Some people have suggested that the easiest way to determine when the next wave of litigation against brokers/advisers will begin is to mark the calendar one year after the market hits bottom. It takes about that long experts say for the anger to well up to the point where attorneys are brought in to the mix. And after the market hit bottom and the vast majority of the 401(k)s, pensions and individual retirement accounts (IRAs) lost more than they ever expected to lose, the lawsuits have spiked.
It is not just the individual investor who is suing; it is the companies who have hired plan administrators. But before we get to that, let’s talk for a minute about the individual investor. If you have been in the markets for at least a decade, invested in a mutual fund or some stock that was hot during the dot com era, you probably have received some sort of class action information in the mail. While you are entitled to just pennies on the dollar for any investment you lost, the goal of the lawsuit is to bring action against companies or advisers who misrepresented their wares to the investing public.
As an individual investor who feels as though you have been wronged, you most likely signed a right to arbitration amongst the paperwork you received upon opening the account. Arbitration in and of itself is a good way to get some relief from your anger (stats point to a 55% win rate for individual investors who take this route) but the process is time consuming.
In many instances, you will be told by your broker/adviser that the first step is a complaint letter. According to North Carolina law firm Hartzell and Whitman, this is a waste of time if an attorney isn’t involved right away. They tell clients that “After receiving the letter, the firm then spends considerable time “reviewing” the matter prior to denying the claim some months later by means of a terse, non-responsive letter. We recommend that customers not write complaint letters to their brokerage firms without the assistance of a lawyer.” Which translates into money out of pocket.
There is a time limit depending on the claim – which is why delays with the suggested complaint letter and the normal course of action most individual investors take by going to regulatory agencies – is often the first step your broker will tell you to take. And this is where many of these cases die.
But what if the claim is larger, against a firm who sold a small or medium sized business a plan that was not well-suited for the workers they employ. Few companies have reserve cash to pursue these types of lawsuits or begin to instigate the class action. So how does this occur? Investors pay.
Richard Fields is chief executive of Juridica Capital Management. which runs a fund that invests in one side of a lawsuit in exchange for a share of any winnings. He knows that the cost of bringing any sort of action against a plan administrator is a costly affair. Seeing the opportunity to profit on a wave of this type of action, hedge funds have jumped into the mix. Juris Capital, a Chicago firm backed by two hedge funds recently told the New York Times that its investments in such lawsuits generally run up to $3million and if their returns are any indication, this is has been a very lucrative business.
Lawyers like the idea of getting paid with the average law firm charging about $650,000 to represent clients. But these hedge funds have certain parameters. They don’t like juries. This puts their investment in the hands of people who may not understand everything at stake. Juries are often used when there is a novel legal issue being discussed, another reason to avoid investing in the action.
The larger question has yet to be asked: would many of the lawsuits being brought to arbitration there because investors have financed the process? Possibly not. Nine years ago, a group of small companies brought Nationwide Insurance to court over what they felt was a violation of ERISA, the federal law that governs the proper way to act in these sorts of retirement plan situations. It is still bouncing around the court system.
New regulations by the Department of Labor are designed to make the relationship between the plan administrator and the investments they use more transparent might help – if folks read it. If not, nothing will have improved. The bill gives regulators a year to write the rules.
The real test is whether fiduciaries are doing their job. When a company offers a 401(k) plan, they must name a person or group of people as the primary fiduciary of the plan. These people have the ultimate authority when it comes to the overall management with duties that include the prudent execution of the plan as defined by the law, following the plan’s written guidelines, ensuring the plan holds diversified investments, and do all of that while paying only reasonable expenses. This doesn’t mean this job falls to the most qualified person. For small company, it may be someone in human resources, or could be a committee formed of company executives.
The problem is blue sky. This term is used when investors trust their brokers/advisers so much, they could be sold the blue sky if it was recommended. Once the relationship is entered in to, the responsibility of determining the right investments, educating the investor on the risks they might face rather than the gains they might achieve and putting them ahead of the potential financial gain the investment might bring the adviser or their firm is a two way street.
If there are large sums of money involved – and this is the kind of money that could have serious impact on your financial well-being if it were to be lost no matter your net-worth, the investor should do some homework on their own. But when blue-chip stocks tank, as happened in 2008, there might not be a lot you can do or recover.
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