Sep. 28–Eliot Spitzer’s office confirmed to me last week that its investigation into mutual funds is not over.
He’s already looking into Janus, Strong, Bank of America’s Nations funds and Bank One. At the same time, Putnam is the subject of an investigation by Massachusetts’ secretary of state.
Will Congress, already critical of fund fees, launch its own probe into the fund industry?
What about other states’ treasurers, whose public pension funds and college savings plans have stakes in the mutual fund giants? Will they become more vocal about fund sales practices and high fees?
“What’s most upsetting is that the (mutual fund) industry has been relatively scandal-free until now,” Mercer Bullard, former assistant chief counsel in the SEC’s Division of Investment management and now a University of Mississippi law professor, said in a telephone interview. “That claim has been forever lost in part I believe due to the inadequate enforcement of the securities laws by regulators.”
Which brings up the big question of what the Securities and Exchange Commission will do.
The SEC could start with how funds are sold, or as the industry calls it, distributed. By industry accounts, 40 percent of all mutual funds are sold by stockbrokers, who have their own issues surrounding conflicts of interest.
A couple of weeks ago, Morgan Stanley was fined $2 million on charges that it handed out seats at the NBA finals and tickets to Britney Spears concerts in an effort to pump up the sales of its own mutual funds. Sales contests are prohibited by National Association of Securities Dealers rules. Morgan Stanley held them anyway, from 1999 through the end of 2002, including one in the final year designed to increase sales of Morgan Stanley funds by $5 billion, according to NASD documents.
In fact, there is plenty investors cannot know.
“The SEC for decades has not forced anyone to tell you how much the broker is paid for pushing a mutual fund,” Bullard said. “But if you buy a stock, right there on your confirmation statement, you’ll find out how much you paid in commission. But you won’t know what you paid for a mutual fund.”
Money magazine’s Jason Zweig reports in the October issue that Wilshire Associates, which manages the Wilshire 5000 stock index, was a short-term mutual fund trader until 2002. The story says Wilshire typically put $100 million or more into 10 mutual funds for just one to five days, using their shares as a hedge against index futures.
Wilshire says it fully disclosed this arbitrage strategy and it did nothing illegal.
“We never asked for, nor to our knowledge did we receive, any preferential treatment from any mutual fund while executing this investment strategy,” the company said in a statement issued last Friday.
However, if you or I had tried short-term trading, we would have faced hefty transaction fees, if we were allowed to do this at all. Funds insist they guard against these traders, who drive up costs for everyone invested.
“Our controls include short-term trading fees and fair value pricing, along with daily monitoring of trading activity within our funds,” Putnam spokeswoman Nancy Fisher said in an e-mail. “As a result of these controls, we have revoked trading privileges of those who have violated the policy.”
This is not to say there’s law-breaking going on throughout the mutual fund industry. I don’t believe there is.
While Morningstar has advised investors to get out of the funds that Spitzer is investigating, I tend to go with Sheldon Jacobs, editor of the newsletter No-Load Fund Investor, who says funds have been squeaky clean for 60 years, with a few notable exceptions. If you sell, he advises, do so because you don’t like the investment performance.
What is brewing, in my opinion, is an ethical or equity problem in which big-timers like the hedge fund Canary Partners were supposedly allowed to place trades after hours, which individual investors cannot do. Treating one class of investors differently from another is, “morally, that’s totally wrong,” said Jacobs in a telephone interview.
It’s also illegal.
Jacobs points out, in his next edition, a list of things that mutual funds do to their shareholders that he thinks are worse than the allegations Spitzer has raised. Among them:
— Funds that are closed to new investors which continue to charge so-called 12(b)-1 fees — fees designed to attract new customers. Jacobs identifies 187 funds that do.
— Excessive fees. “When economies of scale would suggest fees would go lower, they have gone up 44 percent over two decades,” Jacobs said.
— Failing to disclose how mutual fund managers are paid and how their bonuses are figured.
— Running funds that are designed for short-term gains — for the fund managers. You can’t help but notice that when a category is hot, the number of funds in that category proliferates.
Such issues — and any damage they do to the image of mutual funds as the investment vehicle best suited for the individual investor — could turn out to be larger problems than any technical rule violations that eventually turn up.
—–
To see more of The Miami Herald — including its homes, jobs, cars and other classified listings — or to subscribe to the newspaper, go to http://www.herald.com.
(c) 2003, The Miami Herald. Distributed by Knight Ridder/Tribune Business News.
BAC, ONE,
