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PREVIEW-US Supreme Court case to test funds' fee structure

* Jones vs. Harris Associates biggest fund case in years

* Trade group fears fallout from adverse ruling

* Obama administration backs petitioner, seeks fee limits

BOSTON/WASHINGTON, Oct 30 (Reuters) - The $11 trillion mutual fund industry, which handles much of the nation’s retirement savings, is about to get some rare public scrutiny on how it charges fees to many small investors.

The U.S. Supreme Court on Monday hears arguments in Jones v. Harris Associates, a case involving decades-old standards on how mutual fund overseers determine fees for shareholders.

The petitioners will argue that Harris Associates LP of Chicago, though its mutual fund unit Oakmark Funds, charges much higher fees to individual investors than to large institutional clients.

In theory, boards of independent directors look after the interests of individual shareholders. The justices are likely to ask how well those directors have done on that score.

The issue could be a high-stakes test for an industry whose complex structure receives little public notice, even after a period of unprecedented volatility for the 401(k) retirement savings accounts it dominates.

The industry’s trade group has said that an adverse ruling could lead to a big industry shake-up -- including the potential for higher fees by triggering more lawsuits.

“If the petitioners have their way it would be a radical departure from the (fee-setting) regime we have had for the past 25 years,” said Paul Schott Stevens, president of the Investment Company Institute, whose members include Fidelity Investments, Vanguard Group Inc and other giant mutual fund firms.

BOGLE SEES CONFLICT OF INTEREST IN FEES

Some shareholder advocates, though, see the case as a rare chance to put the industry’s complicated governance under the microscope. They include John Bogle, the legendary founder of Vanguard, who is now an industry critic.

In a friend of the court brief, Bogle wrote that fund companies operate with “an inherent conflict of interest” in setting fees because they bargain with relatively weak boards.

Congress set rules to address some issues in 1970, but since then “the explosive growth in mutual fund assets has only exacerbated the problems,” Bogle wrote.

The case was brought by Jerry N. Jones and two other shareholders of the Oakmark Funds. Harris Associates serves as those funds' investment adviser, deciding which stocks the funds should buy and sell. Harris is an indirect subsidiary of Natixis SA CNAT.PA affiliate Natixis Global Asset Management LP.

The petitioners argued the fees charged by the Oakmark Funds were about twice what Harris charged to handle money for bigger institutional clients, violating the funds’ duties to individual shareholders.

Harris responded that it followed industry practices, and mostly won a series of lower-court decisions.

But along the way the chief judge of the U.S. appeals court in Chicago, Frank Easterbrook, voiced skepticism about a 1982 ruling known as Gartenberg that governs how funds are administered, leading the Supreme Court to take the case.

The immediate question is whether courts should have jurisdiction to consider lawsuits over excessive fees, even when advisers do not mislead fund directors.

A final ruling is likely to take months; one possible outcome could be new fee limits for fund firms.

The Obama administration has filed a brief siding with the shareholders. Solicitor General Elena Kagan said an investment adviser would have violated its duty if it negotiated and received an excessive fee, even if it fully disclosed the facts to the fund’s board of directors.

Business groups say competition is the answer, since investors can freely change fund companies. They warn that new rules could open the floodgates to more, costly litigation.

The Independent Directors Council, which represents directors on fund boards, said the petitioners’ arguments are “an attack on the entire mutual fund industry, as currently constituted under a congressionally mandated system.”

Not everyone sees the stakes as so high, though.

JPMorgan Securities analyst Kenneth Worthington wrote in a note to clients on Friday that even with an adverse ruling, fund companies would discover new ways to charge retail clients higher fees.

“We see the likely outcome of this case as a non-event for asset managers and the fees they charge,” Worthington said. (Editing by Steve Orlofsky and Gerald E. McCormick)

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