Summary judgment sought both by vanguard and S&P in lawsuit over

April 01, 2001

The McGraw-Hill Companies and the Vanguard Group are both seeking a summary judgment in a lawsuit that revolves around Vanguard's right, or lack thereof, to launch its VIPERS exchange-traded funds products without seeking a new licensing agreement from McGraw-Hill's Standard & Poor's division to use its well-known indices to replicate the price and yield performance of the stocks underlying them (see ETFR, February 2001, page 1).

Legal documents supporting each side's position were submitted in early January but only recently appeared in the official public court record.

While the arguments Vanguard and S&P have presented closely follow those previously made in oral and written statements made in United States District Court for the Southern District of New York, where the case is being heard, they more than ever rely on determining, first, whether an original 1985 licensing agreement entered into at that time remains operative and, if it does, how it should be interpreted.

McGraw-Hill's basic contention is that VIPERS, and by extension all exchange-traded funds, are so fundamentally different from open-end mutual funds that the agreement with Vanguard does not cover them.

Conversely, Vanguard argues that a revised 1988 agreement-not that much different in any case-superseded the 1985 contract, and that while there are differences in the VIPERS products, they are not sufficient to fall outside the agreement.

In addition, McGraw-Hill makes a good part of its argument on the basis of an attachment to the agreement of a draft prospectus issued by Vanguard in 1985 for its Vanguard Index Trust product (since renamed the Vanguard 500 Index Fund, as allowed under the 1988 agreement), which was structured using the S&P 500 Index and which the company claims prohibited Vanguard from making changes to the fund's operation and management-including the type of shares that may be sold by the fund.

However, since McGraw-Hill has been unable to produce a copy of the prospectus for evidence, Vanguard belittles that argument in no uncertain terms, noting, among other things, that the 'phrase 'open-end fund' or 'open-end investment company' appears nowhere in the 1988 Agreement (nor anywhere else in the record of the negotiations of that Agreement).'

On that same note, Vanguard notes that 'McGraw-Hill has offered no explanation as to why it did not retain a copy of the document that it claims was integral-indeed key-in defining the rights of the parties in this litigation. Surely, if the 1985 prospectus had the importance that McGraw-Hill claims, it would have been retained.'

 Instead, Vanguard contends that the primary motivation of McGraw-Hill's actions to stop the mutual fund company from offering VIPERS to the public is to seek a higher licensing fee than the maximum $50,000 per year now paid by Vanguard.

For its part, McGraw-Hill dismisses the lack of mention of 'open-end fund' in its agreement with Vanguard as unnecessary at the time it was entered into, relying largely on the expert witness testimony of Arthur Loring, the former general counsel of Fidelity Management and Research Co, who in a statement before the court noted that in 1985 and 1988, ETFs had not been contemplated by anyone in the mutual fund business, nor indeed by anyone in the financial services industry.

And the failure to retain the 1985 document, McGraw-Hill argues, is 'meaningless,' as it simply proves the difficulty of safekeeping each and every record for so long a period.

Concerning its attempt to obtain a more lucrative licensing agreement, McGraw reiterates its previously made argument that it is willing to live with the current agreement, which has no expiration date.

The dispute with Vanguard, according to McGraw-Hill, has nothing to do with its ability to use the S&P 500 to invest in the underlying securities its performance reflects, nor to prevent it from creating other stock mutual fund portfolios, but instead with the authority granted to it by the licensing agreement.

Although the 1988 agreement admittedly fails to preclude Vanguard from developing products other than open-end funds, McGraw-Hill calls the company's arguments 'backwards,' instead noting that 'nothing in the 1988 agreement grants Vanguard a license to use S&P intellectual property in anything other than an open-end mutual fund.'