Investment management claims: the turning tide
6 July 2009
Since August 2007, when the credit crunch really started to effect the investment community and when liquidity and confidence in structured products began to plummet, there has been surprisingly little litigation.
That is now beginning to change. Having addressed to a large extent the priority of protecting the short term financial health of their business, investors and financial institutions are analysing their losses and the merit of any claims they could bring against third parties.
The message from clients, particularly in the fund management sector, is that risk issues and dispute handling and avoidance are higher up on executive agendas now than they have been for over a decade.
Since the spotlight is very firmly on the financial institutions sector at the moment it’s unlikely that any significant dispute will go under the media radar and we are increasingly being asked to advise on the potential damage that a dispute could do to our clients’ brand value and share price.
Clients are recognising that there are real benefits to resolving disputes quickly and quietly with many increasingly opting for confidential processes such as mediation or arbitration.
Claims involving structured products often arise from relationships where large institutional investors handed over their assets to fund managers to invest.
Generally speaking, for almost a decade actively managed portfolios have been performing well against benchmarks. Now that market conditions have changed for the worse, investors have been revisiting the terms of their investment management agreements (IMAs) to identify possible breaches by the manager.
Many of these disputes will involve analysis and dissection of the products in question so the tribunal can determine whether the securities were in fact in breach of restrictions in the investment mandate.
Claims of this type are novel and, in some cases, the underlying documentation is being stress-tested by the courts and arbitral tribunals for the first time. The case law is evolving and the courts are very much looking at each case on its facts.
Despite the complexity of some of the underlying investment products which are giving rise to claims, the causes of action can be relatively straightforward with many cases being built around breach of contract, negligence and misrepresentation.
The scope and limits of fiduciary duties are also being stretched and tested in the courts. This is all the more relevant in the context of CDOs where the investor’s contractual relationship may be with a bankruptcy remote special purpose vehicle with few assets.
In cases where claimants have no incentive to sue their contractual counterparty, they will need to be more imaginative in selecting their targets.
A line of case law is developing in relation to failed investments and it is instructive to look at the key messages arising from them. Relevant cases include Peekay v ANZ Bank (2006), IFE v Goldman Sachs (2006) and JP Morgan Chase v Springwell (2008).
While each case is being determined very much on its specific facts, on the whole, the courts are taking a robust approach and litigants should be wary about bringing the more speculative claim.
In the claims where a cause of action can be established, quantum and valuation arguments can be the most complicated (and labour-intensive) part of the exercise.
This is particularly the case in claims against fund managers for breach of investment mandate or negligent portfolio management. The starting point is often South Australia Asset Management Corp v York Montague  AC 191 which confirmed that losses suffered as a result of a general fall in the market are not recoverable, even where those losses were foreseeable in the sense of being “not unlikely”.
This principle is usually reflected in the wording of IMAs which disclaim liability for fluctuations in the market and, whilst referring to a benchmark, often expressly state that achievement of the benchmark is not a contractual obligation.
Where assets have been acquired by a portfolio manager in breach of investment mandate, quantification of loss will involve tribunals being presented with expert valuation evidence on the decline in value of the prohibited assets.
Expert evidence from the fund management perspective may also be required on what compliant assets would have been acquired by a prudent fund manager at the relevant time without the benefit of hindsight and how those compliant assets would have performed over the relevant period.
Alternatively, depending on the nature of the claim, quantum may be assessed by way of a more straightforward peer group analysis or a scale up of the compliant portion of the portfolio.
Aside from the more opportunistic claims in relation to failed investments, we are now starting to see an increasing trend of litigants who have given serious thought as to their losses and are asking us to advance (or defend) high value claims. Financial institutions are preparing themselves for this trend to continue.
Ben Bruton is a partner at Eversheds.