Financial services: suing fund managers

The landmark professional negligence claim brought by the Unilever Superannuation Trustees against Mercury Asset Management Plc (MAM) was settled during trial in December 2001. The settlement involved a substantial payment by MAM to Unilever, reported to be in excess of £70m, and led to widespread speculation that a number of similar claims by other pension funds would immediately follow. Of these, the only claim reported to have resulted in a recovery was that by the Sainsbury's pension fund, which also resulted in an out of court settlement with MAM. So why is it that the flood of claims did not materialise and what does this herald for aggrieved parties who feel their funds or assets have been badly managed?

The Unilever Trustees had alleged that MAM had managed the assets of the fund negligently, causing the fund to underperform significantly. The fund was a segregated UK equity fund with an investment objective of outperforming a composite benchmark by 1 per cent over rolling 3 year periods and a downside risk tolerance level of 3 per cent below the benchmark over any 4 consecutive quarters. Between January 1997 and March 1998 exceptional gains were made on the FTSE All Share Index which had a weighting of 60 per cent of the enchmark. The Unilever fund was not seeking recovery of losses but rather claiming compensation for the fact that its investments did not grow as much as the rest of the market.

The investment objectives quoted by fund managers do not amount to performance guarantees. They are merely targets which the fund managers seek to achieve. Accordingly, there is no question of a claim for breach of contract because the performance objective is not achieved. Any claim for mismanagement, leading to underperformance, must be based on an allegation of negligence, which requires proof that the fund manager failed to provide a level of service that the fund was entitled to expect and that that failing caused a loss.

Possibly the greatest difficulty with such claims is their novelty. As yet, there is no reported decision in which a fund manager has been found to have been negligent. In this respect, it is unfortunate that the Unilever case was settled before judgment as future claimants would benefit from some guidance on the courts' attitude to the legal principles applicable to such a claim.

It is clear that it is not sufficient simply to show either that the fund manager did not meet its performance objective or that other fund managers did better. It is necessary to show that, in all the circumstances including any agreed performance objectives, a competent fund manager would not have performed so badly.

In the absence of any authorities relating directly to fund management, it is necessary to look at case law in analogous situations, such as surveyors' valuations, for guidance. The fact that a valuation fell outside the "bracket" of reasonable valuations is a necessary condition of liability but it is not of itself sufficient. It is also necessary to show that the reasons why the valuation fell outside the bracket were caused by negligence. Further, the mere fact of a negligent mistake in the process of valuation will not necessarily mean that the overall valuation is itself negligent, if it falls within an acceptable bracket.

By analogy, to bring a successful claim against a fund manager, it would be necessary to prove both that the performance was exceptionally bad and that it was outside the "bracket" of reasonable performance. In addition, the claimant would have to show that the reasons for such bad performance were due to the negligence of the fund manager in the day-to-day management of the assets of the fund. This would involve examining in minute detail the manner in which its funds were invested and identifying a serious failing in the fund manager's investment strategy.

Lessons for other claimants

One of the greatest difficulties in establishing negligence by fund managers is the cost and expense of unravelling what has, and has not been done, and why. In the case of pooled funds the beneficiaries and/or trustees may have been provided with only relatively little information as to the underlying assets in which the fund was invested. This makes it almost impossible to obtain sufficient evidence to demonstrate the reasons for underperformance. The sums involved must be very substantial to justify the cost and, in most cases, the performance is bad rather than dreadful. It was alleged that MAM's performance was so poor, and the fund so large, as to justify the claim and MAM's investment strategy so ill thought out as to be clearly negligent. No doubt there are many funds and investors looking at their underperforming investments and wondering if they can bring a claim. The lack of reported decisions and law generally on the issue should not be a disincentive. It does not mean that suing these professionals is impossible but, rather, it reflects that these professionals would prefer to settle a claim before a judge decides in open court that their investment strategy has been negligent. There is no reason in principle why claims for negligent underperformance against fund managers should not succeed.

For further details please contact Neill Shrimpton at [email protected] or tel +44 (0)20 7367 2393 or Tony Marks at [email protected] or tel +44 (0)20 7367 2508.