Sep. 7–Mutual funds have been the white hats of the investment world — standing above the scandals of WorldCom and Wall Street, smiling like the survivors at a convention of undertakers.
That was last week.
Then Eliot Spitzer revealed accusations that a hedge fund manager, a bank and several big-name mutual fund families were rigging the game.
Spitzer is New York state’s attorney general and a hard-driving regulator. He headed the conflict-of-interest probe that resulted in a $1.4 billion settlement with 10 securities firms last spring.
Wednesday, Spitzer said that Canary Capital Partners LLC, a multimillion-dollar hedge fund, gained unfair and sometimes illegal trading privileges. Canary and its managers agreed to pay $30 million restitution for disputed profits generated from unlawful trading and a $10 million penalty.
That’s the tip of the iceberg. “As a result of ‘late trading’ and ‘timing’ of mutual funds, Canary, the mutual fund companies and their intermediaries profited handsomely,” according to Spitzer’s 44-page complaint. “The losers were unsuspecting long-term mutual fund investors. Canary’s excess profit came dollar-for-dollar out of their pockets.” Canary did not admit or deny wrongdoing.
Those losses could be in the billions each year, according to Spitzer.
Among those named in the complaint are Bank of America, Bank One, Janus and Strong. All say they are cooperating with the investigation.
Many Americans could be touched by the scandal, especially if it spreads. An estimated 95 million Americans have invested in mutual funds. For many, that includes retirement money in 401(k)s and individual retirement accounts.
“If this is widespread, it’s going to shake the mutual fund industry,” said Mike Bishop, an Atlanta lawyer who represents individual shareholders. “The typical public perception has been that mutual funds are the average investor’s way to participate in having professional money management. We could see the same type of fallout as with the analyst scandals.”
At week’s end, the investigations were certainly spreading.
The federal Securities and Exchange Commission, not wanting to be upstaged too long, sent letters to mutual fund companies and investment banks asking for detailed information about their trading practices.
Massachusetts Secretary of the Commonwealth William Galvin told Bloomberg News that he will likely file charges against Prudential Securities, which was taken over by Wachovia Corp. in July. Galvin has been investigated allegations of short-term trading by some brokers in Boston.
Even Vanguard, one of the old reliables among mutual fund families, has been subpoenaed by Spitzer. Others receiving subpoenas include Invesco Funds Group and Millennium Management, according to The Wall Street Journal. A subpoena is request for information, not an allegation of wrongdoing.
Spitzer said in his Wednesday news conference that “many entities” are being investigated in a probe that “will radiate out in many different ways,” reported the Los Angeles Times.
So how can individuals protect themselves?
You can’t do much about funds you already hold, said Don Cassidy, senior research analyst at fund-tracking company Lipper. “Whatever the damage, it has been done,” Cassidy said. “One would think and hope that any company not named Wednesday began cleaning up its act Wednesday.
“If you decide to leave those fund families, it’s basically as a matter of protest,” he added.
“It’s pretty much an ethical question,” added Roy Weitz, publisher of the www.FundAlarm.com Web site. “Do you want to be doing business with a company that does these things? And some will say, ‘A company that stabs me in the back is not a company I want to do business with.'”
Screening mutual funds in the future is an entirely different question.
“The first risk to any investor is who you choose to associate with,” said Ned Montag, chief operating officer of A. Montag & Associates, an Atlanta investment counseling firm.
“Investors should look again at the people who are running their mutual fund,” he added. “They should discover what the practices have been in the past, and they should take the time to learn who runs the institution.”
One way is to ask the mutual for biographical information on the managers, then use that to start an Internet search for items about those persons. Chat groups sometimes are a help, as are Web sites like www.morningstar.com.
If you use a professional adviser, you can make sure he has checked your fund managers.
Don’t sell in a rush. “There are always other considerations,” said analyst Brian Portnoy at Morningstar. “How would it impact your portfolio overall? What are the tax consequences?”
One other thing: Save the confirmation slips from all mutual fund transactions. “Sooner or later there will be some kind of reparation pool,” said Lipper’s Cassidy. When that comes along, you’ll need proof of any claim you make.
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(c) 2003, The Atlanta Journal-Constitution. Distributed by Knight Ridder/Tribune Business News.
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