Does pay make watchdogs lap dogs?

A widespread industry practice in which trustees simultaneously serve on several mutual fund boards — in some cases collecting hefty fees from each — is facing a showdown with irate fund shareholders in federal court.

Judge Robert W. Sweet of the U.S. District Court in New York City set the stage for a trial on the issue with a Jan. 19 ruling in a shareholder suit against Credit Suisse Asset Management.

The case has widespread implications for the mutual fund industry because other companies, including Fidelity Investments, T. Rowe Price, Franklin Templeton, Prudential Investments and BlackRock Advisors are mired in similar suits.

By allowing the action to continue, industry lawyers say Judge Sweet will create a precedent that could cause dissatisfied shareholders to line up and sue fund trustees.

“The fear is that they will go in attacking all funds with high expenses and bad performance,” says a lawyer who serves as counsel to the independent trustees.

The suit was originally filed in May 1998 on behalf of Robert Struogo, a shareholder since 1993 of the Brazilian Equity Fund, one of several originally advised by BEA Associates of New York, which became Credit Suisse Asset Management last year.

It alleges that five independent trustees on the boards of those funds compromised their independence by taking pay for their multiple board service.

breach of trust?

The trustees breached their fiduciary duty by approving a 1996 rights offering allowing existing shareholders to buy additional shares of the fund, the suit alleges, thus diluting ownership while boosting management fees.

The Struogo suit alleges that the independent trustees of the Brazilian Equity Fund took no action to lower BEA’s management fees or to replace BEA as the adviser after the fund performed poorly.

It also charges that the trustees thwarted a shareholder’s attempt to seek shareholder approval to end the fund’s advisory agreement with BEA.

Moreover, the suit contends, the independent trustees allowed the fund’s assets to be used to challenge the shareholder.

“In so conducting themselves, the fund’s `disinterested’ directors acted not as watchdogs, but as lap dogs for BEA,” the lawsuit claims.

The five Brazilian Equity Fund trustees also sat on at least four, and as many as nine other boards of funds advised by BEA. For their service on these boards, each trustee received between $45,500 and $94,500, the court papers allege.

Mr. Struogo argues that receipt of those fees compromised the trustees’ independence.

The court must decide at what point a fund trustee’s independence might be called into question based upon what the adviser pays them, say industry lawyers.

Mr. Struogo’s lawyer, Joel Feffer of Wechsler Harwood Halebian & Feffer in New York, declined comment.

In a statement to InvestmentNews, Credit Suisse wrote:

“CSAM believes the decision was wrongly decided and is actively reviewing its litigation options.

We are confident that the facts of the case, once developed on the record, will ultimately vindicate Credit Suisse.”

“What complicates the issue of trustee independence even more is the question of which laws prevail, federal or state law,” says David Sturms, a lawyer with Vedder Price Kaufman & Kammholz in Chicago.

In his recent opinion, Judge Sweet allowed the question of trustee independence to be interpreted under federal law, holding that there may be cases where independent trustees are so compromised as to become “house trustees.”

This ruling now allows the suit to be judged on the merits of the case, says Carl Frischling, a mutual fund industry lawyer with Kramer Levin Naftalis & Frankel in New York. Prior to that it was more of a generic issue.

“Judge Sweet is now saying, `Let’s see if this fund has independent directors or not,’ ” he says.

While some fund companies prefer to have a slate of independent board trustees oversee all funds, others have adopted the “cluster board” structure, says Mr. Frischling.

Often, very large fund groups maintain a handful of boards, each with their own trustees often broken out based on the funds’ objectives, he says.

One group of trustees, for example, may serve on the boards of international funds while another group oversees all fixed-income funds.

“What annoys me is the assumption that if you serve as a trustee on all boards, you are not independent, so any action is questionable,” Mr. Frischling says.