A US district court has ruled in favour of Nasdaq in a civil lawsuit against white-label provider ETF Managers Group (ETFMG) over the appropriation of several ETFs including a highly profitable thematic cybersecurity fund now known as the ETFMG Prime Cyber Security ETF (HACK US).
ETFMG has been ordered to pay nearly $80 million in compensation and punitive damages.
The dispute
The affair started in May 2017 when ETFMG cut HACK’s fee from 0.75% to 0.60%, a move that was not agreed by PureFunds, the original issuer of the ETFs.
PureFunds subsequently commenced legal proceedings against ETFMG.
Then in July 2017, ETFMG surprised the industry by announcing it was terminating its agreement with PureFunds, alleging that the firm had violated existing agreements.
ETFMG subsequently took sole control of all PureFunds ETFs and rebranded them with the ETFMG prefix.
While HACK is the blockbuster fund – with current assets under management above $1.5 billion and earning over $9 million in annual management fees – the suite also includes the PureFunds ISE Mobile Payments ETF (IPAY US), now rebranded as the ETFMG Prime Mobile Payments ETF. IPAY generates $6m in annual management fees thanks to AUM of $800m and an expense ratio of 0.75%.
Until July 2017, both ETFs tracked indices provided by International Stock Exchange (ISE), which was acquired by Nasdaq in 2016. When ETFMG split from PureFunds to take control of the ETFs, it also dropped ISE as the index provider, which is when Nasdaq stepped into the legal battle.
Typically, in a white-label ETF agreement, one party will develop the investment idea and index and will take responsibility for marketing the fund, while the white-label provider will set up the ETF and handle all administration and operations duties relating to running the fund.
Usually, the income from the fund will be split between the two parties; however, ETFMG alleged that there was no formal requirement under the terms of the agreement with PureFunds and ISE for it to distribute any of HACK’s profits with either of the other firms.
The verdict
In delivering his verdict, Judge Paul Engelmayer for the US District Court for the Southern District of New York has ordered ETFMG to pay nearly $80 million in compensation and punitive damages.
“The court further finds that ETFMG blatantly breached its contractual duty to furnish those profits to Nasdaq and PureShares by appropriating these profits for itself, as it continues to do this day,” Engelmayer wrote in his ruling.
Responding to the verdict, ETFMG issued a statement respectfully disagreeing with the judge’s opinion and indicating its intention to appeal.
“We continue to believe the contracts at issue are clear and that Nasdaq’s insistence that the terms be disregarded will be rejected on appeal,” the firm said.
Adhering to the adage that ‘the best defense is a good offense’, ETFMG has also stated it will petition the US Securities & Exchange Commission regarding certain abuses of power conducted by Nasdaq. These include cutting off access to fund indices during the trading day and failing to address conflicts of interest it had as developer and index provider of the First Trust Nasdaq Cybersecurity ETF (CIBR US), HACK’s competitor.