The second of two lawsuits filed against large banks in as many weeks, if decided in favor of the various plaintiffs, has the potential to threaten the entire landscape of bank proprietary mutual funds.
What is more, similar lawsuits against additional banks that sponsor proprietary mutual funds and jumpstarted their fund groups through trust account conversions are on their way to court on behalf of other plaintiffs. The suits charge that banks knowingly breached their fiduciary duties by acting in their self-interest in funneling trust assets into proprietary mutual funds.
A potential class-action lawsuit refiled on June 16 in U.S. District Court in the Eastern District of Missouri by six plaintiffs charges Bank of America (BoA) with several counts of violating securities laws, breach of fiduciary duty and self-dealing. The allegations were brought by six individuals, each of whom was the co-trustee or beneficiary of a trust account under which BoA, or its predecessor banks, including Boatmen's Bancshares, the parent of Boatmen's Trust Co., served as fiduciary.
The lawsuit was refiled by Richard D. Greenfield of the Royal Oak, Mich., law firm of Greenfield & Goodman. Steven Hamburg with the St. Louis law firm of Summers, Compton, Wells & Hamburg serves as co-counsel on the case. Greenfield is also representing plaintiffs in the lawsuit recently filed against Wachovia Bank and its Evergreen Funds unit (see MME 6/19/06).
In the Wachovia suit, the bank is charged with acting in its own self-interest without regard to its responsibilities to the sole beneficiary of two discretionary trust accounts created in 1990 for a boy who had been shot and crippled. The trust accounts, originally funded with $81,700, were invested in Evergreen Funds for years, which, the lawsuit charges, levied high fees, despite the availability of lower-cost, better performing non-proprietary mutual funds.
"The BoA and Wachovia lawsuits are similar inasmuch as both banks improperly force their fiduciary accounts' assets to be invested in their proprietary mutual funds instead of investing accounts in the best managed funds with the lowest expense ratios," Greenfield said. "I am working with several prominent lawyers nationwide on similar suits against other major banks that do the same thing and rip off the affected beneficiaries," he added.
This lawsuit names BoA as a defendant but does not specifically name BoA's mutual fund unit as a co-defendant.
Focus on Trusts
The lawsuit charges that over a 15-year period, BoA acquired a string of banks, each with its own trust department and trust clients. In an effort to reduce costs and expand profit margins, the suit alleges that BoA subsequently consolidated those individual trust departments into a single private client wealth management division, which systematically converted trust clients' common trust funds into the bank's proprietary mutual funds, then known as the Nations Funds, but since transformed through additional mergers into the current Columbia Funds.
"With each new acquisition, [BoA executives] required the centralization and streamlining of the fiduciary services offered by the bank, including the increased usage of Nations Funds as vehicles for investment of the bank's fiduciary assets," the suit charges. Instead of assessing whether other, non-proprietary, less expensive mutual funds, such as those from Vanguard Group or Fidelity Investments, were more appropriate for trust customers, BoA systematically pumped those trust assets into the proprietary Nations Funds family, a clear breach of fiduciary duty, the suit claims.
In fact, the suit charges, in an October 1999 letter from the president of the bank's private client division to two of the plaintiffs, the bank attested that "the use of outside mutual funds in fiduciary accounts is in violation of corporate policy."
The lawsuit alleges, "in the process, these formerly independent institutions' [trust] fiduciary operations were transmogrified into just cogs in the fee-generating machinery of the bank and its corporate parent." It goes on to charge that those conversions were intended to pump up the assets in the Nations Funds, making the mutual fund complex significantly more marketable to other prospective investors.
The suit also charges that although BoA sought clients' formal approval to make those conversions, it failed to provide proper notice to its trust clients that they had the right to object to the transfer of fiduciary responsibility to the bank and could seek a replacement trustee. Moreover, the suit claims that for one defendant, her formal notice to BoA that it was being fired as her trust's fiduciary fell on deaf ears, with the bank's officers responding with a refusal to resign.
At the very least, the recent lawsuits against Wachovia and BoA shine a spotlight on alleged conflicts of interest banks face regarding their conversions of commingled trust or common trust fund assets into proprietary mutual funds in the late 1990s.
As the BoA lawsuit points out, those potential conflicts were at the very core of a Feb. 26, 1997 cautionary letter (SR-97-3) issued by the Board of Governors of the Federal Reserve System of Washington. In that letter, the Fed cautioned banking organizations to be sure trust fund conversions to mutual funds were in the best interest of fiduciary customers. It additionally raised the issue of possible conflicts of interest arising from a bank's use of proprietary mutual funds to invest trust funds when other non-proprietary funds could be equally as appropriate for clients.
A Master Plan?
Additionally, the lawsuit against BoA charges that bank executives hatched a master plan to eliminate previous trust departments and service trust clients with fewer personnel and greater standardization of investments. While trust clients had been dealing with a single bank trust officer, or so-called relationship manager, after the conversions, that personalized service was replaced with generic customer service provided by unsophisticated call center personnel.
As Bank of America swallowed up bank after bank, all but the highest-net-worth accounts were serviced by call centers in Dallas, Atlanta and other locations and manned by "lower-level bank personnel with little or no investment expertise" who relied on computerized asset allocation programs that were "designed to maximize the use of the bank's Nations Funds," the suit claims.
Also at issue are the higher fees trust clients incurred after the transfers. The transfers, the suit charges, resulted in direct and indirect charges to the fiduciary accounts that were 20 to 30 basis points higher. A letter to clients explaining the new mutual fund fee structure and promising credits to fiduciary accounts, was written in legalese and indecipherable, the suit claims. Further, the impression was given that such trust account "credits" would offset all fees, which was not the case, the suit notes, making the mutual fund accounts more costly to clients.
This particular lawsuit, although refiled last month, has been bouncing around various courts since February 2004 and has had to be refiled due to jurisdictional and other technical issues.
"We believe this suit is without merit and our position will be vindicated," said BoA spokeswoman Shirley Norton, who pointed out that this is an old claim that has been dismissed several times and refiled with various charges by an attorney hoping to get the case heard by different judges in different courts.
This BoA case centers on two key issues: the level of disclosure provided to trust clients about the conversion and subsequent fees, and whether clients fully understood the benefits of the conversion and what was occurring, said Jim Moorhead, partner with the Washington office of the law firm of Steptoe & Johnson. The suit seeks to prove that the bank breached both the duty of loyalty and duty of care, as well as losing its personal touch with clients, he added.
"While we tend to look for an overarching rule from a particular case, a vast majority of these class-action cases settle," he said. Even if the suit is found for the plaintiff, if may not have a huge impact on the bank proprietary fund industry, he added. "I don't think this would be an earthquake for the industry."
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