Banks are being socked with lawsuits over reorganizations of trust portfolios into mutual funds.
Though the cases differ in details, the common denominator is criticism of the banks' decisions to shift personal trust assets into mutual funds. The suits raise questions about whether the banks elevated self-interest above their fiduciary duty to trust beneficiaries.
In Jane Stein et al. v. First National Bank of Chicago, beneficiaries claim the bank, owned by the former First Chicago Corp., now part of Bank One Corp., beefed up its mutual fund family at their expense.
A former executive of Provident Bancorp, Cincinnati, claims he was demoted for challenging a demand that personal trust funds follow an earlier conversion of employee benefit funds into mutual funds.
A beneficiary accuses Amsouth Bancorp of imposing "exorbitant" fees on trusts as a result of investing in its mutual funds, an action described as "a preferential, self-dealing breach of fiduciary duty" in a court filing.
The suits involve a fraction of the trust conversions that have become commonplace in recent years, boosting the assets of many banks' proprietary mutual fund families.
Last year $18.1 billion of assets flowed from common trusts to mutual funds, and $9.1 billion has been converted this year, according to the Investment Company Institute, a Washington trade group for fund companies.
"Banks out there converted an incredible amount of money," and the litigation could create a test for how these conversions should be done, said David F. Toth, a former bank mutual fund executive and a senior consultant for Spectrem Group, a consulting firm based in San Francisco.
Though the transactions he is familiar with took place with "very thorough, very good" procedures advised by teams of attorneys and tax accountants, Mr. Toth says, bankers are asking, "Do we feel good about what we did in light of what's going on now?"
The wrongful-termination suit pending in the Supreme Court of Ohio against Provident is a result of a 1994 dispute between a former investment executive in its trust department and his boss over a plan that was never implemented. Management had wanted to shift assets out of personal common trust funds to "jump-start" mutual funds so they would be "profitable day one," according to a court filing by the former employee, Declan O'Sullivan.
Mr. O'Sullivan, who resigned, claims he was demoted after stating that the proposed conversion would be an imprudent investment.
In a brief filed by the bank, Mr. O'Sullivan's removal as president of Provident Investment Advisors Inc. was termed a "reassignment" and he was described as "a valued member of the Provident team." A spokesman for Provident declined to comment on the ongoing litigation.
The case against Amsouth, filed in the circuit court of Jefferson County, Ala., in July 1997, is not likely to continue much longer, a bank spokesman said. "A technical step needs to be completed," he said, adding "we expect the suit to be dismissed shortly." The plaintiff's attorney declined to comment.
The trust beneficiaries suing First Chicago are fact-finding and planning to gather additional plaintiffs. The bank's motion to dismiss was denied Dec. 10 by Judge Sheldon Gardner in Cook County Circuit Court in Illinois.
The case stems from a March 1995 conversion of $1.3 billion of assets in personal trusts from common funds that brought First Chicago's proprietary mutual fund family, then known as the Prairie Funds, to $2.75 billion of assets under management. Before the conversion, the majority of Prairie Fund assets were in money market funds, not retail-oriented stock and bond funds.
Unlike First Chicago, most banks waited to convert private assets from common trust funds to proprietary mutual funds after changes to federal and most state tax codes-effective 1997-deferred capital gains taxes. The plaintiffs claim their tax liability was not disclosed by First Chicago in forms they signed approving the switch.
They also say their investments in mutual funds are costing more in annual fees than when the assets were in First Chicago's common trust funds. Though banks typically rebate the investment management component of mutual fund fees, the converted trust accounts are charged the additional fees associated with administration and compliance costs of mutual funds.
Though some particulars of the First Chicago case are unique, such as the tax liability issue, the allegation that the bank used trust funds to bolster a nascent business could have implications for others, said one of the plaintiffs' attorneys, Charles Barnhill, a partner in Madison, Wis.- based Miner, Barnhill & Galland.
"It's one thing to have taken somebody's money and convert it into an ongoing mutual fund and charge a reasonable fee," he said. "It's another thing to take a person's money and start a business and use it as capital
to benefit themselves."
A spokesman for Bank One said he could not comment on pending litigation. The company is being represented the law firms of Mayer, Brown & Platt and Sidley & Austin.
There is no checklist to insulate conversions from legal attacks, because of the nuances of each situation, lawyers said. Trustees have to determine the appropriateness of any investment for beneficiaries, whether in a separately managed account, common fund, or mutual fund, they added.
"Each bank has to conduct its own analysis first of whether the consolidation is in the best interest of the beneficiaries," said Melanie Fein, a partner with the law firm of Arnold & Porter in Washington.
Mutual funds can be better forms of pooled investments than common trust funds, said Donald W. Smith, a partner in the Washington office of Kirkpatrick & Lockhart. That is, if they provide more diversification than the common trust funds, he added.
And mutual funds have more liquidity, disclosures, regulation, and oversight by an independent board of directors. "You're getting something for the relatively small increase in fees paid," he said.