At the heart of an unusually public dispute in England is the extent of a money manager's legal responsibility for its investment performance for institutional clients.

According to published reports, a pension fund is claiming approximately $160 million in compensation from a Merrill Lynch & Co. division, Mercury Asset Management, that underperformed client-set benchmarks. The client, Unilever Pension Fund, asserts that other clients had better results and attributes this to the firm's lack of controls and central discipline.

The extraordinary public nature of this dispute underscores the major changes occurring in the money management industry. It has become globalized, institutionalized, and quantified.

Not surprisingly, its social mores and dispute resolution techniques are also changing. The legal practice needs to adjust to these changes.

Of course, institutional managers have long been accountable for their results. However, it has been a business rather than a legal accountability. The usual remedy for substandard performance is quiet dismissal. Legal claims (at least public) have been rare.

A manager's view is that an unknowable future cannot be guaranteed. In addition, larger organizations like to have multiple views and strategies, so they allow varying degrees of freedom to individual managers.

However, many institutional investors now expect that even active management strategies will use risk management techniques that prevent excessive deviations from market indexes. Clients hate underperformance more than they value superior performance. And they often expect investment decisions to reflect the view of the entire asset management firm rather than individual manager.

The legal duties of a U.S. money manager depend on various circumstances, such as the type of investor (individual, trust, pension fund, etc.) and the terms of the contract. However, a money manager is usually subject to a "duty of care" based on the standards of the industry, unless the agreement provides otherwise.

The duty of care is said to focus on the investment process, not the result. A manager should not be blamed in hindsight if the investment decisions were reached in a careful and professional manner-and if the records substantiate this (a much-overlooked practical point).

The application of this commonsense duty of care may be less than predictable in complicated settings. Though the standards of the industry are becoming more rigorous, they still vary and are constantly changing. Therefore it is sometimes hard to say what the standards of the industry are.

This ambiguity allows a disappointed investor to assert legal claims that may have settlement value even if they will not support an ultimate verdict.

Moreover, the industry's reliance on benchmarks and indexes changes things. It reflects a focus on relative rather than absolute performance.

The practice of building portfolios meant to deliver performance within a range of the benchmark for their asset class blurs the distinction between process and result-the process ensures the result. A failure to so construct a portfolio arguably violates the relational duty of care.

And money managers must expect that disappointed investors will assert any legal claim - even if questionable. Managers need to anticipate this at the beginning of the relationship, in the written agreement.

Such agreements are usually fairly short, with cryptic, jargon-filled (and thus ambiguous) descriptions of the investment objectives. Since they rarely address liability or performance directly, they create varying expectations for each party.

Agreements need to address performance and clear up this ambiguity. Of course, clients will resist proposed exculpatory language. However, the mere inclusion in a draft will help to flesh out the expectations of the parties, which can serve as the basis for an operative provision.

The manager should know if a client expects a modified index strategy. The contrarian manager should be certain to have the necessary freedom.

The manager must also ensure that its internal policies are consistent with its contracts. Plaintiffs often find damning contradictions in the manager's files during the discovery phase of a lawsuit.

It would be ironic if money managers' risk management ignored their own growing legal risk. Mr. Karol is a partner at Carter, Ledyard & Milburn, a New York law firm.

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