Supremes show fund bosses how to skirt fraud suits
By Reynolds Holding
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The U.S. Supreme Court has shown mutual fund bosses an easy way to skirt class-action lawsuits. All it requires is keeping their big pots of invested money legally separate from management. But the ruling involving Janus Capital Group appears to have even broader implications for aggrieved investors. Exchange-traded funds, money-market funds and other listed firms might be able to follow the same blueprint to avoid liability.
The 5-4 verdict overturns a lower-court decision and marks a huge victory for the nearly $12 trillion mutual-fund industry. Even though Janus controls every aspect of its funds, the Supreme Court justices said it couldn’t be liable for fraud at several of them — because Janus is a public company that merely contracts to manage the funds. That’s how virtually the entire industry works, and makes the majority of funds all but bullet-proof from groups of shareholders alleging fraud.
Other investment firms have a similar structure. And what works legally for mutual funds probably works just as well for the $1.1 trillion ETF and $2.6 trillion money-market industries. That adds another worry for ETF investors in particular, because the fast-growing sector — led by the likes of BlackRock, PIMCO and Deutsche Bank — is increasingly moving into risky or illiquid investments like loans, commodities and municipal bonds.
Regulators are especially concerned about synthetic ETFs, which rely on derivatives for returns. The U.S. Securities and Exchange Commission is considering whether to put added protections on derivative-heavy funds, but any investors misled about the inherent risks would be hard-pressed to obtain legal relief after the Supreme Court’s ruling.
Listed companies more broadly may also now have a roadmap to sidestep shareholder lawsuits. At least in theory, there’s little to stop creative corporations from following the mutual fund model and putting management into a separate company that would then contract to run the operating company.
The structure might not guarantee protection from securities-fraud suits, but it could be worth trying given the court’s inclinations. The justices have rarely backed shareholder class-action lawsuits in recent years. That could mean a great many more duped investors get left high and dry.