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News December 12, 2005 Issue

Plaintiffs' Lawyers Attack Adviser's Marketing of Separate Accounts

As one California adviser has quite painfully learned, Investment Company Act Rule 3a-4 provides a safe harbor from investment company status.

But it doesn’t provide any protection from attacks by plaintiffs’ lawyers.

In a class action lawsuit filed in January 2004 and wrapped up (in the adviser’s favor) last month, a group of clients represented by San Diego law firm Krause Kalfayan Benink & Slavens asserted that Fisher Investments, a Woodside, California-based adviser with $26 billion under management, falsely advertised that it would provide personalized services to its clients.

Instead of the providing the promised customization, the suit claimed, the adviser managed client accounts according to a pre-determined strategy developed by a central investment policy committee. The suit alleged that while Fisher collected individual client information, such as age, income, risk tolerance, and time horizon, it did nothing with that information.

A Fisher spokesperson described the suit as "wrong-headed" and the plaintiffs’ lawyers as "opportunistic." He noted that his firm’s clients do receive personalized service and have long been able to customize their portfolios by excluding individual stocks, as well as industry or geographical sectors. "You can come to us and say ‘I don’t want any exposure in Japan, I don’t want any exposure in tobacco,’" he said. And, he added, "we fit within the four corners of [ICA Rule] 3a-4." The plaintiffs’ lawyers, he said, "didn’t know our business," and despite efforts to educate them, persisted in bringing the suit.

It’s easy to empathize with Fisher. Like many firms that attempt to distinguish their services from mutual funds, Fisher had emphasized its personalized client service and the ability of clients to customize their portfolios. And what large adviser doesn’t utilize some sort of central investment decision-making process? At least in the mind of the plaintiffs’ lawyers, however, those two features — typical to most separate account managers — should not go together.

The latest version of the plaintiffs’ complaint, filed on behalf of the adviser’s "Private Client Group" clients, provides a glimpse of what Fisher’s been dealing with for the past two years. The complaint alleged that Fisher’s marketing materials falsely stated that the firms’ personalized service and customized portfolios were designed to meet individual clients’ unique investment goals and objectives. Fisher, it claimed, "deceived" its clients by advertising that "investment counselors would work with each client to set up and maintain a customized portfolio designed to meet individual needs." The complaint alleged that Fisher’s three-person investment policy committee was the sole investment decision maker for the firm’s 10,000-plus clients. And, it alleged, clients were placed into pre-set model investment portfolios, without regard to their investment needs, risk tolerance, age, tax situation, or investment time horizon.

"Fisher feigned a portfolio customization process in order to further deceive customers about portfolio customization," alleged the complaint. For example, during an "information gathering call," the firm gathered personal information from clients that it asserted would be used to construct a portfolio meeting their unique needs. However, it alleged, even before the call had taken place, "Fisher had already developed a pre-determined portfolio . . . that was recommended to all clients. None of the information in the information gathering call was used by Fisher to prepare a portfolio recommendation."

The complaint made no mention of ICA Rule 3a-4, which provides separate accounts a safe harbor from investment company status, provided a certain level of account-level customization is present and other factors are met.

The plaintiffs’ lawyers alleged three causes of action against Fisher:

  • a violation of the California Consumer Legal Remedies Act (the firm "represented that its services had sponsorship, approval, status, characteristics, uses, or benefits [that] they did not have" and "advertised its products or services with the intent not to sell or administer them as advertised" in violation of the Act);
  • a fraud violation of the Advisers Act (seeking rescission of the clients’ advisory contracts with the firm and restitution of all fees paid to Fisher for its services); and
  • deceit ("Defendant engaged in acts that were intentionally deceptive by knowingly or recklessly disseminating [false representations] through its marketing scheme . . . . ")

The good news for Fisher: the Superior Court of California recently declined to grant the lead plaintiff’s motion for class certification (in fact, noted the Fisher spokesperson, it was the fourth time the court had denied class certification). Among other things, the court noted that the case would involve individualized issues of damage. "The remedy under the [Advisers Act] concerns not only the rescission and restitution of each class member’s initial service fee, but also requires an inquiry as to the reasonable value of the services to each class member," said the court in its November 17 ruling.

While Fisher may have come out intact, other advisory firms should be aware that their marketing materials could be challenged if they over-promise (in the eyes of plaintiffs’ attorneys) personalized services. As one investment management lawyer put it: "If you seek to shore up your Rule 3a-4 position by claiming individualization, make sure you balance that with some disclosure that you follow a model and that similar accounts will look . . . similar."

Vincent Slavens of Krause, Kalfayan, Benink & Slavens explained how he found the case. "I originally had an arbitration against [Fisher]," representing one of the plaintiffs subsequently named in the class action proceeding. The lawyer learned about the firm’s operations during the arbitration. "I personally went into the arbitration thinking that they actually did customize peoples’ portfolios," said Slavens. "I just happened to learn from testimony that it didn’t appear to be that way, so we brought the case."

The Fisher spokesperson noted that following the filing of the complaint and a subsequent BusinessWeek article about the case, the SEC launched an "informal enforcement inquiry." After a "soup-to-nuts" review that "exhaustively covered this issue," he said, the staff did not make an enforcement recommendation.

His advice for firms facing challenges from plaintiffs’ lawyers: "Do the right thing, and if you are doing the right thing, fight to the end, and you’ll win."