January 21, 2013

The professional liability of investment advisors

Posted in Commercial Litigation by Gene Killian |

A New York state court recently handed down a very brief but interesting decision in the case of CMMF, LLC v. J.P. Morgan Investment Management, Inc.  The decision deals with the limits to be placed on an investment advisor’s liability.

The lawsuit, brought by an entity ultimately owned by billionaire Len Blavatnik, blamed JP Morgan Chase for losing $98 million in an account owned by Blavatnik’s industrial holding company, Access Industries, by betting on risky mortgage securities.  According to the suit, Access had hired JP Morgan’s investment management unit to manage the account, held by CMMF, LLC, with conservative objectives.  Instead, according to plaintiff, JP Morgan invested in risky and illiquid mortgage-based securities, at the same time that JP Morgan was dumping the same kinds of assets in its own portfolios.

Plaintiff terminated its contract with JP Morgan on May 6, 2008, and moved the securities to Bracebridge Capital.  Bracebridge later sold the securities on plaintiff’s behalf, at a substantial loss.  One question in the case was whether JP Morgan could be held liable because the prices that Bracebridge received on plaintiff’s behalf were lower than the estimated prices of the securities on the date they were transferred to Bracebridge.

The court said no.

First, the court referred to the specific terms of the investment management agreement between JP Morgan and plaintiff.  The agreement specifically stated that JPMorgan could not be held liable unless the claimed losses were “judicially determined to be proximately caused by the negligence or willful misconduct” of JPMorgan (emphasis added).

Second, the Court stated that there had been a “severing” of the “investment advisory relationship.”  Therefore, the Court opined, “[l]osses suffered as a result of the investment advice and decision-making of another advisor cannot be charged to [JPMorgan], and evidence concerning such losses is inadmissible.”  Presumably, the “investment advice” of Bracebridge was to sell the risky securities.

I confess that I’m wrestling with this one a bit.  Assuming that JPMorgan gave bad advice and that Bracebridge offloaded the risky securities in an effort to stop the bleeding, what difference does it make that the “investment advisory relationship” with JPMorgan had been “severed”? I note that this decision was rendered in the context of a motion in limine (to prevent the admission of evidence at trial), but had the practical effect of a partial summary judgment motion (essentially adjudicating a claim).  Sometimes, trial judges preclude the introduction of evidence in the belief that doing so will force a settlement.  Here, if settlement doesn’t happen, I have to wonder whether the appeals court will view the “causation” issue in the same way that the trial court did.  I have my doubts.         

As far as the liability of professional advisors goes, common sense prevails:  good communication can prevent heartache.  All professional advisors should keep good records of client communications, avoid giving unrealistic opinions or forecasts, respond quickly to complaints and criticisms, and encourage clients to become more proactive in investment management and decision-making.  If the CMMF case goes against the plaintiff and gets overturned on appeal, it’ll obviously be helpful to JPMorgan if records exist showing that the client was advised of the risks and approved of the specific investments that were made.       

- Gene Killian