Perspectives on Investment Management Disputes

A Q&A with Affiliate John W. Peavy III and Managing Principal D. Lee Heavner

John W. Peavy III testified on portfolio management issues in the American Funds mutual funds fee litigation, one of the largest securities matters ever to go to trial. In the following conversation with Managing Principal D. Lee Heavner, Dr. Peavy shares his perspectives developed from 38 years in portfolio management. 

Analysis Group affiliate John W. Peavy III 

Dr. Heavner: The allegations in portfolio management disputes vary dramatically across cases. For example, plaintiffs have alleged that they were harmed by portfolio managers’ deviation from historical strategies, portfolio managers’ failure to deviate from historical strategies, from returns tracking benchmarks too closely, and from returns not tracking benchmarks closely enough. How did these issues play out in the American Funds matter?

Dr. Peavy: In the American Funds litigation, even though the plaintiffs claimed they had been harmed by the funds’ under-performance, they did not dispute that the funds had performed well relative to their benchmarks or peer funds. Instead, the plaintiffs alleged that the defendants’ failure to control the growth of the funds’ assets under management caused the funds to perform less well than they otherwise would have. I've consulted on more than 100 investment management disputes, and I do not recall any other case in which plaintiffs have alleged that they were harmed because investments only performed well.

It’s also unusual that the American Funds plaintiffs’ allegations regarding investment performance did not challenge any of the defendants’ investment decisions. Typically, disputes over investment management focus on whether specific investment decisions were imprudent and/or negligent.

Managing Principal D. Lee Heavner

Dr. Heavner: Your background includes both academic research and professional portfolio management. How does this combination affect the way you approach your work in expert engagements?

Dr. Peavy: I often find it helpful to rely on a combination of my academic and professional experiences rather than approaching an assignment from a purely “academic” or purely “industry” perspective. For example, in the American Funds matter, I drew more on my academic background when I discussed the flaws in the opposing expert’s statistical analyses. However, I relied more on my portfolio management experience when I discussed trading costs and portfolio performance.

My teaching experience helps me explain complex concepts to audiences that typically do not have advanced training in finance. For instance, to teach students the difference between correlation and causation, I have used the relationship between the conference that wins the Super Bowl and stock market returns. I used the same example to explain the concepts in my work in the American Funds matter.

Dr. Heavner: Let’s step away from the American Funds case and talk about other securities matters. In many instances, litigation arises after portfolio managers invest in securities that subsequently experience large declines in value. Recent examples include investments in mortgage-backed securities (MBS) and in Lehman Brothers securities. Is there a straightforward approach to determining whether an investment professional is at fault in those situations?

Dr. Peavy: There is no one-size-fits-all approach to these cases, but there are some consistent themes. It’s important to evaluate investment decisions using only information that was knowable when the decisions were made. In addition, experts should avoid allowing the realized outcomes of investment decisions to bias their opinions about what a portfolio manager should have known at an earlier point in time. It’s also important for the expert to evaluate the decisions at issue in the context of the portfolio manager’s investment process as well as the portfolio’s investment guidelines.

Dr. Heavner: Looking ahead, how do you see the focus of investment management litigation evolving?

Dr. Peavy: Given the staggering magnitude of losses either directly or indirectly related to MBS and related derivatives, I expect these topics to remain a primary focus of investment-related litigation for at least the next few years. Litigation involving defined contribution plan investments that lost substantial amounts of money also will continue. Among other things, these litigations will focus on whether the plan fiduciaries acted prudently when they selected the investments to be offered in these plans. ■