Investor Lawsuit Caps a Rough Year for This Veteran ETF Manager

(Bloomberg) -- A bad year for one veteran of the $3.6 trillion market for exchange-traded funds is only getting worse.

Elkhorn Capital Group, which once oversaw more than $200 million, is being sued in Delaware federal court by investors who say founder Benjamin Fulton misrepresented a marketing relationship between his firm and Barclays Plc. It caps an annus horribilis for Fulton in which a merger fell through, another adviser took over two of Elkhorn’s products, and the firm’s remaining funds shuttered.

It’s a reminder that not everyone can make it in the fast-growing ETF industry. More than 80 money managers offer exchange-traded products in the U.S., yet 82 percent of assets are controlled by BlackRock Inc., Vanguard Group and State Street Corp., mostly in low-cost funds. And when assets mean revenue, smaller ETF issuers are finding it increasingly hard to compete.

Investor Lawsuit Caps a Rough Year for This Veteran ETF Manager

“If you are a shop with only a couple of funds and less than a billion dollars in assets, there’s probably not a good reason for that shop to be around,” said Alex Bryan, director of passive strategies research at Morningstar Inc. “The ETF business is really a scale business.”

Elkhorn is far from the first ETF issuer to call it a day. Scottrade Inc. closed FocusShares in 2012, while Old Mutual Ltd. axed its U.S. ETF business in 2010. More than 100 exchange-traded funds liquidated or delisted in 2017 alone, a record year, and over 50 additional funds have closed this year, according to data compiled by Bloomberg.

Buyouts have also been on the rise. Guggenheim Investments chose to sell its ETF business to Invesco Ltd., Global X Management Co. accepted a bid from Mirae Asset Global Investments Co., and Aberdeen Standard Investments acquired the U.S. unit of ETF Securities -- all within the past 12 months.

Barclays Payment

That was the plan for Elkhorn. Turner Investments -- a struggling mutual-fund shop -- agreed to acquire the firm in August 2017. When that deal collapsed, the board of Elkhorn’s ETF trust picked Innovator Capital Management to run two funds in place of Elkhorn and voted to terminate two others. Those funds shut in April.

In a complaint filed on Aug. 13, the investors allege that Fulton and his firm misrepresented a commercial arrangement with Barclays that rewarded Elkhorn for selling exchange-traded products on the bank’s behalf. The plaintiffs say that a $500,000 marketing payment from Barclays was represented as guaranteed, when it was in fact contingent on sales.

Fulton, who used to help run Invesco’s ETF business, set up Elkhorn in 2013 and is now listed as a managing director at ProShare Advisors, an issuer that specializes in leveraged products. Fulton declined to comment when reached by phone. A spokeswoman for Barclays declined to comment.

Plaintiffs Keystone Associates LLC and Cable Mountain Partners LLC are both run by Larry Lunt, according to a person familiar with the matter, who asked not to be identified because the details are private. Larry Lunt is the father of John Lunt, founder of Lunt Capital Management, which designed an index tracked by one of the funds that Elkhorn used to manage. The Lunt Low Vol/High Beta Tactical ETF is now run by Innovator.

A court document cites conversations about the Barclays arrangement between John Lunt -- described in the suit as a manager at Keystone -- and Elkhorn’s Fulton.

Keystone and Cable Mountain are suing Elkhorn and Fulton for alleged securities fraud, common-law fraud and negligent misrepresentation, and say they suffered damages of at least $2.5 million. John Lunt couldn’t immediately be reached for comment; Larry Lunt declined to comment. Keystone and Cable Mountain’s Delaware counsel declined to comment.

The case is Keystone Associates LLC v. Fulton, 18-cv-01235, U.S. District Court, District of Delaware.

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