Neither the plain-tiffs’ lawyer nor the defendant mutual fund companies are willing to talk about a pending class-action suit that was filed in early December against I.G. Investment Management Ltd., CI Mutual Funds Inc., Franklin Templeton Investments Corp. and AGF Funds Inc.
The lawsuit, filed by Toronto lawyer Joel Rochon, a partner in Rochon Genova LLP, a law firm that specializes in class-action lawsuits, is alleging that the fund companies, by permitting certain institutional investors to engage in market-timing, breached their fiduciary duty to non-market-timer unitholders by not managing the funds in a manner that would protect the best interests of all investors. Alternatively, the claim alleges that the fund companies breached their duty of care to the unitholders on a similar basis.
The plaintiffs are seeking an amount of general damages for the alleged breaches of duty, as well as special, punitive, aggravated and exemplary damages — all to be determined. The laundry list of damages is standard for a class-action statement of claim.
Normally, class-action defendants don’t file a statement of defence. Instead, the next step is a motion to have the lawsuit certified as a class action to enable the defendants to find out whom, if anybody, they will be defending against. That means the plaintiffs’ lawyer will have to show that the “representative plaintiffs” named in the claim represent a large and ascertainable number of people who have a common interest in the facts and legal issues raised by the claim. This claim has one for each fund company.
“It’s a good case for certification,” says Michael McGowan, senior partner in Toronto law firm McGowan & Co. and an experienced class-action lawyer. “There are no individual issues.” The companies are trading for the funds as a whole; therefore, all investors are in the same position, he says. The fund company’s action will have “affected all or none. There’s a good deal of commonality, which is the main [certification] hurdle.”
That doesn’t mean that the defendants’ lawyer won’t try to derail the lawsuit at the certification motion stage, says Neil Gross, a partner with Carson Gross Christie Knudsen in Toronto. Certification motions can be mini-trials, in which both sides spend thousands of dollars in legal fees.
The defendants will challenge the claim’s two key assumptions: that mutual funds are held for the long-term by all investors and, therefore, there is an identifiable large class of plaintiffs who have been harmed, says Gross.
The defendants will demand practical solutions, he says. For example, how will potential losses be calculated? The plaintiffs’ lawyers “are going to have to have a viable method of quantification — even if they don’t have the [exact amount of plaintiff] data.”
Defendants often try to undo a class action by suggesting there is a long list of plaintiffs whose claims are monetarily insignificant. But, Gross notes, the Ontario Court of Appeal has released a number of decisions in recent months that show it is taking a more liberal approach to allowing class actions.
“Defendants know they’re behind the eight ball,” he says.
The OCA has said, McGowan notes, that if a common issue connects the plaintiffs, the case has to advance, no matter what the size of a individual plaintiff’s claim.
“Quantification comes after,” says McGowan.
If the lawsuit is certified, the next step will be discoveries, to ensure that anyone who applies to join the class-action suit has a valid claim. For now, four individual plaintiffs have been named as representatives of the four separate plaintiff classes, one for each fund. Dennis Fischer, a resident of Victoria, B.C., is the named plaintiff against Investors Group Inc.. Manon Sim of Newmarket, Ont., is the plaintiff against CI. Lawrence Dyken of Toronto is named as being against Franklin Templeton, while Ray Shugar of Toronto is the representative plaintiff suing AGF.
Within a few months of filing the claim, says McGowan, the parties will be brought together by a judge to set down a timetable of events, including the date for the certification motion.
There may be other motions designed to derail the claim, too, he adds. For example, the defendants might challenge an aspect of the claim. That type of motion would have to be scheduled before the certification motion.
The statement of claim in the lawsuit doesn’t assume the court will understand the mutual fund industry. Instead, it is educational in nature, describing mutual funds and market-timing.
@page_break@For example, the claim states: “Conventional equity mutual funds are intended to be long-term investments, designed for ‘buy and hold’ investors, and are, therefore, the favoured homes for family savings and retirement and college accounts.”
The portion of the claim describing market-timing states that the net asset value of mutual funds is set only once a day at the market close. Market-timers capitalize on this by using “time-zone arbitrage.”
The statement of claim gives the example of an international mutual fund that invests in shares of Asian companies. Because of the time-zone difference, the closing prices of the securities on Asian exchanges may be 12 to 15 hours old by the time the fund’s net asset value is calculated at 4 p.m. ET.
Market-timers can take advantage of the “stale” prices of the stocks that are in a fund by buying the fund at the NAV based on the stale prices, and then watching to see if the price of the stocks goes up. An increase in Asian stocks will result in a new, higher NAV the next day at 4 p.m. ET. Then the timers can sell and make a profit.
The wealth transfer, states the claim, “results in a cost of a minimum of 1%-2% of the assets under management.” The profits take away from long-term investors on an annual basis “in the range of several hundreds of millions of dollars.” Companies have attempted to minimize the impact of market-timing by keeping cash on hand, but this also detracts from the ability of the fund to invest fully on behalf of long-term investors, says the claim.
The claim also lays the groundwork for the duties owed to investors. “Portfolio managers must make investment decisions that are in accordance with the fund’s objectives, as stated in the fund’s prospectus, and they are prohibited from making investment decisions that are in their own interests, rather than in the interests of the fund and its investors,” it states. “In addition, portfolio managers are precluded from favouring one class of investors over other investors. Portfolio managers owe a fiduciary duty to all fund investors of utmost good faith, and of full and fair disclosure of all material facts.”
Not only does market-timing place fund management companies in breach of their fiduciary duty to investors, but “conflict arises because the managers are compensated on the basis of the amount of assets they have under management, whereas the return on a fund is based on the performance of the fund’s investment. The timer understands this perfectly, and frequently offers the manager more assets in exchange for the right to time.”
Glorianne Stromberg, former commissioner at the Ontario Securities Commission and now an independent industry commentator, says: “All of this reminds us of the incredible conflict of interest that exists between managers and fundholders, and the importance of independent fund company directors who are focusing on the interests of the fundholders.”
The lawsuit states that the facts alleged against each company are drawn from “some of the findings of fact made by the OSC.” However, it should be noted that each settlement agreement explicitly states that the “agreed facts” set out therein are done “without prejudice” with respect to any civil court proceedings. So, while the plaintiffs may have a head start with respect to making allegations based on those facts, a court cannot accept them as proven.
Among the suit’s allegations: I.G. had one market-timer that earned $36 million, CI had three that earned $90.2 million, Franklin Templeton had three that earned $120.8 million and AGF had six that earned about $47.9 million. In each case, not all the profits were due to market-timing, the claim alleges.
Most important among the allegations against each fund company is that the fund company settled for a small fraction of the assets under management. Based on an estimated cost to the mutual funds held within each company of 1%-2% annually, the settlements fell “well short of providing full reparations” to investors, says the claim, while also not recovering several million dollars in management fees paid by the funds to the fund management companies.
I.G. settled with the OSC for $19.2 million plus interest, and with the Mutual Fund Dealers Association of Canada for $2.7 million plus interest. IG’s settlements reflect only 0.68% of its AUM, says the claim.
CI settled with the OSC by agreeing to pay $49.3 million, which represents only 0.97% of its AUM, says the claim. Franklin Templeton’s OSC settlement reflects only 0.49% of AUM, while AGF’s OSC settlement represents 1.26%, the suit states.
It should be noted that all four settlement agreements state that the fund companies have adopted practices to prevent and detect market-timing, and eliminate the any potential adverse impact of frequent market-timing. IE
Companies, plaintiffs mum on class-action suit
Four mutual fund firms face a class-action lawsuit over market-timing; allegations are that companies breached fiduciary duties
- By: Stewart Lewis
- January 27, 2006 January 27, 2006
- 14:26