In the wake of the mutual-fund scandals, New York Attorney General Eliot Spitzer in 2004 forced nine mutual-fund firms to cut the fees they charged to investors for the next five years. Now, in a rash of lawsuits against at least 11 of the industry's top firms, individual investors aim to repeat that feat -- and obtain compensation for alleged past overcharging.
The stakes are huge. Spitzer alleged that small investors are paying $10 billion a year too much in management fees -- the charges for researching, picking, and trading stocks and bonds. But the hurdles are considerable, too: For decades, courts have given the $7 trillion fund industry a pass on setting fees by finding that charges were not "excessive," the standard set by precedent. In fact, no investor has ever persuaded a judge to force a fund to roll back its fees. Most suits have been dismissed before getting to trial because fund companies successfully argued that their fees were in line with those of competitors.
In recent months, however, federal judges have turned down motions to dismiss cases against Franklin Resources (BEN), the largest publicly traded fund company; Ameriprise Financial, the fund unit being spun off from American Express (AXP); Putnam, owned by Marsh & McLennan (MMC); and ING Investment Management Americas, a unit of ING Group (ING). The suits are now headed to trial, with the first scheduled for next spring.
NEW PROGRESS. "Suddenly, you see a few cases where the courts are starting to send a shiver down the spine of every fund [company]," says Tamar Frankel, a Boston University School of Law professor who has followed the industry for almost 40 years. Six of the companies being sued -- Fidelity Investments, Ameriprise, Putnam, Janus Capital Group (JNS), ING, and American Century Investments -- say the suits are without merit and that they will vigorously fight them.
"Management fees at Fidelity are well within the range of fair and reasonable," says spokesman Vin Loporchio. The other five -- Franklin; Federated Investors (FII); MFS Investment Management, a unit of Sun Life Financial (SLF); AIM Management Group, a unit of Amvescap; and Waddell & Reed Financial (WDR) -- declined to comment.
The new litigants are apparently making headway because they've adopted a different legal strategy. The suits argue that fund companies routinely charge retail investors twice as much -- or more -- as big pension funds and other institutional clients for managing similar funds.
"TAINT ON THE INDUSTRY." The approach is based on a 2003 study by University of South Carolina Law School professor John Freeman and Florida State University finance professor Stewart Brown. They found that the management fee levied by the average retail stock fund was 0.56% of assets, vs. 0.28% for a similar institutional fund. It was the study Spitzer used to pry details of their fees from Alliance Capital Management, Putnam, Bank of America, and six other firms, and then force cuts of as much as 20%.
Investors might also be helped by a changed legal climate in which courts may be more skeptical of the industry's rationale for its fees, says Frankel. "The industry is concerned [about these lawsuits] because of all the enforcement actions and investigations," says Thomas S. Harman, a former Securities & Exchange Commission attorney who represents fund companies and is a partner at the Washington (D.C.) office of law firm Morgan, Lewis & Bockius. "There's a taint on the industry."
Of course, selling and running a mutual fund with thousands or even millions of individual customers is much more expensive than serving a single pension fund. To recoup these extra costs, though, fund companies typically charge separate marketing and administrative fees.
Fund companies are being forced to prepare a new line of defense. They say they will show that management fees paid by retail investors cover a much greater array of services than those paid by institutions.
EXECUTIVE SHAKES. "The management fee is not the same in both cases," says Brian Reid, chief economist for the Investment Company Institute, the fund industry's trade group. He notes that each mutual fund for retail investors is actually a separate entity and must pay for a board of directors. It's also subject to accounting and legal requirements that don't apply to pension accounts, he says.
It's still early days for these suits -- the fund companies will get another chance to have them dismissed before trials begin. But if the cases end up in front of juries, many fund executives may feel a lot more than just a shiver down their spines.
By Aaron Pressman in Boston