UPDATE 2-US judge rules against capping mutual fund fees

(Adds details, industry reaction, new paragraphs: 3, 10-15)

By Joan Gralla

NEW YORK, May 20 (Reuters) - A U.S. appeals court judge has ruled that mutual fund fees should not be capped, clearing the way for trustees and market competition to make these decisions, a lawyer who represented a defendant investment advisor said on Tuesday.

Judge Frank Easterbrook of the Seventh Circuit in Chicago in his decision said: "A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation. The trustees (and in the end investors, who vote with their feet and dollars), rather than a judge or jury, determine how much advisory services are worth."

The decision was welcome news for the $12.3 trillion mutual fund industry where millions of Americans invest their life's savings, with experts saying it will help retail investors understand what they are paying for more clearly.

The appeals court upheld a lower court ruling that reached the same decision, increasing the value of Easterbrook's ruling as precedent, said John Donovan, a lawyer with Ropes & Gray in Boston who represented Chicago-based Harris Associates.

The investment advisors who worked for the Oakmark funds, which also are based in Chicago, were sued for charging overly high fees, in violation of the 1940 Investment Company Act and a 1970 provision added to it, the decision said.

Such fees typically range from 1 to 1.5 percent of the assets managed, according to Donovan, who said Harris' fees were within that range. Such fees typically decline as the pool of assets rises.

"The entire mutual fund industry has been under assault by plaintiff lawyers for the size of their fees," Donovan said. The ruling, issued on Monday, changes nearly 30 years of precedent, and takes judges out of such decisions, he said.