New rules for the blame game

Thu Jun 3, 2010

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Fraud and breach of fiduciary contract related lawsuits for Madoff et al. are flying about everywhere. But what does it takes to win a case and will it change who takes responsibility in the end?


By Susan Barreto

When things went wrong in 2008, many investors learned that greed wasn't good. Now some of these same pension funds are learning that greed on the Gordon Gekko scale also does not necessarily equal success when it comes to the courtroom.

As rumours swirl that defendants in an early Madoff-related lawsuit are setting aside property and assets in preparation for a possible settlement, the court system in the US is seeing its fair share of pension investment litigation surrounding issues of potential fraud and fiduciary responsibility.

Recent non-Madoff related lawsuits do not seem to have been successful, although they may more easily lay claim to breach of fiduciary duty. Or is this something pension funds have forgotten about?

For example, Seattle City Employees' Retirement System lost the legal action it took earlier this year against a fund called Epsilon Global Active Value Fund II (see page 13). Rather than claiming fraud or failure of fiduciary responsibility, Seattle took aim at the failure of Epsilon to provide audited financial statements at the end of 2008, then its suspension of redemptions in the early months of 2009 and the fees it charged on money that was locked up.

Whether Seattle will follow up with an appeal has yet to be seen. But the city pension fund's defeat in such litigation follows similar disappointment at San Diego County Employees' Retirement Association, which lost its case against Amaranth Advisors. Officials at one time said they planned to appeal the court's decision, but it looks a tricky case - as Amaranth didn't engage in illegal activity and the court has ruled that the pension fund's contract with Amaranth did indeed contain routine disclosures that advised of some level of risk.

What about outright fraud? Bernard Madoff has been providing an interesting test when it comes to fiduciary responsibility - a hitherto largely untested area, but part of a mindset and sales technique that are often bandied around. Much of the Madoff-related litigation continues to clog the court system and includes a variety of pension funds and ancillary entities.

The recent case against Ivy by New York Attorney General Andrew Cuomo seems to be very detailed. Instead of focusing on failed fiduciary responsibility alone, the case goes into the profits Ivy allegedly made from misleading clients into believing Madoff was a legitimate investment, while officials at the firm apparently revealed in internal emails their misgivings over the investment.

Showing a profit from malfeasance may be the key to winning the argument. But Ivy says that the complaint relates to non-discretionary advisory services that it provided to a limited number of professional investment advisors who, in turn, chose to invest their own clients' assets with Madoff (see page 12).

As Cuomo makes his bid for the New York Governor's office, it may be that much of this activity is politically motivated. Public pension trustees themselves are subject to prudent investor standards, but does that mean they are responsible for losses if a manager messes up? Or is the adviser or consultant to blame?

The town of Fairfield, Connecticut's case against NEPC could ultimately determine who holds fiduciary responsibility. In early 2009, the town filed its first complaint which emphasised that NEPC conducted no due diligence on the Maxam fund that ended up being a feeder into Madoff. That case involves a number of defendants and has yet to be decided.

For now, the outcome is a whole new concept of headline risk. So whether more such lawsuits will be filed in future is doubtful, especially if it is up to the pension fund trustees to adequately define fiduciary responsibility within their portfolio - as they themselves may ultimately be held to the same test by the pensioners they serve. Then again, if Fairfield or the New York Attorney General's ­office were to win, it could create an interesting legal precedent.

ISSN: 2151-1845 / CDC10004H