Investor Robert Kenny is suing Pacific Investment Management Company LLC (PIMCO) and PIMCO Investments LLC, alleging the company received excessive compensation that had no relationship to the services rendered.
The lawsuit claims the excessive compensation received by the investment company through the PIMCO Total Return Fund, Kenny and the other fund shareholders is so disproportionately large that it could not have been the product of arm’s-length negotiations.
Kenny seeks to rescind the investment advisory agreements, the supervisory and administration agreements, and the distribution and servicing agreements the fund has entered into with PIMCO, and to recover the amounts charged by PIMCO or, alternatively, recover any improper compensation retained by PIMCO in an alleged breach of its fiduciary duty under Section 36(b) of the Investment Company Act of 1940 (ICA). The complaint states that because the excessive compensation is continuing in nature, Kenny seeks recovery for a period commencing at the earliest date in light of any applicable statute of limitations through the date of final judgment after trial.
The lawsuit calls into question compensation paid to former co-chief investment officers and co-chief executive officers Mohamed El-Erian and William H. Gross. Gross is PIMCO’s founder and started the PIMCO Total Return Fund in May 1987.
The complaint notes that the fund was until recently the largest mutual fund in the world. At the close of the fiscal year 2013 (i.e. March 31, 2014), the PIMCO Total Return Fund held more than $230 billion in assets under management.
However, according to the complaint, as the increase in assets in the fund led to larger and larger amounts of compensation being paid to the PIMCO, the fund’s performance suffered. In 2012, the fund failed to outperform its benchmark, and 60% of the fund’s peers outperformed the fund. In 2013, the fund lost 1.92% and trailed 70% of its peers in its worst performance since 1994. In calendar year 2013, for example, shareholders in Class A of the Fund saw returns of -5.97% before taxes, while shareholders of Class B shares saw returns of -6.36% before taxes.
The complaint argues that the fund’s poor performance has shaken up management at PIMCO. In early 2014, El-Erian announced his departure after purportedly butting heads with Gross over management of the fund. In a move that shocked investors, Gross also left the firm in September 2014, leaving to join competitor Janus Capital Group. News of both El-Erian’s and Gross’s departures compounded the poor results of the fund and led to billions of dollars in redemptions, the complaint notes. As of September 2014, the fund had seen outflows of investors for 16 months, totaling more than $60 billion in redemptions.
The lawsuit alleges that despite this poor performance, the compensation PIMCO has received for its work for the fund and fund complex has remained excessive and has led to extraordinary payments to its executives. Last year alone, PIMCO paid more than $1.5 billion in bonuses and compensation to Gross and El-Erian. According to the complaint, PIMCO claims that the compensation it pays “is designed to pay competitive compensation and reward performance, integrity and teamwork consistent with the firm’s mission statement,” but no other executive officer of a peer publicly-traded financial company came close to either of these bonuses on an individual level. It notes that one must aggregate the compensation of the CEOs of 20 publicly-held peer finance companies to come close to the amount of money Gross took home last year.
The lawsuit cites hearings before the Subcommittee on Commerce and Finance of the U.S. House Committee on Interstate and Foreign Commerce, in which one participant said the essence of a claim for unfair fees is “whether or not under all the circumstances the transaction carries the earmarks of an arm’s length bargain.” The participant also noted that a breach of fiduciary duty occurs “when a fiduciary permits an unreasonable or excessive fee to be levied on the fund,” or “when compensation to the adviser for his services is excessive, in view of the services rendered—where the fund pays what is an unfair fee under the circumstances.”
The complaint charts the fees charged by PIMCO for both institutional and retail class shares. It says for the fiscal year 2013, PIMCO received $641,047,097 in investment adviser fees and $608,321,040 in supervisory and administrative fees from the PIMCO Total Return Fund, for a total received of more than $1.2 billion. The complaint alleges various analysts criticized these fees, including one who said: “Pimco’s expense ratios for Total Return are no better than average, which seems ridiculous for a fund so large, and its prospects are worse.”
The lawsuit accuses PIMCO of raising fees over the years and not using the fund’s economy of scale to lower fees. The complaint explains that economies of scale are created when (as with the Total Return Fund) assets under management increase more quickly than the cost of advising and managing those assets. It notes that the work required to operate a mutual fund does not increase proportionately with the assets under management.
In a statement to PLANSPONSOR, PIMCO said, "PIMCO believes this lawsuit is without merit and intends to vigorously defend itself."