The once genteel world of institutional investment management appears to be changing.
Litigation involving investors, consultants and money managers — once relatively rare — has become more frequent, and might represent a new era.
The threat of such litigation, fueled by losses caused by apparently sloppy due diligence by consultants or managers, and a lack of action by regulators, might lead all parties to greater due diligence in their activities.
One example: Consulting Services Group LLC filed suit against Morgan Keegan & Co. Inc. in Shelby County Circuit Court in Memphis on Dec. 22.
CSG alleges misrepresentations and a number of other illegal actions regarding mutual funds managed by Morgan Keegan on behalf of CSG pension clients, according to a news report. CSG sued in connection with alleged losses from investments in several of the funds.
Morgan Keegan, which hasn't filed a response yet in court, said in a statement about the suit, “The complaint filed by CSG is full of omissions, misstatements and half-truths, and we believe that the courts will find that it has no merit. As a registered investment adviser, CSG's continuing recommendation” of the funds in question “turned out to be wrong. Rather than admit to clients that it misread the economic situation — including that the credit crisis would severely impact the funds — CSG has instead sought cover by claiming that it was misled about the funds. This suit is a defensive move by CSG, part of an effort to divert its clients' attention from this and several other well-publicized problems.”
Ed Balsmann, CSG general counsel, couldn't be reached for comment.
It's unusual for a consultant to sue a money manager it has recommended for some investment-related relationship.
Consultants, on the other hand, have been subject to legal action by pension plan sponsors. The town of Fairfield, Conn., sued its former consultant, NEPC LLC, and accounting firm KPMG in connection with losses its defined benefit fund sustained in the Bernard L. Madoff Investment Securities LLC fraud. The suit alleged NEPC and KPMG failed to adequately perform due diligence and auditing duties, respectively, that would have uncovered the Madoff fraud.
Even individuals — participants and taxpayers — appear to be getting into the act, taking legal action when officials have failed to detect inappropriate actions.
In 2008, a group of whistleblowers — Associates Against FX Insider Trading — sued State Street Bank & Trust Co. alleging that State Street “added a secret and substantial markup” to foreign currency trades for CalPERS and CalSTRS. Last October, California Attorney General Edmund G. Brown Jr. joined the suit. The suit seeks estimated damages and penalties exceeding $200 million for what Mr. Brown's office estimates was an overcharging of more than $58.6 million over eight years.
Pension plan participants rely on their fiduciaries to oversee due diligence, and they in turn rely on consultants and money managers. Participants also rely on the Department of Labor to oversee the efforts of the fiduciaries, consultants and managers, and to provide guidance.
Clearly, given the numerous financial scandals of the past decade, many fiduciaries are failing in their duties, possibly because of complacency brought about by the lack of attention and lack of serious enforcement by the DOL and the Securities and Exchange Commission.
As a result, investors have too often been left on their own, and so have begun to take action on their own.
Theoretically, the SEC is going to help. With great fanfare, Robert Khuzami, director of the Division of Enforcement of the SEC, announced last August that his office was creating a number of specialized units “dedicated to particular highly specialized and complex areas of securities law.” One of those is the Municipal Securities and Public Pensions Unit, which in part is designed to conduct intensive scrutiny of disclosure issues, underfunded liabilities, “and "pay-to-play' schemes in which money managers and advisers pay kickbacks and give other favors in return for the right to advise the funds,” Mr. Khuzami said in a speech at that time.
In short, this new SEC unit would help clean up activity involving public pension funds. But the SEC has yet to appoint a head of the unit. Information is not available from the SEC on when it might do so.
Meanwhile, participants might have to rely more on their own efforts to bring about accountability. When due diligence comes up short, the question is whether an examination was thorough enough, or were the examiners misled. Legal action might be their only recourse.
Despite our so-called litigious society, litigation has not often been a course of action pursued by pension plan participants or consultants. But legal action appears to be increasing, and might be the best way to bring greater accountability until regulators toughen their enforcement.