Two shareholders of a family of exchange-traded funds have brought suit against the ETFs' investment adviser and trustees for allegedly excessive compensation paid to an affiliated securities lending agent. Laborers' Local 265 Pension Fund v. iShares Trust, No. 3:13-cv-00046 (M.D. Tenn. filed Jan. 18, 2013). The plaintiffs argue primarily that the fee split, in which (they allege) the ETFs receive 60% of securities lending income and the lending agent receives the remaining 40%, results in a disproportionately large fee to an affiliate of the ETF's investment adviser. The plaintiffs seek relief under Section 36(b) of the Investment Company Act of 1940, which provides a right of action for excessive fund advisory compensation, as well as under Section 47(b), which provides a right of rescission for contracts made in violation of the 1940 Act, and Section 36(a), which authorizes the SEC to bring actions for breach of fiduciary duty.
Securities lending is a common practice to increase investment returns. An ETF, mutual fund, or other institutional investor lends a security to a borrower, which uses the lent security to meet its delivery obligation on a short sale or to prevent a settlement failure. The borrower makes payments to the lender in the amount of any dividends or interest that the lender otherwise would have received. In addition, the loan is fully collateralized, and the lender invests that collateral. Depending on the demand for the lent security, there may also be additional compensation paid to the lender, or the lender may rebate a portion of the income from the collateral. Most lenders use a lending agent (often but not always the lender's custodian), which usually receives compensation through a split of the securities lending revenues.
As far as I know, this is the first securities lending case to be brought by fund shareholders. Plaintiffs rely in part on a recent working paper, which found that funds with sponsor-affiliated lending agents have lower returns on lent securities. John C. Adams, Sattar A. Mansi & Takeshi Nishikawa, Affiliated Agents, Boards of Directors, and Mutual Fund Securities Lending Returns (Jan. 25, 2012). Plaintiffs look primarily to Section 36(b) for their remedy and, despite the novelty of the claim, there is a well-established framework for evaluating claims for excessive advisory compensation under Section 36(b). Courts in recent years have been less willing to consider claims under other provisions of the 1940 Act, including Sections 47(b) and 36(a).
I have placed the complaint on the FundLaw website (free registration with Yahoo Groups may be required), and it is available at
The article by Adams, et al., is available at
An article in the Financial Times suggests that the agent's share typically is from 10% or 20% to 40%. BlackRock (the defendant in this case) is cited as being at the higher end of the standard, but also as generating twice the market average from its securities lending program:
Are agents' shares decreasing or staying the same? Staying the same, according to Financial News, which says that the average fee split has remained unchanged since the early 1990s, with typically 15% to 30% retained by the custodian or agent lender:
Changing, says Securities Lending Times, which writes (on p. 12) that "I remember 50:50 and 60:40 fee splits as common. Nowadays, 90:10 is common, and the split can be even less if you are a big enough lender":
John M. Baker
Stradley Ronon Stevens & Young, LLP http://www.stradley.com
1250 Connecticut Avenue, NW, Suite 500
Washington, DC 20036
FundLaw Listowner http://groups.yahoo.com/group/FundLaw/