, and there isn't enough incentive for compensation to be appropriately adjusted. Abuse in these organizations was rampant, he felt, regardless of the number of firms available to the sophisticated investor.

Based on a review of the oral arguments from yesterday, it looks like the case is winding up in the weeds of figuring out how much is too much to justify the view that a fee is exhorbitant.

A fantastic symposium on the case is here and a good Wall Street Journal explainer is here. The SCOTUSwiki entry is here.