Mutual Fund Investors Sue Merrill Lynch for One Billion Dollars

Miami Daily Business Review

November 10, 2002

Financial services giant Merrill Lynch mismanaged its highly touted Focus Twenty mutual fund and misled investors, costing them $1 billion in losses, according to a lawsuit filed Wednesday in Broward County, Fla., Circuit Court.

Darren Blum of the Law Offices of Darren C. Blum in Plantation, Fla., filed the suit on behalf of a handful of clients, including Thomas Strano, a Boynton Beach, Fla., retiree who Blum says lost $102,000 in the fund. The fund focused primarily on technology and energy stocks, including those of Enron.

The lawsuit, which seeks class action status, has three counts: breach of fiduciary duty, negligence and breach of contract. Blum, who handles investor suits against stockbrokers, says hefiled the suit after receiving hundreds of complaints during the past two years about the Focus Twenty Fund.

Merrill Lynch spokesman Mark Herr called the lawsuit “baseless and without merit.”

“The prospectus for the IPO adequately disclosed the risks,” he said, adding that “the average Nasdaq stocks have lost 80 percent and the average Internet stocks have lost 85 percent in the last year. Clearly, this is a side of the economy that has not done well.”

The lawsuit attempts to piggyback onto New York Attorney General Elliot Spitzer’s high-profile investigation of Merrill Lynch. Spitzer reported that the company’s stock research was compromised by pressure from its investment bankers. On May 21, with its top executives facing deposition in Spitzer’s litigation, Merrill Lynch agreed to pay $100 million to New York and other states. It has apologized for its behavior and says it has changed the way its analysts are compensated, so they are not beholden to their investment banking clients.

Other financial giants are also under scrutiny from Spitzer and the Securities and Exchange Commission.

In his complaint, Blum alleges that New York City-based Merrill Lynch, with offices worldwide, knew that the Focus Twenty Fund had problems but withheld that knowledge from investors; that the firm wrongly steered retirees and other long-term investors into the risky fund; and that the firm had a conflict of interest because it simultaneously was representing some of the companies whose stock was in the mutual fund as their investment banker.

“There was no conflict of interest,” Herr said. “The plaintiffs are confusing the investment banking side with the brokerage side. There’s a wall between them.”

Exhibit 1 in Blum’s lawsuit is an affidavit from Spitzer’s investigation, which includes e-mails from Merrill Lynch analysts showing that their research was compromised by pressure from investment bankers.

In addition, the suit claims, Merrill Lynch over concentrated the fund’s portfolio in high-tech and energy stocks, including Enron, Sonus Networks and Millennium Pharmaceutical.

In his complaint, Blum estimates there are thousands of alleged plaintiffs around the country.

Merrill Lynch still operates the Focus Twenty Fund. Shares in the fund initially sold for $10, but they now sell for about $1.

Strano, 54, told the Miami Daily Business Review that he invested $120,000 in the fund in 2000 after seeing it touted on TV and in newspaper articles. He sold his shares in the Focus Twenty Fund last year for $18,000. Morningstar.com rated the Focus Twenty Fund as one of the worst-performing mutual funds of 2001.

“I told my broker to cut this fish from the line when it lost 50 percent,” Strano said. “But he kept saying, ‘Let’s ride it out, 2001 will be better.'”

Blum said Merrill Lynch failed in its obligation to protect fund investors. “When you’re watching the stocks fall 10 percent, 15 percent, 30 percent, 40 percent, at what point do you say, ‘Should we diversify?'” Blum said. “As money managers, they had a responsibility to stem the tide.”

In 1999, according to the suit, Merrill Lynch was the largest securities firm in the world but was not considered a leader in the underwriting of then-hot technology companies. It sought to remedy that by starting the Focus Twenty Fund and other tech funds in early 2000.

The company lured James McCall from Pilgrim Baxter & Associates to manage the Focus Twenty Fund and others. According to a Merrill Lynch press release dated March 13, 2000, Focus Twenty raised $1 billion, beating all IPOs to date.

“Merrill Lynch obtained their fantastic sales achievement by marketing the fund to investors saving for retirement or a child’s education without disclosing the significant risks associated with investing in the fund, the aggressive style of the fund, or the material conflicts of interest between Merrill Lynch analysts and the shares of companies purchased for the fund,” according to Blum’s lawsuit.

McCall quit in November 2001, reportedly taking a voluntary severance package, after his Focus Twenty Fund and Premier Growth Fund were ranked as the company’s two worst performers.