The Curious Case of the ETF Maven Who's Making Lawyers Very Rich

(Bloomberg) -- Court cases seem to follow Sam Masucci around.

There’s an index dispute with Nasdaq Inc. A (dismissed) court case alleging a planned hostile takeover of several funds. And now-settled allegations of trademark infringement that prompted the change of a ticker for a controversial marijuana fund. And that was just January’s business.

It’s a lot of judicial juggling for one man and his company, and the costs are adding up. So much so that Masucci’s firm, ETF Managers Group, which oversees more than $2 billion in affiliated exchange-traded funds, recently announced that investors would help bankroll its litigation.

Shareholders will pay between $3 and $7 extra per $10,000 invested -- on top of their management fee -- to reflect “extraordinary legal expenses” related to five ETFMG-branded funds that are involved in two of the suits, according to a Jan. 26 filing. That might sound like peanuts, but a similar sum would cover a year’s management fee for an S&P 500 ETF, possibly with change leftover.

“It’s unfortunate,” Masucci said of the lawsuits in an interview before the price changes last month. “I have a lot of great partners, I have dozens of partners, we get along well. All of our funds are growing with them. But it’s not uncommon to have one partnership that doesn’t work.” Masucci declined to comment on the extra fees when contacted through a spokeswoman.

Relationship Problems

Of course, when it comes to Masucci’s dealings, two or three partnerships that don’t work is more accurate. Because this isn’t the first time he’s run into trouble with former coworkers and collaborators. A claim back in 2000 over a supposed joint venture ended in an award of $276,000 in compensatory damages after Masucci and co-defendant Bear Stearns & Co. were found to be “jointly and severally liable” in arbitration. Meanwhile, a 2006 suit from a former chief executive displaced by Masucci was ultimately dismissed by the plaintiff.

But rather than swearing off partnerships, Masucci has embraced the arrangements to build a stable of ETFs focused on everything from video games and drones to whiskey and climate change.

It’s a style of ETF issuance that’s become increasingly popular. Setting up a fund takes time and money, particularly for institutions that lack the clout of giants such as BlackRock Inc. or Vanguard Group. So companies like ETFMG have found a niche in helping aspiring fundies cut costs and accelerate their path to market by acting as their partner.

This role might include helping create an index, drawing up a marketing plan or handling regulatory filings. But crucially, these so-called white-label providers arrange the ETF’s issuance, giving them enormous power.

Messy Fallout

You wouldn’t know it from the fund names, but ETFMG oversees the $140 million AI Powered Equity ETF and the BlueStar TA-BIGITech Israel Technology ETF. Both were sold by what’s now the ETF Managers Trust, which is overseen by a board that Masucci heads and includes two independent trustees. ETFMG is the funds’ adviser and responsible for portfolio management, sub-advisers and custodians (subject to board oversight).

When the arrangement works, the client gets an ETF without the cost or time of being an issuer. But when it doesn’t, things can get messy.

“The reputational damage is astronomical,” said Phil Bak, chief executive of Exponential ETFs, which sells its own funds and also helps others get to market. Other issuers “are the ones that are going to have to answer these questions every time they do a deal.”

That’s what happened with HACK -- the $1.1 billion cyber security fund at the heart of two of ETFMG’s lawsuits.

When the fund was sold, PureShares LLC was a sponsor, ISE (now owned by Nasdaq) was the index provider, Factor Advisors was the adviser and the FactorShares Trust -- now ETF Managers Trust -- was the issuer. Masucci was chief executive officer of the adviser and chaired the board.

New Wording

ETFMG has since been sued by both PureShares and Nasdaq, which accused the firm and Masucci of misappropriating several funds, including HACK. The PureShares case was dismissed without prejudice last month. ETFMG filed counterclaims against Nasdaq and said Masucci is “submitting a separate motion to dismiss” in that case.

In the wake of the lawsuits, clients are asking for more details about their agreements, Masucci said last month. Executives at several rival companies report having similar conversations. At least one issuer has added stronger language to its contracts to reassure prospective partners, a person familiar with the matter said. But if those words fail to soothe concerns, ETF entrepreneurs could back away from the market altogether, limiting investors’ choices.

For example, the $2.2 billion ROBO Global Robotics & Automation Index ETF and even one of the recent blockchain funds were sold by a white-label issuer, Exchange Traded Concepts of Oklahoma City.

“The ETF industry does need to say there are good people out there, but it’s going to take a little bit of rebuilding the trust,” said Kip Meadows, chief executive at Nottingham, a mutual fund administrator that’s starting its own white-label ETF business. “It’s unfortunate that so early in the ETF industry we have such a bad experience.”

‘No Bad Press’

Masucci knows the stakes are high. Before ETFMG, he helped run the FactorShares suite of leveraged funds, which shuttered in 2013 after failing to gain assets. By the end, one of the funds needed to post gains of nearly 33 percent a year for a new investor to offset ‘‘routine offering, operational, administrative and other ordinary expenses,’’ a May 2013 filing shows.

While asset growth has been healthier with ETFMG, the company has yet to break into the Top 20 issuers in the U.S. It’s in this light that Masucci sees his most recent litigation as helpful to his business, even as his competitors say it’s hurting theirs.

“There’s no bad press,” he said on Jan. 23.

“This is a shelf space business for guys like us -- it’s dominated by the top, call it six, and then there are the little guys like us, trying to break our way in,” he added. “And certainly the visibility and the recognition -- people know who we are, good or bad -- but I’m happy to have the forum to at least tell them who we are.”

--With assistance from Annie Massa

To contact the reporter on this story: Rachel Evans in New York at revans43@bloomberg.net.

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Eric J. Weiner, Margaret Collins

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