A years-long battle over control of the world’s first cybersecurity exchange-traded fund may soon be over.
Nasdaq and ETF Managers Group announced May 1 plans to settle their dispute over the ETFMG Prime Cyber Security ETF (HACK) and four other ETFs with combined assets of $2.1 billion. Nasdaq will take over the funds from ETFMG in the second half of 2020, according to the press release.
What’s at stake is control of the funds along with the lucrative fund fees paid by investors. In December, a federal judge ordered ETFMG to pay $80 million to Nasdaq for breach of contract, but did not grant Nasdaq’s request to wrest day-to-day control of the funds away from ETFMG.
The brief statement gave few details. It’s unclear whether all of the disputed funds will be covered by the deal. It’s also unclear what role, if any, ETFMG or Sam Masucci, the firm’s founder and chief executive officer, will play in the funds after the settlement. Financial terms were not disclosed. A spokesman for Nasdaq declined to comment; a spokesman for ETFMG did not immediately respond to a request for comment.
Cash Payments & Change Of Control
Nasdaq and ETFMG have agreed to certain cash payments from ETFMG to Nasdaq and PureShares, and have executed an asset purchase agreement to transfer certain ETFMG intellectual property and related assets, to a Nasdaq affiliate, according to the May 1 statement. “The transaction is expected to close in the last half of 2020.”
The settlement marks the end of a tangled feud that began nearly four years ago, shortly after Nasdaq bought the International Securities Exchange. The acquisition included ISE’s small ETF incubator, which helped would-be issuers bring new funds to market.
One such hopeful was Andrew Chanin, a former ETF trader and co-founder of PureShares, a New Jersey ETF startup. ISE provided the financial backing for Chanin’s PureFunds ETFs in exchange for the lion’s share of any profits—a risky venture, since most new funds fail.
Cash Payments & Control Transfer
HACK was by far the partnership’s biggest success. The fund debuted in November 2014, days before Sony Pictures suffered a massive cybersecurity breach. The publicity helped HACK raise $1 billion in assets in its first year.
To manage day-to-day business of the PureFunds ETFs, Chanin and ISE hired ETFMG, a New Jersey firm run by Masucci, a former mortgage trader turned ETF entrepreneur.
As the advisor to the funds, ETFMG collected the management fees from investors—at times as much as $600,000 a month from HACK alone—and used the money to pay the fund’s bills, including ETFMG’s own fees. Any profits—at times more than $300,000 a month just from HACK—were forwarded to ISE, which paid Chanin his share.
Nasdaq reaped the bulk of the profits while the ETFs traded under Chanin’s PureFunds brand, but the arrangement gave Masucci significant operational control. Masucci also led the board of trustees for the funds.
The arrangement began to fray after Nasdaq bought ISE in June 2016. The final rupture came in 2017 when ETFMG stripped the PureFunds brand from the ETFs, renamed the funds with the ETFMG moniker, and claimed that ETFMG was entitled to keep all the fees for itself. Nasdaq sued in October 2017 in the U.S. District Court for the Southern District of New York.
In December 2019, Federal Judge Paul Engelmayer sided largely with Nasdaq, ordering ETF Managers Group to pay $80 million to Nasdaq. Engelmayer ruled that ETFMG had breached its contracts with Nasdaq and misappropriated millions of dollars in fund management fees.
Though ETFMG appealed, it was a major setback. Engelmayer called ETFMG’s conduct “little more than an act of theft.” In his 166-page judgment, Engelmayer described portions of Masucci’s testimony as “contrived and unpersuasive,” “threadbare and unconvincing,” “incredible—and clearly false,” consisting of “uncorroborated after-the-fact assertions,” “demonstrably false,” “knowingly false” and “fictitious” and “overwhelmingly disproven by the evidence at trial.”
(The full text of Engelmayer’s Dec. 20 opinion can be found at www.pacer.gov. The case is Nasdaq Inc. v. ETF Managers Group, LLC et al, in the U.S. District Court for the Southern District of New York.)
The deal announced May 1 will also settle a separate lawsuit brought by PureShares against ETFMG in New Jersey Superior Court. Chanin declined to comment.
Unanswered Investor Questions
The brief statements from Nasdaq and ETFMG leave several questions unanswered.
It’s unclear whether the deal covers all five of the former PureFunds ETFs now trading under the ETFMG name. All five are passive funds tracking industry indexes. HACK is by far the largest, with $1.29 billion in assets under management.
The other ETFs are:
The settlement announcement also leaves a number of unanswered questions for investors.
The settlement is still “subject to future negotiations and approvals among independent third parties,” the statement said. It’s unclear whether the PureFunds brand will be restored to the funds, or indeed whether PureFunds will have any future role in the marketing or operation of the ETFs.
It is also unclear whether the settlement requires Masucci to resign from the board of trustees governing the funds, or whether the deal seeks to replace other independent trustees. It’s additionally unclear whether Nasdaq will continue to use benchmarks created by Prime Indexes, a firm run by a former Nasdaq employee who had been involved in ISE’s ETF business before Nasdaq’s acquisition.
For the time being, little has changed for investors. The funds continue to trade under the same tickers, tracking the same indexes.
Asjylyn Loder is an ETF.com contributor. She can be reached at [email protected].
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