The stakes for institutional investors that fail to file claims in securities class action settlements just got much higher.

During the week of January 10, 2005, over 40 mutual fund managers were reportedly sued by shareholders of those funds in class action lawsuits alleging that the funds failed to collect as much as $2 billion in settlement payouts to which the funds’ shareholders were entitled. The lawsuits allege that the funds’ failure to claim this money during the three-year class period dating back to January 2002 was a breach of fiduciary duty, was negligent, and in violation of the Investment Company Act of 1940. The lawsuits seek compensatory damages for all of the money that the funds allegedly left on the table, as well as punitive damages and the forfeiture of all commissions and fees paid by fund shareholders.

Several of the funds named as defendants promptly responded that they did, in fact, file claims in settlements in which they were eligible to recover, and that the claims against them are without merit. Many of the defendants, however, are likely to have no such defense—recent academic studies have indicated that as many as two-thirds of institutional investors do not file claims in securities class action settlements, resulting in an estimated $1 billion in unclaimed settlement proceeds per year. Unclaimed funds typically are distributed on a pro rata basis to those investors who do file claims in a particular settlement, providing them with an additional measure of recovery that they otherwise would not have received.

Key Issues
The lawsuits against these mutual funds will likely turn on several key legal and factual issues. As a threshold matter, the court will need to decide whether mutual funds have a legal obligation to file claims in settlements under any of the theories advanced by the plaintiffs: (1) a fiduciary duty to do so, arising under either common law or the Investment Company Act; or (2) a common law duty of care requiring them to do so (a “negligence” standard). The plaintiffs allege in one of the lawsuits that

an investor pools her money with other investors in a mutual fund and entrusts complete control and dominion over her investments to the directors and advisors of the mutual fund. As a result of this relationship of special trust, directors and advisors of mutual funds owe a fiduciary duty directly to each individual in the fund….

The plaintiffs conclude that “Defendants’ failure to protect the interests of the Fund investors by recovering monies owed them is a breach” of that fiduciary duty.

Although the existence of a mutual fund’s duty to file claims does not yet appear to have been addressed by any court, it is well established that officers and directors of corporations owe a duty to shareholders to protect the company’s assets. Several commentators have opined that it is not a big step to conclude that just as a mutual fund must assure the safety of the securities in its portfolio, it also must assure that material amounts of money owed to the fund that can be claimed in securities class action settlements are not left unclaimed. Whether the courts agree with this conclusion will be critical, as will be the determination of whether a failure to file claims is, in and of itself, negligent conduct.

Key factual issues in these cases will include whether the funds were eligible to participate in settlements during the class period and, if so, whether they filed claims in such settlements. The lawsuits do not appear to include specific allegations concerning these facts, presumably because detailed information on fund holdings and claims filed by a fund is not publicly available. Rather, the lawsuits allege that (1) the fund in question typically owned billions of dollars in stocks; (2) during the class period there were hundreds of securities class action settlements, and the fund was eligible to participate in a “significant number” of these cases; (3) if the fund had filed claims in a particular settlement, the proceeds would have increased the total assets and immediately impacted the fund’s Net Asset Value; and (4) “upon information and belief, the Defendants failed to submit Proof of Claim forms in these cases and thereby forfeited Plaintiffs’ rightful share of the recovery obtained in the securities class actions.”

It is unclear upon what “information and belief” the plaintiffs base their conclusion that a particular fund failed to file claims in a particular case, but the allegations noted above suggest that this conclusion is based on the fund’s Net Asset Value (NAV) not rising following the distribution of proceeds in a class action settlement. It is correct that any settlement proceeds from a class action relating to a fund’s portfolio security belong to the fund, the receipt of which will have the effect of increasing the value of the portfolio and enhancing the portfolio’s performance. If this is the plaintiffs’ theory then there appear to be at least some holes in this logic. First, proceeds have not yet been distributed in many of the securities class action settlements listed in the lawsuits. Second, there may well be situations where although the proceeds from the settlement increase a fund’s NAV, external negative forces such as a drop in the market or other securities in the portfolio offset any gain in the fund’s NAV resulting from the receipt of the settlement proceeds. Third, proceeds from a settlement may in some cases simply be too small to impact the NAV.

Still, it is indisputable that funds often are entitled to receive hundreds of thousands—if not millions—of dollars in a single securities class action settlement, and the absence of any rise in a fund’s NAV in certain cases may demonstrate that the fund did not file claims in such a case. The true facts concerning a fund’s eligibility and claims filing are out there, of course, and can be easily determined by plaintiffs if they are able to obtain discovery (relevant documents and testimony) from the fund through the litigation process. The big question is whether an “NAV-based” allegation that a fund failed to file claims can withstand an immediate motion to dismiss the case filed by that fund seeking to have some or all of the lawsuit thrown out of court prior to any discovery.

Conclusion
Although some institutional investors are diligently filing claims in securities class action settlements, as many as two-thirds of institutional investors continue to leave billions of dollars on the table by failing to complete the basic tasks of monitoring and filing claims in such settlements. These tasks can easily be accomplished by engaging a claims filing service or by an institution training and committing its own internal resources. The recent barrage of lawsuits against mutual funds for their alleged failure to file claims should serve as a real wake-up call to any institution that is still leaving settlement money on the table.