Do Bailouts Sow the Seeds of Suits?

Mutual fund firms have increasingly become targets of lawsuits as angry investors try to recoup losses from the poor performance of many stock and bond funds in 1994.

More often than not, investors have claimed that they were somehow duped. Suits against the Piper Jaffray Institutional Government bond fund and the Managers Intermediate Mortgage fund, for example, contend that shareholders were misled into thinking they were buying conservative funds--when in fact the portfolios were loaded with high-octane “derivative” bonds.

Likewise, the American Heritage stock fund was sued after diving 35% in ‘94, dragged down by losses in illiquid securities.

No matter how shocking the losses, however, experts warn that as long as a fund’s prospectus laid out the investment possibilities, charges of misrepresentation can be tough to make stick. Partly for that reason, prospectuses usually are written very broadly.

Yet some critics say the fund companies themselves may be encouraging lawsuit mania via highly visible fund bailouts. In dozens of cases last year, fund firms bailed their money market funds out of derivatives rather than allow the funds’ share prices to decline. Brokerage Paine Webber did the same for one of its short-term bond funds, specifically to settle a lawsuit.

The dangerous message of a bailout, analysts note, is that “we may be guilty, though we say we’re not.” It also implies that the fund firm has deep pockets--always alluring for lawyers. But if a lawsuit proves frivolous, the victims are the fund shareholders, who ultimately pay a fund’s operating costs, including legal fees.