IGNITES
Article published on Sep 9, 2005

Seligman-Spitzer Fight Could Be Epic Battle
By Alison Sahoo

J& W Seligman’s lawsuit against New York Attorney General Eliot Spitzer has all the earmarks of an epic battle. It addresses a controversial, high-stakes issue and it could drag on for quite some time, industry observers say.

The firm recently filed suit against Spitzer in Manhattan federal court, alleging the prosecutor exceeded his authority when he initiated a probe into Seligman’s mutual fund fees. It contends that only the SEC has jurisdiction in such matters.

Last month, Spitzer issued subpoenas asking for details about the company’s fee negotiations with independent directors. A representative from Seligman could not provide comment on the suit by press time.

Spitzer’s questions are in line with tactics his office has used to force firms that are in settlement negotiation to reduce their fees. Those demands grew out of his investigations into mutual fund market timing and late trading, but now have taken on a life of their own. So far, 11 of the companies settling with Spitzer have agreed to fee reductions. The cuts will cost some firms hundreds of millions of dollars. The mandated cuts have been controversial as many in the fund industry have opposed government officials setting market prices.

Spitzer’s approach of obtaining fee reductions through enforcement proceedings has generated enormous controversy within the industry. The SEC has notably steered clear of this approach, relying on traditional remedies of monetary damages, fines and compliance and governance mandates. Ropes & Gray partner Greg Sheehan notes that it’s an open secret that many have been hoping that a major industry participant would take Spitzer on regarding some of his more aggressive tactics.

“The Seligman litigation is not frivolous, and there are credible arguments to be made that Spitzer’s fee crusade is not within the scope of his authority under state law or is preempted by federal law,” he says.

Spitzer has used the states Martin Act as a means to force those fee reductions, It allows him a lower threshold than most other states or the federal government requires to establish wrongdoing because it lets him prosecute fraud without proving intent.

The Martin Act is so far-reaching and ambiguous, says Sheehan, that many firms have decided not to fight Spitzer’s allegations even though some have had ample grounds to do so.

The industry will watch the suit closely, says Kirkpatrick & Lockhart Nicholson Graham partner Robert Zutz,

“It’s a bold move, and Seligman raises an excellent question as to whether or not Spitzer and other state regulators have the authority to enforce contract approval standards established by the [ Company Act of 1940],” Zutz says, noting that the SEC explicitly rejected the notion of trying to use market-timing enforcement cases to address any potential advisory fee issues.

Further, when the National Securities Markets Improvement Act of 1996 was adopted, according to Zutz, Congress intended that the SEC be the primary regulator of the mutual fund industry while permitting the states to retain authority under anti-fraud provisions.

“Perhaps this case can add clarity on where the boundaries are,” he says.

However, it’s likely to be a long, drawn out battle because, Zutz notes, the case doesn’t lend itself to a settlement. Seligman isn’t asking for the type of relief that can be negotiated or split down the middle. It’s seeking an interpretation of laws that would prevent Spitzers office from proceeding with certain potential legal claims.

Spitzer could say he won’t pursue the subpoena or his inquiry into Seligman’s advisory fees any further, Or Seligman could drop its suit and comply with the AG’s requests. Either option would make it an all-or-nothing battle.

If Seligman does prevail, it could encourage other firms to bring suit against Spitzer or other pushy state AG5 by providing a precedent, says McCormick & O’Brien senior counsel Harry Delagrammatikas.

But a lot of the big fund companies are already on their way to resolving their issues and have come to some kind of an agreement with Spitzer, he says. “Many of them also may not necessarily want to follow the same route. Even though there can be a significant impact on firms from these large fee cuts, including workforce reductions, settling is still usually the path of least resistance,” says Delagrammatikas.

According to Morningstar, Seligman’s U.S stock funds’ fees average 1.77% of assets. That compares with an industry-wide, dollar-weighed average expense ratio of O,89°h. The average is low due to the large number of shareholders invested in index funds and other low-cost products.