How investors' right to litigate will impact returns

Author: | Published: 2 Feb 2012
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Institutional investors may have to pay higher advisory fees following the New York Court of Appeals December 20 decision to allow investor-initiated litigation against financial advisers.

In Assured Guaranty (UK) v. J.P. Morgan Investment Management, New York’s highest court affirmed the Martin Act, the state’s blue sky law, does not vest the attorney general with exclusive ability to file claims against investment advisers, when damages are sought on grounds of negligence or breach of fiduciary duty.

“This is opening up a new avenue to New York litigants, so we can expect more claims being made that will increase costs to investment firms generally,” said Kevin Carroll, managing director and associate counsel at the Securities Industry and Financial Markets Association (SIFMA). “Those costs are likely to be passed on to investors in higher cost services.”

Investment company costs are also expected to increase as investment advisers purchase liability insurance or conduct more extensive written analyses and documentations of investment decisions, along with internal audits, as a precautionary measure against litigation.

Preventive measures like those might not improve the advice given to clients, but will add to client fees and erode investor returns, according to an amicus brief submitted by SIFMA, The Clearing House, The American Bankers Association and the New York Bankers Association.

Levin, Papantonio, Thomas, Mitchell, Rafferty & Proctor partner Peter Mougey, former president of the Public Investors Arbitration Bar Association, which filed an amicus brief in favor of the plaintiff, said investors will not see higher costs as a result of the decision.

“The argument that costs will be passed on to investors is the off-key drum beat used in front of every government agency against investor protection, like Dodd-Frank, across the country,” said Mougey.

Mougey pointed to states like California and Florida with higher fiduciary standards but average investor costs as an argument in support of allowing investor brought claims against financial companies.

Another lawyer preferring to remain anonymous said New York’s position as the US financial epicenter will encourage all investment advisers to raise their fees to combat potential litigation costs.

Columbia Law School professor John Coffee thinks the litigation costs to result from the decision have been overblown.

“Some have said this will open the flood gates,” Coffee said. “I think that’s exaggerated. There probably will be a successful effort made by financial institutions to put arbitration clauses in agreements with customers.”

Most broker-dealers already have mandatory arbitration provisions with their customers, so there would not be much of a change in broker costs because securities arbitration requirements do not hinge on whether claims are made under common law restrictions of negligence and fiduciary duties or the Martin Act’s restriction on securities fraud. Investment adviser costs may be different, though.

Investors might become more confident in the capital markets as a result of newfound right to file claims of negligence against investment advisers, perhaps increasing investment despite potential higher costs.

“I think if investors saw there was legislation and oversight of our markets to the point there wasn’t fraud du jour every few years, investors would have more confidence,” Mougey said. “Everyone is scared.”

Coffee does not expect increased investment as a result of the decision because investors have not yet won damages in a claim against an adviser.

“Investors don’t look at formal changes in the law; they look at whether there is significant difference in outcome,” said Coffee.

A decision on whether J.P. Morgan was negligent in its investment of funds guaranteed by Assured is currently before the state Supreme Court. Market effects of the NY Court of Appeals decision to hear the case could be determined by the presence, and amount of, awarded damages.

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