(CN) – Mutual fund offering statements are not required to disclose potential conflicts of interest arising from the dismantling of the “information barrier” between investment bankers and stock researchers, the 2nd Circuit ruled.
Upholding a lower court decision, the Manhattan-based appellate panel found that two essentially identical class actions against two open-ended Morgan Stanley mutual funds failed to identify any illegal omissions in the mutual funds’ registration statements or prospectuses.
Investors argued that they should have been told that the mutual funds’ managers relied on broker-dealers for stock research, and that this could taint the objectivity of the research.
They sued Morgan Stanley under various sections of the Securities Act of 1933, claiming the broker’s offering documents for technology and information industry mutual funds omitted the potential conflict of interest, thereby increasing the risks associated with the funds.
The named plaintiffs allegedly lost more than $500,000 total due to the omissions; they estimated the combined class losses to “exceed $1 billion.”
But a federal judge in New York dismissed the actions, saying they failed to prove that the law requires disclosure of potential conflicts of interest.
Relying primarily on the logic of an amicus curiae brief filed by the Securities and Exchange Commission, the three-judge circuit upheld the lower court’s decision.
The SEC said that what the plaintiffs see as risks specific to the Morgan Stanley funds are actually “generic risks” encountered by every investor.
“All investors, including the funds’ managers, face the risk that the research they use to make their decisions may be biased or flawed, and that the prices they pay for securities may not accurately reflect the securities’ intrinsic value,” Judge Richard Wesley wrote.
The ruling quotes the SEC’s brief: “[T]he danger that analyst reports … will be tainted by undisclosed conflicts of interest or actual corruption is but one of an indefinitely large number of factors that could cause a fund (or any other investor) to buy overpriced securities, and it would not be useful to investors to require an attempt to set all of those forth in the prospectus.”
The 2nd Circuit added that the “true object” of the plaintiffs’ claims is “the alleged malfeasance of the mutual funds’ affiliated broker-dealer entities and not the public offerings conducted by the funds themselves.”
A ruling for the plaintiffs would require the court to expand liability under certain sections of the Act, and would mandate affiliate disclosures “not otherwise called for by the securities laws,” the panel concluded.