Following an in-depth trial, a federal court judge recently found Metropolitan West Asset Management charged a reasonable fee for a fund it advises, considering the services it provides and risks it takes for the fund.
Amy Roy, one of the lead defense attorneys on the case and a partner in the securities litigation group of Ropes & Gray, fielded a series of questions about the lawsuit and what it’s outcome means for the investment management industry.
PLANADVISER: Having now successfully represented the defendants, can you give us some contextual information and reflect broadly on the ruling in Kennis v. Metropolitan West Asset Management?
Roy: The case fits among a slew of others that have been brought in the last 10 years, following the Supreme Court ruling in Jones vs. Harris. That case established a new standard of liability in these matters that courts have since been grappling with and trying to apply. For context, the Supreme Court determined the Seventh Circuit erred in holding that claims alleging mutual fund management’s fees were too high is not cognizable under Section 36(b) of the Investment Company Act of 1940.
After that decision, we saw the plaintiffs’ bar bring more than 25 lawsuits against various investment companies. The cases all make claims based on the discrepancy that is typically charged when an entity is acting as a primary adviser for a fund versus acting as that fund’s sub-adviser.
This case in particular is among the first where the district court has so thoroughly dug into the evidence and the record. The court has firmly discerned and determined that there are very meaningful differences between the services provided and the risks carried by a primary investment adviser servicing a proprietary mutual fund compared with a sub-adviser fulfilling a much more discrete role for an externally sponsored mutual fund.
This court has identified a number of the differences in detail, and I think this will prove to be helpful in related cases yet to be decided. At this stage, only two of the 25 or so cases were dismissed, and only a handful have been resolved through summary judgement. This is the case because these matters are complex and they involve fact-based inquiries. We hope that the result of this court’s very thorough examination of the evidence is that it will allow other courts to acknowledge the fundamental difference between advisers and sub-advisers to mutual funds.
PA: We write a lot about lawsuits filed under the Employee Retirement Income Security Act. Many of those cases make it through the summary judgement and dismissal phases, ultimately to be decided in favor of the defense. Do you see parallels here?
Roy: Yes and I am hopeful that this finding will serve as something of a deterrent to the plaintiffs’ bar when contemplating these types of suits in the future. At the end of the day, this has been four years of investment in the lawsuit by the plaintiffs and they have not prevailed. That’s not a great outcome for them. So, I’m hopeful that this thorough finding by the court will act as a deterrent for erroneous suits.
PA: Can you elaborate on the core theories in the decision and explain the difference between the two types of services investment companies provide to mutual funds—advisory and sub-advisory?
Roy: Sure. Every mutual fund has its own primary adviser, often called the sponsor. That sponsor is responsible for carrying out the day-to-day activities that are required for the fund to be compliant with the Investment Company Act of 1940, such as striking the net asset value on a daily basis, making sure there is adequate liquidity to meet shareholder redemptions, making sure disclosures are meeting SEC regulations, etc. All of these things are managed by the primary adviser—not the sub-adviser.
When an investment firm is acting as a sub-adviser, the primary responsibility for all of that aforementioned activity rests with the fund’s primary adviser/sponsor. At the end of the day, the primary sponsoring entity is doing more of the day-to-day compliance work, and they are legally on the hook if anything goes wrong. If a sub-advised fund, for example, makes a net asset value calculation error, this is not ultimately going to come back to the sub-adviser. It’s ultimately the responsibility of the primary adviser/sponsor.
The court in our case has firmly recognized the differences are meaningful, both operationally and in terms of the overall risk/liability profile.
PA: To what extent do you think plaintiffs’ misunderstanding of the complexities of the mutual fund marketplace are to blame for the filing of this type of lawsuit?
Roy: My view is somewhat cynical here. I think it’s pretty clear that the investors that are buying these products are largely sophisticated institutional investors. Or, if the shareholders are retail investors, they are typically having their funds selected for them through sophisticated retirement plans or other sophistical intermediaries. In this particular case, nearly 80% of the shareholders were sophisticated institutional shareholders.
I think that fact is important to mention and it’s something that our judge really took notice of. The plaintiffs’ bar likes to paint a different picture of these lawsuits. They try to find individuals who claim after the fact not to have understood the products they own. At the end of the day, most of the investors influenced in these cases are sophisticated, and they pressure their advisers and asset managers to keep fees low. They also have every ability to vote with their feet every single day. They are free to pursue other funds. The court in this case recognized these facts.
PA: Do you expect an appeal in this case?
Roy: In fact, the opposition has already filed a notice of appeal, and that’s not surprising. These plaintiffs have invested four years of time and resources into pursuing this claim, so there’s little downside for them to attempt an appeal. We feel very strongly that the decision, being so thorough and clearly reasoned, will stand.