Not ... Just ... Yet ... Wells, Fargo

If Wells Fargo didn't already have enough to worry about, last week things got a little bit more “interesting” with the filing, against Wells, of a class action complaint filed by employee-participants in its $35 billion retirement plan.

Wells is busy dealing with the aftermath of its fake accounts scandal.  It has paid the CFPB a $185 million penalty, but the reputational fall-out is ongoing, as outsiders seem to show more empathy towards the (former) employees at the heart of the scandal, and less with the company itself. Hundreds if not thousands of Wells' employees were let go over a period spannin years, accused of fraudulently opening 2 million customer accounts ... enough to cost former Chairman and CEO John Stumpf his job.  He fell on his sword last month. 

Much has been made of  the culture at Wells Fargo that may have enticed (or even compelled) thousands of employees to conclude that it was better to conjure up fake customer accounts than to fall short of sales quotas, especially after some of the 5,300 workers fired for the scandal decided to sue for wrongful termination that they allege was in retaliatory.  (With a nod in Wells Fargo's direction, the CFPB put out a bulletin yesterday on "Detecting and Preventing Consumer Harm from Production Incentives.")

The complaint filed last week  alleges that Wells Fargo enriched itself at the expense of its employees by engaging “in a practice of self-dealing and imprudent investing of Plan assets by funneling billions of dollars of those assets into Wells Fargo’s own proprietary funds.” The plaintiffs argue that Wells Fargo’s proprietary funds, specifically its target date funds (which were a default investment option), charged higher fees than, and under-performed against, comparable funds. 

It is a familiar tune that we have heard from employee plaintiffs at other financial services firms, such as Morgan Stanley and Putnam Investments, two of several financial services firms recently accused of self-dealing through its employee retirement plans. Similar cases have already been settled (e.g. Ameriprise for $27.5 mm and Mass Mutual for $31 mm). Self-dealing asset managers are not the only alleged culprits – 2016 has seen at least two dozen lawsuits over retirement plan fees and offerings, including twelve by university employees.

Pat Bagley, Salt Lake Tribune; licensed by PF2

A primer on the ERISA litigation can be found here.

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The case is: Meiners v. Wells Fargo & Company et al (16-cv-03981) 

More on issues of corporate culture at financial institutions, here

Buy-Side Pricing Alerts

The money center banks have for years been heavily criticized for their pricing operations going awry. 

Many of these issues occur in the fixed income or over-the-counter (OTC) markets, where transparency is limited, secondary market liquidity near invisible, and pricing discrepancies sometimes easily and innocently explained away.

The banks have had their troubles and issues with consistent pricing across different divisions.  The "London whale" saga at JPMorgan was one of the big ones.  

Anybody who watched The Big Short recently will remember the palpable frustration in the air as the "shorts" waited anxiously for RMBS and CDO price depreciation, which lingered endlessly, much to their frustration, despite the obvious downward change in fundamentals.  In the book, Scion Capital’s Michael Burry is quoted as saying: 

“Whatever the banks’ net position was would determine the mark,” ... “I don’t think they were looking to the market for their marks. I think they were looking to their needs.”

Pricing Concerns ... Coming to a Fund Near You

In the Big Short, the focus on pricing was on banks' failure to lower prices quickly enough.  But pricing concerns are more typically focused in the other direction: asset price inflation. And nowadays the buy-side is taking the brunt of the investigative interest ... with the focus being drawn on their valuation of private companies.

First, let's step back.  Everybody who owns a computer (even a smartphone) can see where Apple's stock trades.  Yes there are off-exchange venues (including dark pools) but generally there is plenty of price transparency for liquid large-cap stocks.  

Importantly, all institutions would hold Apple stock at the same value on their balance sheets, whether they're long or short, expecting it to rise or fall.  Each institution's opinion doesn't matter: the market dictates.

In OTC and private company's equity valuation worlds, there isn't necessarily a ready market...so instead of marking-to-market the world more generally marks-to-model.  Each firm can hold the same security at a different price.

But the problem is, well, funds charge fees based on performance.  Higher asset prices translates into better performance.  Ergo, mark your assets higher and you'll make more money.  Voila!  Next, funds advertise their performance.  Higher marks therefore means better performance; marketing of stronger performance can translate into higher capital inflows from investors, which means more money under management, which means more fees.  Brilliant!

So that's the problem (the incentive/motivation is too compelling!).

The news pieces are coming in thick and fast.

On Friday, Reuters published a piece called: U.S. mutual funds boost own performance with unicorn mark-ups which explained that:

"The Securities and Exchange Commission (SEC) has been asking mutual fund companies how they value their stakes in companies like Uber, Pinterest Inc and Airbnb...  The regulator is worried investors could get hurt in case of a sharp tech downturn, according to two people familiar with the SEC's queries."

The WSJ had written a similar piece back in November 2015: Regulators Look Into Mutual Funds’ Procedures for Valuing Startups, noting that:

"According to a Journal analysis of data provided by fund-research firm Morningstar Inc. of startups worth at least $1 billion, there were 12 instances over the past two years in which the same company was valued differently by more than one mutual fund on the same date."  

And BloombergBusinessweek, back in March 2015, had put together perhaps the most entertaining read of all:  We Tried to Re-Create JPMorgan’s Mutual Fund Returns and Gave Up: "The bank’s impressive mutual-fund-group performance figures come with little explanation ."


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We're keeping a close eye on asset pricing issues, especially in the credit space.  If you notice anything we're missing, let us know.  Click here for a compilation of pricing issues we have seen recently, including specific investigations.

Investigations of Fund Fees (and Fees and Fees)

With the Blackstone settlement from earlier this week (see below), now is as good a time as any to start a list of investigations into fund fees.  If we're missing any, let us know!

1. August 2018: 18-229MR Update on financial advice institutions' fees for no service refund programs: "AMP, ANZ, CBA, NAB and Westpac have now paid or offered customers $222.3 million in refunds and interest for failing to provide advice to customers while charging them ongoing advice fees."


2. June 2018: THL: Accelerated Fees: "This matter arises from inadequate disclosures by private equity fund adviser THL regarding THL’s potential future receipt of lump sum fees from the portfolio companies of two THL-managed private equity funds launched in 2000 and 2006."


3. April 2018: A.G. Schneiderman Releases New Report On Mutual Fund Fees, Announces Agreement By 13 Major Firms: "NEW YORK – Attorney General Eric T. Schneiderman announced that after an industry-wide investigation into mutual fund disclosures and fees, 13 major mutual fund firms—including those run by some of the largest players in the mutual fund industry—have agreed to voluntarily publish important information about their mutual funds to all retail investors."


4. Dec. 2017: TPG: Accelerated Monitoring Fees: "From at least April 2013 through April 2015 (“Relevant Period”), upon either the private sale or an initial public offering (“IPO”) of a portfolio company, TPG terminated certain portfolio company monitoring agreements and accelerated the payment of future monitoring fees pursuant to the agreements. Although TPG disclosed that it may receive monitoring fees from portfolio companies held by the funds it advised, and disclosed the amount of monitoring fees that had been accelerated following the acceleration, TPG failed to disclose to its funds, and to the funds’ limited partners prior to their commitment of capital, that it may accelerate future monitoring fees upon termination of the monitoring agreements."


5. April 2017: SEC Charges Credit Suisse and Former IA Representative With Breaches of Fiduciary Duty: "The [SEC] today announced that [Credit Suisse] and one of its former investment adviser representatives have agreed to pay almost $8 million to settle charges that they improperly invested clients in more expensive “Class A” shares of mutual funds rather than less expensive “institutional” shares for which they were eligible. The SEC’s orders find that Credit Suisse and Sanford Michael Katz breached their fiduciary duties and failed to adequately disclose the conflict of interest created by such investments as they enriched themselves at their clients’ expense."


6. September 2016: ING Bank compensates Living Super customers due to potentially misleading costs and fees statements


7. August 2016: SEC fines Wilbur Ross firm $2.3 million over fees: “Billionaire investor Wilbur Ross' investment firm WL Ross & Co agreed on Wednesday to pay a $2.3 million fine to the Securities and Exchange Commission to settle charges that it did not properly disclose some fees it charged investors."


8. August 2016: Apollo to Pay $52.8 Million Over Fee Practices: “A common theme in our recent enforcement actions against private-equity firms is their failure to properly disclose fees and conflicts of interest to fund investors,” said Andrew J. Ceresney, director of the SEC Enforcement Division.


9. August 2016: Suits Target University Retirement Plans: "Many of the cases challenge 403(b) plans’ use of retail share classes of mutual funds, rather than lower-cost institutional versions of the same investments. They also contend that the plans’ arrangements with multiple record keepers cause participants to pay excessive administrative fees"


10. August 2016: SEC Probes Silver Lake Over Fees: "Investigation is part of regulator’s broad push to make sure buyout firms are being upfront with investors"


11. July 2016: Investors Are Getting Ripped Off on Index Fund Fees, Lawsuits Say 


12. Feb. 2016: George K. Baum Overcharged School District, Regulator Says: “Municipal-bond underwriter George K. Baum & Co. agreed to pay a $100,000 fine over allegations it charged a school district four times the typical fee to sell debt, in part to help cover the cost of bond elections, a regulator of securities dealers said.”


13. Jan. 2016: SEC: Alternative Fund Manager Overcharged Fees, Misled Investors 


14. Oct. 2015:  Blackstone to pay about $39 million to settle SEC charges over fees: the payments Blackstone received "essentially reduced the value of the portfolio companies prior to sale, to the detriment of the funds and their investors."


15. Sept. 2015: CalPERS: Tensions rise over private equity fees


16. Aug. 2015: Private equity industry sees more federal regulation: OICE...examiners had turned up widespread "deficiencies" in how private equity firms charge clients for fees and expenses and the agency had found "violations of law or material weaknesses in controls over 50% of the time."


17. June 2015: Earlier this year, a senior executive of the California Public Employees’ Retirement System, the country’s biggest state pension fund, made a surprising statement: The fund did not know what it was paying some of its Wall Street managers.


18. April 2015: N.J. pension fund heads to investigate investment fees and bonuses to private companies.


19. Dec. 2014: Two of the biggest private-equity firms are disclosing fees that had largely been hidden as U.S. regulators demand increased transparency from the industry.


20. Dec. 2014: With private equity firms under the regulatory microscope, the balance of power may be shifting — at least a bit — away from fund executives and toward investors.
    


21. Nov. 2014: Blackstone Group, which manages $279 billion, no longer will pocket extra consulting fees when selling or taking public companies it owns.


22. Sept. 2014: SEC reviews completed as part of a two-year effort involving nearly 200 funds have found cases where potential investors were given only the most favorable description of past performance rather than full disclosure of winning and losing bets.


23. Sept. 2014: SEC Charges New York-Based Private Equity Fund Adviser With Misallocation Of Portfolio Company Expenses: "An SEC investigation found that while Lincolnshire Management integrated the two portfolio companies and managed them as one, the funds were separately advised and had distinct sets of investors. Despite developing an expense allocation policy as part of the integration, it was not followed on some occasions, resulting in the portfolio company owned by one fund paying more than its fair share of joint expenses that benefited the companies of both funds."


24. July 2014: Federal regulators are looking at commissions that buyout firms receive for helping companies they control get goods and services at discount prices, as part of a stepped-up probe of private-equity fees.


25. May 2014: The Deal’s Done. But Not the Fees: “In some instances, investors’ pockets are being picked,”


26. May 2014: BlackRock faces lawsuits over “disproportionately large” fees.


27. May 2014: The SEC found illegal fees or severe compliance shortfalls in more than half of the firms it examined since starting a review of the $3.5 trillion industry two years ago.


28. April 2014: More than half of about 400 private-equity firms that SEC staff have examined have charged unjustified fees and expenses without notifying investors,


29. March 2014: Muni Investors Getting Fleeced On Trading Costs: Investors typically pay twice as much in trading commissions for municipal bonds as they would pay for corporate bonds.