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News January 24, 2005 Issue

Role of Fund Companies in Securities Class Actions Challenged in Nationwide Series of Lawsuits

In the last two weeks, over forty lawsuits have been filed against major U.S. mutual fund companies, each alleging that the fund complex in question was derelict in collecting settlement money in class action lawsuits for their fundsí shareholders. Specifically, each suit alleges that the fund companyís advisers, directors, and/or affiliates failed to file "proof of claim" forms or otherwise participate in a list of 136 specific securities class action settlements.

"Because of Defendantsí refusal to complete and submit a short form, monies contained in dozens of Settlement Funds, which rightfully belonged to the Fundsí investors, have gone unclaimed," the suits claimed. "Defendantsí failure to protect the interests of Fund investors by recovering monies owed them is a breach of the fiduciary duty they each owe directly to Plaintiffs and members of the Class."

The forty-four suits are virtually identical. Aside from the period of time covered in the complaint, which ranges from two to four years as determined by state law, "all that changed in the complaints was the plaintiff-specific information and the defendant-specific information," said Randall Pulliam of Dallas-based Baron & Budd PC. His firm, together with Little Rock, Arkansas-based Cauley Bowman Carney & Williams and various local law firms, filed the suits.

Pulliam told IM Insight that the suits were filed over a three-day period beginning January 10, and that defendants began being served on January 12. As of last week, he said, "weíve served maybe half" of the "just over 800 defendants."

How did Pulliam, the apparent mastermind behind the suits, come up with the idea? At a previous firm, Pulliam explained, he specialized in plaintiffís securities fraud class actions. "I would see that when we settled cases, not all of all the institutional investors that had claims would actually file them." One day, it occurred to him: "I canít believe that they are not filing claims." Pulliam says that heís been preparing the cases for the past six months.

The suits began to receive national press attention last week. "The litigation may yet prove to be another potential embarrassment for the mutual fund industry," the New York Times warned in a January 19 article.

According to the complaint, when a recovery is achieved in a securities class action lawsuit for plaintiffs, investors owning shares in the settling company have the choice of opting out of the class and pursuing their own lawsuit against the company, or remaining in the class and participating in the recovery. If the latter option is chosen, the investor completes a proof of claim form and submits it to the caseís claims administrator. The claims administrator then takes the "pie" of recovered money from the settlement and divides it up amongst all those who have submitted valid claims.

The lawsuits, in essence, allege that the fund companies didnít file the proof of claim forms and failed to ensure that the funds either participated in or opted out of the class action settlements. The suits allege that only the fund companies (through their advisers, directors, and affiliates) were able to submit the claim forms on fund shareholdersí behalf. Fund shareholders "trusted Defendants to carry out this simple task on their behalf," said the complaints, but "Defendants failed to do so." The cases each apparently list the same 136 securities class actions that occurred during the class period. If the funds had submitted claim forms on behalf of the funds, said the plaintiffs, the settlement funds would have increased the fundís total assets, and therefore fund shareholdersí NAV would have increased.

In aggregate, Pulliam estimates that "in excess of $2 billion" was allegedly left lying on the table by mutual funds.

The cases acknowledge that the facts need to be brought into sharper focus and that there are legal questions to be decided, such as whether the fund companies actually owed fund shareholders a fiduciary duty to submit the claim forms. Each of the cases alleges that defendants breached their fiduciary duty to fund shareholders and were negligent. The cases also bring Section 36(a) and 36(b) counts under the Investment Company Act, and seeks to void the fundsí management contracts under Section 47(b) of the Act.

Making things more dramatic, the lawsuits ask the various courts to require the fund companies to forfeit "all fees and commissions" they received from plaintiffs and members of the class. Pulliam said that in fact, plaintiffs are "only seeking forfeiture of the management fees, not the commissions," acknowledging that advisers donít receive commissions.

What will happen next? "I donít know," said Pulliam. "Traditionally, mutual fund companies have been very vigorous in their defense in other, different types of suits," he said. However, he added, "itís my thought that itís such a simple case, that if the facts bear out as weíve alleged them, thereís not a lot of wiggle room."

Plaintiffs in each case have asked for jury trials. Pulliam said that his 70-lawyer firm, together with 26-lawyer Cauley Bowman, are willing to put a "tremendous amount of resources" into bringing the trials. "We will be prepared to take the mutual fund companies to trial," he said. "Itís going to be in their hands."

The defense is ready. The Dechert law firm quickly posted an update on its website warning that while the claims "need to be approached with care," a coordinated response by fund companies "will help litigate these matters efficiently and effectively." Dechert noted that some of the claims "may be factually incorrect." One of its clients, said the firm, determined that it invested only in one of the securities involved in the listed class actions, and that it had, in fact, filed a timely claim with regard to that issuer. The law firm said that it had asked the plaintiffs in that particular case to dismiss the action before they serve defendants or issue a press release announcing it.

Should non-fund advisers be concerned?

An adviserís obligation to a private client would seem to be a bit different from any obligation of a fund to file a proof of claim or otherwise participate in a class action settlement (assuming, of course, that the fund has such an obligation ó something that remains to be litigated). Unlike the fund scenario, where individual fund shareholders do not receive notice of pending securities class actions and do not have any individual standing to opt in or out of the settlement, private advisory clients may receive proof of claim forms directly and may very well file them on their own, without the adviserís involvement. Moreover, advisory clientsí custodians also may receive proof of claim forms and other class action-related communications, and may assist the client with filing the information. In other words, the adviser is not the only party able to act on behalf of the client.

And, of course, assuming the adviserís management contract is silent on the issue, there are a range of factors that may lead an adviser to conclude that it should not automatically file any proof of claims forms it receives on behalf of clients. The adviser may not be aware of the clientís other holdings in the affected security; the adviser may not be aware of other extenuating circumstances that may cause the client to want to "opt-out" and pursue his own remedy; the decision of whether to participate in the recovery or opt-out may be a legal one that the adviser is not qualified to make; and, as noted above, the client and the custodian also may take action on their own.

Even Pulliam acknowledged the difference between funds and advisers. Although he said that "the cause of action weíve pled is not particular to mutual funds," and that "any institutional investor could have the same claim pled against them," he went on to note it would depend on whether the clientís securities are held in the name of the client or in the name of adviser. "Thatís a huge difference," said Pulliam. "I could at least see a competing defense" by the adviser that the account is in the clientís name.

Nonetheless, with the recent lawsuits making headlines, advisers may want to review their practices in this area. One industry consultant reported that "over the years," heís heard of advisory clients threatening to sue advisers over their failure to participate in recoveries in securities class action settlements.