Class-action suits piling up against Strong funds

Payoff may be small, but some investors think cases could force accountability

By PAUL GORES pgores@journalsentinel.com, Journal Sentinel

Monday, December 22, 2003

Peter Kugi isn’t expecting a big financial payoff in his class- action lawsuit against Strong mutual funds.

With only a $6,000 investment for his son in mutual funds managed by Strong Capital Management Inc., the Grafton resident probably won’t get much money if alleged improper market-timing trades at Strong are found to have harmed investors.

But Kugi, who agreed to be the plaintiff in a suit by a San Francisco law firm with expertise in class-action litigation in securities cases, said he hopes the pressure of legal action will force regulators and mutual fund firms to clean up the system.

“I think they should be held accountable, and I think a prospectus needs to mean something,” Kugi said.

At this point, it’s not clear how much any investor might recover in a class action against Strong. But that has not stopped lawyers from filing the suits, which are intended to represent the interests of large groups of people injured by a common action.

Since Sept. 3, when New York Attorney General Eliot Spitzer implicated Strong and other mutual fund companies in a scandal involving improper trades, at least 40 class-action lawsuits have been filed against Strong, said attorney James C. Mentkowski, whose Milwaukee firm filed one of the suits.

The suits cite Spitzer’s contention that Strong allowed New Jersey hedge fund Canary Capital Partners to rapidly buy and sell shares in its mutual funds, an opportunity not available to average investors. Experts say such market timing can dilute the share value of long-term investors in mutual funds. Spitzer’s office also has alleged that company founder Richard S. Strong himself engaged in improper short-term trading of his company’s mutual funds.

However, Spitzer, who is on a crusade to reform the $7 trillion mutual fund industry, has yet to file formal charges against the company or Richard Strong.

Strong spokeswoman Stephanie Truog said the company does not comment on pending litigation.

The dozens of class-action lawsuits against the company eventually will be consolidated, and a lead plaintiff and lead counsel will be chosen, said Edward Fallone, an associate professor at Marquette University Law School. Most firms want to be the lead counsel because it collects the most in fees — an amount that must be approved by the judge — if the case is settled or resolved in a trial, Fallone said.

“You go with which lawyer is representing the plaintiff with the largest economic harm and the jurisdiction they have filed in. That would typically rule,” Fallone said. “You also look at the lawyer — are they an experienced counsel, do they know what they’re doing in this area?”

No one knows yet which class-action plaintiff potentially has the biggest stake.

Several firms with national reputations in shareholder or financial litigation jumped in with class-action suits against Strong after Spitzer’s allegations. In most cases, out-of-state attorneys have teamed up with a local firm familiar with the court system here. For example, the Los Angeles firm of Cotchett, Pitre, Simon & McCarthy and the Denver law practice of Shughart, Thomson & Kilroy have partnered with Mentkowski.

With lawsuits now filed in jurisdictions ranging from federal court in New York to circuit court in Waukesha to superior court in Los Angeles, a body whose job it is to resolve such issues — the Judicial Panel on Multidistrict Litigation, in Washington, D.C. — may have to decide the venue, Mentkowski said.

Milwaukee a likely venue

At the moment, U.S. District Court for the Eastern District of Wisconsin, based in Milwaukee, may be the front-runner as the place for the cases to be consolidated. One case from the state’s Western District already has been transferred there, Mentkowski said.

“Strong has requested that the litigation be in the Eastern District of Wisconsin, so I think there is a really strong likelihood that it will take place here,” Mentkowski said.

It is also possible a judge in the Eastern District could decide to start consolidating the cases here and get the process moving, he said.

In any event, Mentkowski said he thinks a venue for consolidating the cases and assigning a lead law firm will be determined by March.

Speaking generally about class actions, Marquette’s Fallone said that “it’s in everyone’s interest to settle” them.

“The plaintiff’s lawyers don’t necessarily want to sink millions of dollars into trying the thing over a period of years. They have an interest in settling the case and getting some up-front cash instead of spending their money and rolling the dice on a jury verdict or taking a chance that the case gets thrown out on a legal technicality,” he said.

As for the companies being sued, he said: “The defendants want to settle it early before there’s a finding that these officers and directors did anything wrong, particularly if they can settle it under the terms of an insurance policy.”

What’s it worth?

Figuring out how much investors might recover in the Strong case is still a long way off, Mentkowski said. Most class actions take two to three years to close, lawyers say.

Although investors can file their own lawsuits apart from the class action, it may not be worth the legal costs to do so individually, Fallone said.

“The whole reason you have class actions is because the individual injury is very small,” Fallone said. “No shareholder is going to sue and put in all the time and expense if their injury is like $50. But if you get a few hundred thousand shareholders who were all injured $50, what the class action does is it now makes it economical for them to pull together and actually enforce their rights.”

Still, settlement amounts can fall far short of what the shares once were worth.

Investors who sued Heartland Advisors Inc. in a class action after the Milwaukee mutual fund firm slashed the net asset value of its High-Yield Municipal Bond Fund by 69% and Short Duration High- Yield Municipal Fund by 44% in autumn of 2000 settled this year for $14 million.

That worked out to an average of 32 cents a share for High-Yield fund investors and 17 cents a share for Short Duration fund investors. The net asset value per share in each of those funds had been more than $8 before the drastic markdown on Oct. 13, 2000.

Less than two weeks ago, the Securities and Exchange Commission announced it had filed a civil fraud complaint against Heartland and some of its employees in connection with the deep cuts to those two funds.

Even if they don’t get back all that investors have lost, class- action suits and the negative publicity they generate may cause others to think twice about bending rules or going astray, Fallone said.

“Class actions serve a useful function in that they provide a mechanism for deterring and punishing people in these cases,” Fallone said.

Kugi sees it that way, too.

“I honestly believe there is too much litigating in the world,” Kugi said. “But in this instance, if it weren’t for Eliot Spitzer and if it weren’t for some of these things coming out, where would we be? I just don’t know how you go about fixing it without the issues coming to the table legally somehow.”