New lawsuits challenge excessive fees

Your Funds

Your Money

August 29, 2004|By CHARLES JAFFE

IF YOU are looking for the most interesting fallout from the mutual fund scandals of the past year, don't go looking in old headlines.

Look instead at some fairly new court cases.

Plaintiffs attorneys jumped on Putnam Investments in May and Fidelity Investments in July, alleging that the money management firms were making excessive profits through "egregious price-gouging" because the firms charge ordinary customers one price but give huge discounts to big institutional investors for the same services. There's little doubt that a slew of similar cases will be filed against other mutual fund firms soon.

Attorneys have argued cases like this for decades, and routinely have gone down in flames. But the fund industry's trading scandals - helped by the class action lawyers having huge success against other industries - make it look like times have changed and that the fund world could be vulnerable here.

In the end, that's probably going to be a good thing for your investment accounts.

To see why, let's examine the basic charges.

The lawsuits allege that the operational savings that a fund company accrues when its issues reach the multibillion-dollar level never get passed to individual investors. Institutional investors bargain for a better deal when they deposit millions or billions with a money management firm, but the lawsuits filed thus far generally allege that fund trustees aren't negotiating for a better pricing structure when it becomes a giant.

The lawsuits suggest that if the Massachusetts state pension fund can pay Fidelity 0.2 percent to manage $500 million, that it makes no sense for trustees of Fidelity Magellan to let shareholders pay 3.5 times that much to run a fund that is 125 times bigger.

It's a good argument, although it's not entirely on point. With the pension fund, Fidelity is servicing one customer; with Magellan, it serves millions, and that adds up to higher expenses that get passed to the customer.

The lawyers are suggesting, however, that the fees for the actual management of money should be the same, or actually better for the fund investors who have a lot more money in the pool. In other words, if the pension fund is paying 0.15 percent for management - meaning 0.05 in servicing costs and other charges - the fund should be paying that base amount, too.

The fund's overall costs might be higher - reflecting the charges involved in serving the masses - but the individual would not pay more than the big guys for the stock-picking part of the equation.

It has been about 30 years since the last time fund investors won a significant case about excessive fees.

Fund firms fought back challenges with a number of weapons, not the least of which was the prospectus language and the perceived role of the board in running each individual fund as a business. Plaintiffs attorneys were outspent and outgunned.

Today, those attorneys have deep pockets. Some of the guys chasing fund companies were part of the Big Tobacco settlement, and they see the fund world as their next big target.

New York Attorney General Eliot Spitzer never brought charges of excess fees against fund firms, but in his settlements of improper trading allegations, he allowed management to face a smaller upfront fine in exchange for cutting fees over time.

That knocked the foundation out of a key argument that boards could rest upon in the past; if management would voluntarily reduce fees in a case that never even mentioned excessive charges, then obviously it was charging too much.

It all adds up to an environment in which plaintiff attorneys have a case they might win. That ammunition ultimately boils down to a case that fund firms would be willing to settle, rather than slugging things out in court.

Charles Jaffe is senior columnist for CBS MarketWatch. He can be reached at jaffe@marketwatch or Box 70, Cohasset, MA 02025-0070.

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