Sep. 17–Once again, Wall Street finds itself under suspicion.
More calls poured in Tuesday for the resignation of New York Stock Exchange chairman Richard Grasso over his hefty pay package. And the first criminal charges were filed in an expanding New York state investigation of mutual funds.
No one is exactly sure where the fledgling fund investigation is heading or what the fallout will be from the disclosure that Mr. Grasso’s quasi-regulatory job was paying him CEO-superstar money.
But just months after 10 Wall Street firms and analysts agreed to a $1.4 billion settlement for publishing misleading stock research, many investors may be wondering whether these latest revelations will affect their stock portfolios.
On one level, it will be a relatively small impact, experts say. Mr. Grasso may ultimately have to step down, but he will be replaced with little effect on Big Board trading. The improper mutual fund trading activities probably didn’t dramatically affect fund prices.
But on another level, the stain of more scandals will continue to erode investor trust and confidence. And that is the greatest loss.
“We’re absolutely incensed at what happened at the New York Stock Exchange,” Sean Harrigan, board president of the California Public Employees’ Retirement System, told reporters and analysts in a conference call Tuesday.
Here are some of the issues:
QUESTION: The mutual fund industry has been accused of wrongdoing involving hedge funds. So what’s a hedge fund?
ANSWER: Hedge funds are investment vehicles, like mutual funds but with key differences.
Typically, they are available only to accredited investors those with more than $1 million in assets. Also, hedge funds can employ trading strategies not generally used by mutual funds, such as short trading, options and borrowing money. And finally, they are much more secretive about their holdings.
Q: What’s the alleged illegal activity?
A: Several mutual fund companies allowed a hedge fund to engage in late trading. Hedge funds trade huge quantities of mutual fund shares, so the fund companies court them for business.
When small investors place an order to buy mutual fund shares before the market closes at 3 p.m. Dallas time, they typically get the price of the fund at that day’s close.
However, if the order is placed after 3 p.m., they will get the next day’s 3 p.m. price. Some mutual funds allowed a hedge fund to trade after normal hours but still receive that day’s 3 p.m. price.
Q: How would that benefit a hedge fund?
A: Let’s take a hypothetical case. At the close of trading on a Monday, a mutual fund’s price, or net asset value, might be $10 a share. Now suppose some positive corporate news hits the market Monday evening.
Investigators are alleging that the mutual fund companies allowed the hedge fund to buy their shares at $10 in the after hours, knowing full well that the price would be higher come Tuesday. Essentially, it’s a risk-free transaction for the hedge fund, and something small investors can’t do.
Q: Has anyone estimated how much this illegal trading costs investors?
A: The scope of the current scandal isn’t yet clear. But a Stanford University study says that late trading is pervasive and costs investors $400 million a year.
Q: Is that really a lot of money in stock market terms?
A: No, not for a multitrillion-dollar stock market. But Wall Street reeled during the 2002 corporate scandals. Investors want to be confident that they’re getting a fair deal.
Q: Is the Grasso case related?
A: No. But just as critics wonder what the fund industry learned from Wall Street’s recent scandals, some are asking how Mr. Grasso could have been granted such a generous pay package in the post-Enron era.
Mr. Grasso plays two roles bringing in more business for the NYSE, and policing its member companies. He defends his independence.
Critics counter that Mr. Grasso can’t truly be independent if he’s drawing such a princely salary from an institution he is supposed to regulate. Moreover, they say, he got the pay package in secret from a compensation committee beholden to him the type of cozy relationship so often decried during last year’s corporate governance scandals.
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