Has Morningstar gotten too luminous for its stars?

Morningstar leverages its virtual monopoly of the fund ratings business through its ubiquitous Star Rating system by leveraging that clout to gouge fund companies for thousands of dollars, according to a fund-consulting firm.

The controversy stems from the services the Chicago fund researcher provides to fund companies and the way it bills for them. Valla Group, of Scottsdale Ariz., which provides data warehousing and Internet services to financial services companies, said that, in many cases, Morningstar licenses its products, such as its ratings and data feeds, to individual departments within a fund complex, instead of the whole company.

Morningstar might require a fund company to buy two distinct licenses, for instance, so that both its investment-management division and its marketing department can use its data feeds and other services, the consultants said. Valla Group executives said they have come across the issue with Morningstar time and again, as the consultants have tried to help fund clients slash expenses and reconfigure the way they use financial data.

As a result, many fund companies are paying $100,000 or more each year to access Morningstar's Principia data system and use its Star Rating designation and other data in their marketing materials, said Jerry Stockstill, Valla Group's chief operating officer. Valla consultants would prefer Morningstar issue a single license to companies at a reasonable price, so that firms can cut costs.

"If you have multiple entities within the organization, we're writing six checks for the same stuff," he said. This doesn't even begin to address multiple uses of Morningstar data at global firms, where marketing and investment management are still decentralized, Stockstill said.

The Valla consultants, in an effort to protect their clients, declined to disclose the names of specific companies that have been affected by the billing structure. But these are big firms, whose accounts are worth hundreds of thousands of dollars in business to Morningstar, they said.

Red Tape?

Morningstar, meanwhile, acknowledged that it does license its products to individual departments within fund complexes, but said it encourages firms to consolidate licenses because one license is easier to manage. In addition, the firm said it offers licenses at a discount if a firm meets certain criteria, including employing enough workers who use Morningstar services. Morningstar said that many of those discounts vary by the client.

Meanwhile, Lipper Inc. of New York, Morningstar's primary competitor, said that it usually issues a single license to a fund company, allowing complexes "unlimited internal use" of data and analysis tools. But the firm does not allow companies to exchange data between sister firms unless both of those firms have a license, Lipper said. In addition, if a firm wants to disseminate data and other information outside the scope of its licensing agreement, such as within a fund supermarket platform, Lipper said it charges an additional redistribution fee.

Valla Group's complaints illustrate a common scenario between vendors and the companies they serve, observers said. In most cases, vendors will charge whatever they want for one simple reason - because they can. "There's nothing wrong with that," said a San Francisco patent attorney, who asked to remain anonymous because his clients include many large software vendors. "You can even charge different customers different rates. I know it sounds mean or cruel, but it's just Morningstar's rights and their rights alone."

It isn't uncommon for vendors such as Morningstar to issue multiple licenses to one company, the attorney continued. For example, some companies will charge government agencies a discounted rate, he said. And newspapers and magazines will often charge doctors and other professionals less to encourage them to put the publications out in waiting rooms for clients to read. "Selective licensing fees, on their face, are not bad or illegal," he said.

In addition, Valla Group's accusations are, in part, a by-product of the rampant mergers and acquisitions that have swept through the mutual fund industry in recent years. Smaller fund firms have found Morningstar's licensing agreements palatable because they are not comprised of many divisions, Stockstill said. But as those firms are gobbled up or merged into other fund companies, the companies suddenly find themselves with multiple licenses across multiple departments - but little recourse in consolidating them in an effort to cut costs, he said.

"Morningstar is not very proactive, and to some extent obtrusive, in a firm's desire to collapse these multiple contracts into one global contract," Stockstill said.

Morningstar, meanwhile, has tended to let companies that have gone through rapid expansion or mergers or acquisitions to pay a single fee, thus allowing a complex to use the data in multiple departments. However the research giant will charge roughly what it would cost to license each of the departments individually, he said.

"Morningstar sees revenue going away when contracts are aggregated from many to one, so Morningstar charges more for a single contract," he said.

Want Stars? Get Data

The rub is that Morningstar's Star Rating system, which assigns mutual funds a rating of between one and five stars, has become the standard among individual investors for choosing a fund, in essence granting Morningstar a monopoly. So, if a fund company wants to use Morningstar's ratings - and most do - then it must abide by Morningstar's terms for licensing the data, and Morningstar often folds other services into a Star Rating contract.

"It's not fair," Stockstill said. "It's mind-boggling."

Morningstar responded that it prefers consolidated licenses because they make it easier for the firm to provide better customer service. In addition, the firm said that fund companies are free to use the Star Rating system for free in their advertisements, but it does license what is known as an "Essentials Package," which allows complexes to distribute Morningstar data and ratings in other promotional materials, such as shareholder mailers. Costs for such licenses depend on the client, the firm said.

Still, the Valla Group said that Morningstar's tactics have stirred resentment among some fund companies, who have decided to simply break their licenses and use Morningstar data and ratings however they choose, including in marketing materials. "We very often find that their contract is for research purposes, but they distribute the data to other departments," Stockstill said.

"With prices so high, some firms say, So what? We'll distribute the data anyway, license or no,'" he said.

Morningstar said that it has tried to curb the problem by better encrypting its data so that only those with passwords can use its services. "Those are things that we struggle with just like any organization does," said Kathy Weiler, Morningstar's senior product manager in charge of Principia, one of the firm's data software products.

Several fund companies declined to comment on whether they maintain single or multiple licenses with Morningstar. But one, who asked to remain anonymous, said, "People here recognize that Morningstar is a very costly proposition."

"Why do companies do stuff like this?" he asked. "Why do bears do certain things in the woods? It's just how it is."

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