Court calls for more evidence in closet indexing case

A British Columbia court has deferred its decision on whether to certify a proposed class action against a fund manager alleging that it followed a “closet indexing” strategy in a mutual fund that was sold as an active fund.

The lawsuit, which is one of several seeking damages for fund investors on the basis that they paid fees for active management on funds that secretly sought to track an index, targets HSBC Global Asset Management (Canada) Ltd. and HSBC Investment Funds (Canada) Inc. over the HSBC Equity Fund.

According to the B.C. Supreme Court’s ruling, the firms deny the allegations, arguing, among other things, that the fund was actively managed and that the plaintiff’s allegation that it deployed a closet indexing strategy is “a fallacious definition that has been crafted to merge and conflate concepts of investment strategy with actual fund holdings … and fund performance relative to a benchmark, all made to obfuscate the true nature of the allegations.”

The court declined to rule on whether to certify the case as a class action, saying that while the other criteria for certifying a class action were satisfied, the plaintiff must establish “some basis in fact” that the firms actually used a closet indexing strategy — to show that there is a genuine basis for a class action.

According to the decision, an affidavit from a finance professor, M. Simutin, at the University of Toronto’s Rotman School of Management filed by the plaintiff doesn’t specifically address evidence of closet indexing by the HSBC fund.

That filing, the court said, “makes only one passing reference to the equity fund. He does not look at the equity fund using metrics such as R-squared, tracking error or active share to at least identify the equity fund as a possible closet indexer.”

In a couple of the other alleged closet indexing cases, the same professor provided more specific analysis to support certification as a class action, the court noted, and it ruled that the plaintiff should have an opportunity to produce further evidence in this case.

“With the recent clarification of the law on the need to show some basis in fact to support the assertion that a common issue actually exists, I will allow the plaintiff to submit a further affidavit by Professor Simutin or other evidence to show some basis in fact that a common issue actually exists,” the court ruled.

After getting that evidence, ideally within 90 days, the court will rule on whether the case can proceed.

The same judge has handled all four of the closet indexing class actions against various investment managers.

Of those, only one case has been tried, after being certified as a class action on consent.

In that case, the court ultimately sided with the fund manager (TD Asset Management Inc.) and dismissed the claim in a decision handed down in June.

A separate case against RBC Global Asset Management Inc. (RBC GAM) was certified as a class action last year, but that certification decision is under appeal.

The court has heard certification arguments in a third case, involving CIBC, but has not yet released its decision.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.