Keeping Expert Witnesses Off Balance

Criticizing expert witnesses' opinions — and the experts themselves — is standard fodder in depositions, but sometimes the opposition adopts a strategy to wait to attack until it is too late to overcome defects.

In Clancy et al v. BlackRock Investment Management LLC et al, D.N.J. 2019, BlackRock shareholders sued the mutual fund company in a $1.5 billion proposed class action, claiming it had violated the Investment Company Act by charging excessive servicing charges for two of its funds (the BlackRock Global Allocation Fund Inc. and the BlackRock Equity Dividend Funds), charging far more than it did to its insurance company clients for managing their Subadvised Funds (funds for variable annuity products).

BlackRock defended the difference, claiming that Subadviser fees were much lower than adviser fees because Subadviser tasks were limited to investing the fund dollars, that insurance company clients handled everything else, whereas BlackRock provides a broad array of services for the shareholders' funds.

The plaintiff's engaged economics expert witness Ian Ayres, Ph.D., a Yale-educated economist and attorney who provided analysis for the “Gartenberg factors” test for excessive investment advisor fees.¹

Using BlackRock‘s internal cost allocation model, Dr. Ayres divided its estimated costs to service each of the Funds and Subadvised Funds by its Assets Under Management (AUM). His analysis found that, as a percentage of AUM, BlackRock‘s reported costs for the Subadvised Funds were, in all cases, comparable to, if not greater than, its reported costs for providing services to the Fund.

He also reviewed the prospectuses of the plaintiff‘s funds and the Subadvised agreements and found that “the description of the portfolio management objectives and strategies in the prospectuses” were substantially the same as those same services in BlackRock's response to RFPs submitted by the sponsors of the Subadvised Funds.

Dr. Ayres opined as well that BlackRock realized significant economies of scale from 2007 to 2015 because the increases in operating expenses were far less than the increases in AUM. He concluded that BlackRock retained the benefits for itself rather than passing them on to the Funds' shareholders in the form of lower fees.

BlackRock moved for summary judgement, claiming that the Dr. Ayre's comparison between the Advisory Fee and the Subadvisory Fee was inapt as a matter of law.

In denying BlackRock's motion, United States District Judge Freda L. Wolfson found that BlackRock provided “substantially the same portolio management services” for the Subadvised Funds as it does the plaintiffs' Funds, “using overlapping personnel and pursuing the same or substantially the same investment strategies, research and analysis, technology, systems, and resources.”

At trial, BlackRock attacked Dr. Ayres' methodology with witnesses who testified that the numbers he relied on could not be used to compare costs. The firm employed as its finance expert witness Dr. Erik Sirri, a Professor of Finance at Babson College and a former Director, Division of Trading and Markets at the SEC. Dr. Sirri found Dr. Ayres' cost analysis “misleading and flawed” because it relied on allocated cost data that he claimed resulted in illogical conclusions. Dr. Sirri gave the hypothetical example of a single fund that was at first allocated $100,000 in costs, but after adding a second fund the first received $90,000 in allocated costs, even though nothing changed in the services provided to the first fund.

Dr. Sirri also found that the overall package of services provided to the plaintiffs' funds were substantially different and greater than those provided to Subadvised Funds, including security valuations, fund distribution and marketing, safekeeping of portfolio securities, regulatory compliance, etc.

As for economies of scale, several witnesses testified for BlackRock that other factors could have caused the decline in the estimated costs in operating the plaintiff‘s funds. Dr. Sirri testified that the cost decline could be due to BlackRock's entire business growing and changing over time, resulting in fewer allocated costs to the plaintiffs' Funds."

Telling of the final outcome, Judge Wolfson questioned Dr. Ayres on his economies of scale analysis, asking if he analyzed any other factors in determining economies of scale. He admitted that he had not.

Before Dr. Ayres finished testifying, BlackRock‘s counsel managed to get in that Dr. Ayres was once accused of plagiarism,² something that did not help Judge Wolfson's impression of Dr. Ayres testimony.

In her remarks, Judge Wolfson noted:

Dr. Ayres testified over a period of two days, separated by a weekend. I must comment that I found the first day of his testimony to be particularly lacking, as he seemed unprepared. While on his second day he seemed to have taken the opportunity to prepare more, I did not find Dr. Ayres, despite his academic credentials, to be particularly helpful, knowledgeable, or convincing in his opinions on the issues.

In her preliminary ruling of Feb. 8, 2019 ordering all of the plaintiffs‘ claims dismissed, Judge Wolfson found that BlackRock's experts testified “credibly, extensively, and convincingly” about “the flaws in Dr. Ayres use of BlackRock's cost allocation methodology.” The difference between the advisory and Subadvisory fees for two of BlackRock's biggest mutual funds was justifiable.

BlackRock counsel's strategy was to not criticize the potential flaws in Dr. Ayres opinion at deposition to avoid giving the plaintiffs an opportunity to correct any shortcomings. As well, not mentioning the alleged plagiarism until Dr. Ayres was on the stand eliminated the chance of the plaintiffs attempting to neutralize the impact of that accusation.

While BlackRock won this case that began nearly five years earlier, its fortunes of late have seen its stock tumble to nearly a third of its all-time high, near $600 per share a year ago. A month before the ruling, the firm announced it was laying off 500 employees, about 3% of its staff. Then again, it is still the world's biggest asset management firm with some 6.4 trillion in assets under management.