Wachovia Bank has been named a defendant in a potential class-action lawsuit that charges that the bank acted in its own self-interest without regard to its responsibilities to the sole beneficiary of two discretionary trust accounts originally created in 1990 for a boy who had been shot and crippled and relied on those trust assets to cover future medical and educational expenses.
Those accounts, originally funded with $81,700, the lawsuit alleges, had been converted from trust accounts and then invested for years in various Evergreen Funds, the bank's proprietary line of mutual funds, which charged high fees, despite the availability of lower cost, better performing non-proprietary mutual funds.
Furthermore, the lawsuit alleges that as evidenced by Wachovia road show presentations to prospective clients, bank officials were secretly not only told, but required, to funnel trust assets into the bank's own mutual funds without disclosing that mandate to clients.
The suit estimates that Wachovia currently has at least 5,000 trust customers with a collective $300 billion in assets.
In addition, the lawsuit claims that Wachovia layered on extra fees for managing the trust accounts on top of receiving the mutual funds' management and administrative fees, calling the practice "double-dipping." The lawsuit also accuses the bank of inappropriately charging "sweep fees" for shifting uninvested trust assets into a money market account of the bank.
The lawsuit seeks payment of as of yet undetermined monetary damages in order to compensate the plaintiff for mutual fund account losses and a disgorgement of the various alleged ill-gotten fees the bank charged. But if granted class-action status by the court, damages could exceed $5 million.
In an unusual twist, the lawsuit also demands that Wachovia be required by the court to significantly restructure its internal business practices so as to prevent future fiduciary duty conflicts of interest. Those structural changes suggest revamping the bank's procedures and practices so that clients' interests are placed ahead of the bank's interests, including the creation of a Chinese wall separating the bank's fiduciary functions from all other operations. It also recommends nixing the sweep fees or requiring the bank to outsource fiduciary account management.
The lawsuit was filed in U.S. District Court in Philadelphia on June 1 by Ralph Brooks, Jr., a 25-year-old handicapped man who had been shot in 1988 at the age of six. Wachovia Bank and three companies affiliated with its Evergreen Funds unit have been named as co-defendants. Although the board of trustees of the Evergreen Funds is implicated within the lawsuit for its possible culpability, individual fund trustees were not named as defendants.
The lawsuit was originally filed in March of this year, one month after the plaintiff ended his relationship with Wachovia, with an amended complaint recently filed.
According to Richard D. Greenfield, an attorney with Greenfield & Goodman, the Easton, Md., law firm representing the plaintiff, while the balance of his client's accounts had dwindled in part because of necessary withdrawals, fees to his client's accounts were in recent months exceeding income.
"We believe the allegations are without merit, and we plan to defend our firm against the lawsuit vigorously," commented Dan Flaherty, a spokesman for Evergreen Funds.
However, the lawsuit claims: "Contrary to its fiduciary obligations, the bank did not undertake an individualized monitoring and analysis of its irrevocable trust assets periodically in order to protect the interests of such trusts' beneficiaries.
"Instead, the [bank] devised a scheme to maximize its own profits by forcing irrevocable trusts' assets to be invested exclusively in Wachovia's proprietary Evergreen Funds, without regard to whether the investment was in the best interest of those trusts or their beneficiaries."
The suit goes on to charge that "Wachovia's wealth management division is not a proactive, customized and objective trust department but, rather, it serves as a means to funnel assets into the Evergreen Funds and otherwise generate unjustified and unjust profits."
Moreover, the suit charges, "Wachovia's wealth management division required fiduciary accounts to be invested in Evergreen Funds and, to the greatest extent possible, kept this investment strategy' a secret from the beneficiaries of such accounts."
The lawsuit also shines a spotlight on the sweep fees that Wachovia, and its predecessor banks, charged to trust clients when idle, uninvested cash was temporarily swept into a Wachovia money market account. According to the lawsuit, banks as trust fiduciaries are allowed to charge a reasonable fee when shifting uninvested assets. However, in the case of the Brooks trusts, the banks imposed sweep fees unjustly measured by the dollars transferred, not the cost of providing the sweep service. The lawsuit charges that this was "an additional revenue-generating device and scheme."
Wachovia now has several weeks to respond to the lawsuit's allegations, Greenfield, the plaintiff's attorney, said. Wachovia will probably argue that trust officers reviewed other potential investments and mutual funds but found that "the Evergreen Funds were the best possible ones. But that isn't true," he said. Greenfield doesn't expect to see the courts begin considering the particulars of this suit until the Fall at the earliest, and he will request that the court grant class-action status.
A Trail of Lawsuits
This isn't Wachovia's or Evergreen Funds' unit first run-in with a lawsuit alleging breach of fiduciary duty.
The current lawsuit filed on behalf of Brooks refers back to an earlier lawsuit filed due to the very creation of the Evergreen Funds.
In 2000, a class-action lawsuit was filed by trust clients Robert Parsky and Ann Roantree (Parsky et. al. v. Wachovia Bank) and settled in 2003. The suit charged that despite its assurances to trust clients that its intended conversion of the bank's trust assets to the Evergreen family of mutual funds wouldn't produce taxable capital gains, between December 1998 and July 1999, the conversions did generate taxable capital gains. The Parsky suit charged that First Union Bank breached its fiduciary duties. Wachovia and First Union merged in 2001.
The suit also alleged that although the bank knew that the conversion of the common trust funds to mutual funds had caused both long-term and short-term capital gains (short-term gains are taxed at a higher rate), it failed to tell its trust customers until after Dec. 31, 1999, by which time it was too late for customers to engage in offsetting tax planning maneuvers. The lawsuit was settled, and the bank reimbursed trust customers a collective $23 million.
The Parsky case is of significant importance, especially to the Brooks lawsuit, for another important reason, Greenfield noted. As part of the Parsky settlement, First Union demanded that injured class member participants broadly indemnify the bank from any past or any future violations of any nature, which could potentially negate this lawsuit.
By virtue of being a trust client of the bank at that time and sharing in the settlement (it is believed that Brooks received about $1,300 of the $23 million settlement) this very lawsuit that Brooks has subsequently filed against Wachovia could be challenged. However, according to Greenfield, the Brooks lawsuit will question the legality of what it refers to as the "unprecedented breadth of such release language" in the Parsky settlement.
Also of note, in March 2001, First Union settled two lawsuits charging it with self-dealing in relation to its employees' 401(k) plan. The retirement plan offered only the bank's Evergreen Funds as investment options. Employees charged that they lost $100 million in nest egg assets because of the funds' poor performance and high fees. In settling the suit, First Union paid $26 million to 150,000 employees.
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