An Investor Litmus Test for the New Supreme Court

Did the addition of Supreme Court Justice Sonya Satamayor make the court friendlier to investors?  That question should be answered shortly as the Supreme Court decides the case of “Jones v. Harris Associates,” which could impact the 92 million Americans that own shares in mutual funds.  The legal issue the court will address is whether the excessive fees and expenses mutual funds charge is a violation of Section 36 (b) of the Investment Company Act (ICA) that says mutual fund advisors have a “fiduciary duty” with respect to compensation for their services.  The ICA also provides mutual fund investors with the right to file lawsuits if mutual fund advisors violate the law’s provisions.

While the decision itself focuses on this issue, there are broader practices which will also be exposed. Rules state that decisions regarding fees must be done by a board of independent directors.  But it’s not always clear what constitutes being “independent” for this purpose.

In this case, Harris Associates is the manager of several mutual funds including the flagship “Oakmark Fund.”  Investors claim that annual expenses have inappropriately increased as the fund grew larger. Indeed, the firm allegedly increased its expense charges from 1.05% to 1.1% of total assets.  Traditionally, mutual funds decrease expenses as they grow larger because they gain economies of scale.  Moreover, investors contend that Harris charged a smaller fee to large pension funds.

Investors in the Oakmark Fund allege that the expense charges were increased without a careful review by the supposedly independent board that oversaw the fund.  A major problem is that directors are paid by these expenses and routinely mutual funds have a “good ole’ boy” network of directors.  Harris Associates actually had former employees on their mutual fund boards.

Ideally for small investors, the Supreme Court will come down hard on Harris Associates and by doing so accomplish much for these investors.  Mutual fund directors would be more independent, and thus less likely to approve extremely high fees, while at the same time reinforce the fiduciary standard rule as defined by the ICA.

It’s an important decision for investors but it’s also a potential indicator of future decisions that will be of importance to investors.

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Leveraged ETFs: Should Investors Demand Their Money Back?

It’s an age-old trick: if one’s good, then two’s better.  But when it comes to leveraged exchange traded funds or leveraged ETFs and inverse exchange traded funds…that isn’t necessarily the case.

Over the weekend the Wall Street Journal reported that Massachusetts Secretary of the Commonwealth William Galvin sent subpoenas to several top financial firms including Ameriprise, UBS, LPL Financial and Edward Jones.

A leveraged ETF is really just a traditional exchange traded fund on steroids.  The returns are goosed, but the losses are magnified as well.

The groundswell of anger surrounding these products has been steadily increasing for a few weeks and we’ve been getting calls from investors interested in pursuing cases after getting stung by these instruments.

FINRA sent a letter to its member firms warning that leveraged ETFs and inverse ETFs were unsuitable for retail investors.  A great many other firms have abandoned them as retail products altogether.  For his part, Secretary Galvin wants more information about how brokerage firms marketed leveraged ETFs to investors and why so many lost their shirts.  According to the article, leveraged and inverse ETFs held $32.8 billion at the end of June, up $11 billion at the start of 2008.

It’s possible, if not likely, that these instruments were sold to investors as a way to hedge against particular portfolio strategies or even as a cheaper alternative to mutual funds.  But investors weren’t told exactly how speculative and costly leveraged ETFs were.  In fact, to properly use them, investors basically had to bet on what the market would do that day.

Indeed, a buyer of a leveraged or inverse ETF must have the wherewithal to make significantly sophisticated trading decisions everyday based on how the fund’s derivative index performed and guess which way it will move the following day.  I know from over 20 years of working with investors that they are notoriously passive and commonly afraid to take corrective measures without the prodding of their financial advisor.  For this reason alone this is an unsuitable product.

Leveraged ETFs, and ETFs generally, are also touted for the tax efficiency. While this fact may be true it would have no bearing on a retail investor using a tax-deferred IRA or other tax-deferred accounts (or indeed those who are already tax-exempt).

Finally, another major reason for the deserved outrage is that leveraged ETFs look like low-cost mutual funds that are pegged to a certain index or basket of securities.  But in reality they do not track the index like a passively managed mutual fund would.  Rather they trade on the open market and “close” everyday and restart.

This aspect of the instruments is important because it compounds the fund’s expenses, which in the case of the leverage ETFs are very high because of the cost of borrowing.  On a good day, when the investor guessed right, he or she might get twice the derivative index’s return, less expenses.  But on a bad day, the investor takes twice the loss, plus the expenses.  So to make up for the loss, the investor needs two days on the upside to make up for the one day loss.  For every day an investor bets incorrectly, the expenses compound so the break even point (i.e. the index) gets further and further out of reach.

It’s almost impossible to justify this expense for a retail investor.  And a financial advisor or broker cannot say that somehow a leverage ETF is more suitable than a simple index fund.  Thus, the likelihood for another barrage of investor cases is very high.

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Clients Sue Fiserv Over Madoff-Related Investments

Fiserv-Madoff Class Action

On September 30, 2009, the Federal Court in Colorado issued an Order appointing Lovell, Stewart, Halebian, LLP as interim lead counsel for the class in the Fiserv-Madoff Class Action.

Pursuant to Lovell, Stewart’s litigation plan, Zamansky & Associates, LLC will be working with lead counsel in prosecuting the class action.  Our responsibilities will include dealing with class members and assisting in the discovery and research phases of the case.

Any questions regarding the Fiserv Class Action should be directed to Amber Eichner at Amber@Zamansky.com; (212) 742-1414.

To view the amended complaint, click here.

Contact Zamansky & Associates

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