MSCI Falls Most on Record as Vanguard Dumps Its Indexes

MSCI Inc. (MSCI) fell the most on record after being dropped as benchmark provider for 22 index funds by Vanguard Group Inc., the largest U.S. mutual-fund company.

MSCI declined 27 percent to close at $26.21 in New York, the most since it went public in November of 2007, after Vanguard said funds with about $537 billion in assets will replace New York-based MSCI to cut costs for fund shareholders.

Vanguard will adopt benchmarks from FTSE Group for six international stock index funds, and benchmarks developed by the University of Chicago’s Center for Research in Security Prices for 16 U.S. equity and balanced funds. The defection puts pressure on MSCI to lower the licensing fees it charges to BlackRock’s IShares unit, the biggest ETF provider, according to David Nadig, director of research at San Francisco-based ETF research firm IndexUniverse LLC.

“This leaves iShares as really the only game in town for MSCI,” Nadig said. The BlackRock unit is “in a great bargaining position the next time licensing agreements come up for renewal.”

Separately, MSCI disclosed in a regulatory filing today that it received a so-called “Wells Notice” from the U.S. Securities and Exchange Commission, informing the company it will recommend public administrative proceedings for violations of the Investment Advisers Act. A Wells Notice typically gives recipients a chance to dissuade investigators from recommending the agency authorize enforcement action.

Wells Notice

The company said in March that an employee had provided information about clients’ proxy voting to a proxy solicitor in violation of its policies, according to the filing.

MSCI declined as much as 31 percent today, pushing the stock to its lowest level since July 2009. The company first sold shares to the public at $18 apiece.

MSCI’s annualized revenue and operating income tied to the Vanguard funds being transitioned are $24 million, the company said. Second-quarter operating revenue was $239 million, an increase of 5.3 percent from a year earlier, according to an Aug. 2 company statement.

“This is a huge negative reaction to $24 million in revenue,” Ken Leon, equity analyst at Standard & Poor’s in New York, said in a telephone interview.

The reaction may have been so pronounced because MSCI’s index services, one of its three businesses, is “by far” its most profitable, Leon said.

Cutting Expenses

“We are disappointed that Vanguard will no longer use our indices as the basis for these exchange traded funds,” Baer Pettit, head of MSCI’s index business, said in a filing today. “The ETF market in North America is competitive and as it evolves, we will work with those ETF providers who seek to utilize independent, well-respected, and high-quality equity indices in their products.”

Vanguard, known for its low-cost index funds, manages about $1.95 trillion in U.S. mutual fund assets. The change will affect both index mutual funds and exchange-traded funds at Vanguard, whose ETFs are structured as share classes of its mutual funds. Vanguard Total Stock Market Index Fund (VTSMX), the company’s largest index fund with $197 billion in assets, and its ETF share class are among those that will switch from the MSCI benchmarks.

“With our clients’ best interests in mind, we negotiated licensing agreements for these benchmarks that we expect will enable us to deliver significant value to our index fund and ETF shareholders and lower expense ratios over time,” Gus Sauter, chief investment officer Valley Forge, Pennsylvania-based Vanguard, said in a statement.

Fink’s Push

Vanguard’s decision to change index providers was unrelated to the Wells Notice, according to John Woerth, a spokesman for the fund company.

Vanguard, the largest U.S. provider of mutual funds, is the third-biggest competitor in ETFs in the U.S. behind BlackRock, based in New York, and Boston-based State Street Corp. (STT)

The change to FTSE benchmarks, which includes about $170 billion in fund assets, is the largest switch in international index providers, FTSE said in a separate statement.

BlackRock, the world’s largest asset manager, said it plans to deepen its relationship with MSCI. Laurence D. Fink, chief executive Officer of the New York-based firm, said Sept. 10 he intends to announce fee reductions for large ETFs this quarter.

“MSCI is the gold standard of global and international equity indexes,” Mark Wiedman, global head of BlackRock (BLK)’s iShares ETF business, said today in a statement.

BlackRock uses MSCI indexes to guide 197 ETFs with $162 billion in assets, Melissa Garville, a spokeswoman, said in an e-mail.

Charles Schwab Corp. cut fees for its proprietary ETFs last month by an average of 40 percent.

To contact the reporters on this story: Christopher Condon in Boston at ccondon4@bloomberg.net; Saumya Vaishampayan in New York at svaishampaya@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net

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Traders work on the floor of the New York Stock Exchange.

Traders work on the floor of the New York Stock Exchange. Photographer: Scott Eells/Bloomberg