One of the most significant and explosive cases of the year got underway at London’s High Court last month. Significant, because the ramifications for the pensions industry are enormous, and explosive because neither side can afford to blink first in a case that could run for up to eight weeks.
The protagonists are Unilever’s superannuation fund in London and Mercury Asset Management, now part of Merrill Lynch Investment Managers. At stake is £130m (e208m), and the reputations of the all-star cast of fund managers and academics who are on the lawyers’ lists to give evidence.
To set the scene, cast your mind back three years. It was then that the plaintiffs alleged that Mercury had been negligent in managing the pension fund assets, and promptly sacked it. The claim is that the managers had underperformed the benchmark by 10.5 percentage points . The plaintiffs argued that Mercury had said returns would not fall below the benchmark by more than 3%, although this assurance is not legally binding. On that both parties are in agreement, but Unilever claims that to miss the benchmark by such a wide margin, Mercury must have been investing in high-risk sectors and thus had been negligent. The Unilever £3.3bn fund had then some £600m in UK equities with Mercury.
The Unilever case is that its portfolio was managed in a way that was risky even by the standard of Mercury’s house style and that the underperformance limit never received the careful reappraisel required. In any event Mercury’s obligation was to comply with the agreed investment objectives so far as the appropriate ojective standard of skill. “ Their task was to adapt their style to the performance of their objectives, not the other way round,”say the trustees.
With astronomical legal fees in prospect, there has been plenty of talk about settlement in this case, but at the opening of the trial Merrill Lynch’s £25m offer was thought to be a considerable way from an acceptable sum to Unilever, who it is reported had been pressing for around £60m in compensation.
Merrill Lynch will argue that, because fund managers must have a strategy to outperform the market, risks have to be taken based on that strategy. It will further suggest that under Carol Galley’s management, Mercury was the best performing fund manager for Unilever in nine out of 10 years.
Merrill Lynch will point to the fact that Unilever only signed the new agreement with Mercury after nine years of excellent growth, and yet moved to sack the manager after just over a year.
With stock market values thought to have knocked £500m off the Unilever fund, it cannot afford to lose this battle. On the other hand, with other potential litigants following the case closely, neither can Merrill Lynch.
Sources close to the case say that the plaintiffs must establish that no reasonable fund manager would have managed the fund in the way Mercury did. Many feel the high level of proof required may prove difficult to demonstrate.
In its defence, the latter will point to the fact that in the 15-month period in question, the Unilever fund saw gains rather than losses. Some £200m was added to the value in a difficult year. This represented an absolute growth of 20.65%. But against this Unilever points out that the benchmark return in the year 1997-1998 was over 30%.
The defendants can be expected to argue that Unilever set Mercury the task of returning 1% over the benchmark, and to achieve that a fund manager must deviate from the benchmark, and take some level of active risk. The argument could then run: did Mercury take an appropriate level of risk in the process of making a complex series of judgments?
In the light of this the defendants’ lawyers will seek to portray that the 1% and 3% figures were not guarantees or limits or portfolio protection. They did not, it will be argued, guarantee that the portfolio would never perform outside the range in any given period of time. Further, though the fund did not perform better, there was no contractual obligation upon Mercury to reach returns above the benchmark.
Merrills may be encouraged, however, by the fact that in the US a New York judge threw out a class action against Morgan Stanley and one of its senior researchers, in which plaintiffs were seeking to link their investment losses to the research proferred. Indeed, so unimpressed was the judge by the plaintiffs’ submissions that he dismissed the cases “with prejudice” thus barring any further action based on the suits.
The real question, however, is what is the role of the benchmark? ‘The man in the street’ has always been warned his investments may go down as well as up. In this case presumably pension funds would argue that fund managers are well rewarded to ensure this does not apply to them.
So, can fund managers be sued successfully for mismanagement? The simple answer is only if they are proven negligent.
A settlement is not out of the question, but its terms will have to be very carefully worded in order not to give any other funds grounds for litigation.
There is only likely to be one winner in this case, and these will be easy to spot – they will be wearing wigs.

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