Nov. 23–Hank Okraski felt blindsided when he found out his longtime mutual fund, Janus, was linked to ongoing investigations of improper trading practices within the mutual-fund industry.
Nobody from Janus had given him a heads-up. Nobody had called with a warning.
Although Janus has promised publicly to ferret out what it considers to be rogue traders within the company, it still has some explaining to do, said Okraski, who owns a Winter Park consulting firm and is counting on the fund as a source of future retirement income.
“I know what I’ve read and seen, but I haven’t heard from them or received anything in the mail about the situation,” he said. “I think they do owe us all an explanation.”
The mutual-fund industry has been besieged in recent months with investigations, allegations and admissions of improper trading and marketing practices.
So far, the turmoil hasn’t driven many investors to sell their shares in the funds, which are pools of money invested in various things — mostly stocks but also bonds, money-market securities and other financial instruments. After what industry officials describe as a seasonal dip in September, the cash resumed flowing in October.
But as each week brings a new revelation, more and more investors are demanding answers from the companies they once trusted implicitly.
Some investors want more than that. Lawsuits are proliferating; Janus alone faces at least 18 federal suits alleging that it cheated investors by secretly helping certain investors profit from improper trading of mutual-fund shares. The company has hired a consultant to help gauge how much it may owe.
Putnam, Bank of America’s Nations Funds, Bank One, Strong Financial — one after another, a dozen or so major mutual funds have joined Janus in the crosshairs of the federal and state investigations, along with several hedge funds and brokerage houses.
In some cases, the allegations involve mutual funds allowing the hedge funds or brokerages to make illegal, after-hours trades, which let them take unfair advantage of late-in-the-day news likely to affect share prices the next day.
Other mutual funds are accused of allowing aggressive, short-term trading known as market timing, in which certain investors can profit from trades based on news from overseas that affects next-day share prices in this country.
Either way, it appears that certain big-money investors paid secret commissions to mutual-fund traders for preferential treatment that reaped big profits for them while siphoning returns from ordinary investors.
“I have been buying into four types of mutual funds for about five years, and they have done OK through the down and up markets,” said Alma Kadragic, a Winter Park marketing consultant who also looks to her funds as a long-term source of income in retirement.
“But I can tell you that, as a result of this situation, I will be extremely leery of putting any more money into them,” she said of her funds. “And they haven’t even been in the headlines. They’re clean, so far, I hope.”
Of all the financial debacles in recent years — from Enron and WorldCom to the recent conflict-of-interest cases against some of Wall Street’s top brokerages — the mutual-fund scandals probably affect Main Street more than any other.
The mutual-fund industry has undergone explosive growth during the past two decades, thanks in large part to the increase in corporate retirement plans tied to such funds. The industry now manages close to $7 trillion in investments. Twenty years ago, one in every 20 households had some money in a mutual fund; today, it is one in every two households.
Recent surveys suggest that many investors are indifferent to what could be considered just one more scandal in the country’s financial-services business, especially when compared to the outrage that followed by collapse of Enron and WorldCom.
In a recent Gallup Poll, for example, 67 percent of those questioned said the revelations would not affect their decision to invest in a mutual fund.
But part of the reason, experts and advisers say, may be that, while acknowledging the gravity of the allegations, investors are keeping the financial fallout in perspective.
Overall, the problem may seem substantial, with losses ranging as high as $5 billion a year, according to a Stanford University analysis cited by the Chicago Tribune.
But the scandals’ effect on the average investor isn’t very large, financial experts say, with estimates ranging from $10 to $166 for every $100,000 invested in a stock mutual fund. Investors in bond or money-market funds may not have been affected at all.
By such measures, financial advisers say, there’s little reason to ditch a well-performing fund unless the intention is to send its managers a protest message.
Still, the scandals should spur investors to ask serious questions of their advisers, become more educated about their funds and be aware of potential conflicts of interest in the management of their money, said Kimberly Sterling, a partner in Resource Consulting Group, a financial-advisory group in Orlando.
“In the big picture, you don’t want to panic; you don’t want the cure to be worse than the disease,” she said. “And this is a case where you don’t want to give any kind of positive spin to the breach of fiduciary responsibility that has taken place in these companies. It has taken something like these investigations to bring the problem to light and get something done.
“But although the damages may be in big dollars in the aggregate, the financial impact on the individual investor is not a big problem — certainly nothing like the down market of the past few years has been.”
State and federal regulators have been focusing their investigations on late trading and market timing, two practices they allege are prevalent in the mutual-fund industry.
In late trading, certain investors are allowed, illegally, to buy or sell shares at a fund’s once-a-day, 4 p.m. price after that price has been set. Normally, investors who trade shares after 4 p.m. must settle for whatever price is fixed the next day at 4 p.m.
Late trading allows an investor to take unfair advantage of after-hours news that is likely to affect prices the next day.
In market timing, favored investors are allowed to take advantage of time-zone differences when trading mutual-fund shares.
Some funds, for example, may hold stock in Japanese firms. The Tokyo market closes at 2 a.m. Eastern time, but the U.S. funds won’t set their share prices until 4 p.m.
By that time their prices are “stale” because the prices of the Japanese stocks underlying the funds have been fixed for 14 hours.
Market timers can jump into such mutual funds, buying low, then jump out a day later when the delayed effects of corporate, economic or political news show up in the mutual funds’ share value.
While not illegal, market timing is prohibited by most mutual funds to discourage short-term speculation at the expense of long-term investors.
And regulators are arguing that, because mutual funds have formal policies against market timing, those that have allowed it have committed fraud on their long-term investors.
But if the daily announcements and disclosures have shaken the average investor’s confidence, it is not showing up in the industry’s numbers.
After authorities announced the late-trading and market-timing scandals in early September, for example, new investments in stock mutual funds fell to $17.3 billion that month, down 25 percent from August, according to the Investment Company Institute, which represents and monitors the mutual-fund industry.
But industry officials described the falloff as coincidental and typical of month-to-month fluctuations in investment activity — and they cited more-recent research that indicates a significant rebound in stock mutual-fund investments in October: According to estimates by AMG Data Services, $24.5 billion poured into stock mutual funds last month, up 42 percent from September.
“We believe that shows mutual-fund investors haven’t lost confidence,” said James Doyle, a spokesman for the Investment Company Institute, which won’t have official data for October for several more weeks.
“They continue to put money into stock funds, and certainly that may be because the market has turned around and is performing better now.”
Cliché or not, many financial advisers are telling their clients to stay the course.
If a fund has paid well through the years, it deserves a chance to deal with the problem if it has been implicated by one of the current investigations, said Myra Tucker, a certified financial planner and owner of Integrated Financial Services of Central Florida, based in Lady Lake.
Even Putnam Investments shouldn’t be abandoned, Tucker said, even though the Boston-based money-management firm has acknowledged market-timing activity and faces civil charges from state and federal regulators.
Her advice: Become informed, weigh the seriousness of any charges, and give management time to correct the problem.
So far, only one of her more than 400 clients has bolted a mutual fund because of the scandals, Tucker said.
“It would be very easy for advisers at this point to take advantage of client concerns and fears, and move them into another fund, which would put more money in an adviser’s own pocket,” she said.
“Generally, I only advise clients to leave a fund when I see something happening to that fund’s net asset value in relation to its peers and the rest of the market. You have to decide then if a client is going to be hurt and whether it is time to move.”
For some advisers, though, the scandals alone have been enough to abandon certain funds already implicated by authorities.
Roger Johnson, a Winter Park adviser, pulled clients out of Janus after the company was linked to improper trading schemes. But, for now, he has not done the same with Putnam.
“I was not a happy camper to have been duped by Janus all this time,” said Johnson of Certified Financial Group. “I recommended that our clients sell, even though there would be some tax ramifications if they did. I’ll keep an eye on Janus and, some day in the future, consider going back.
“With Putnam, I don’t think the alleged offenses are as serious,” he said, “and I believe they are taking a hit for something that happened several years ago. But if they are found to have committed illegal actions, I will go back to my clients and make recommendations accordingly.”
Likewise, professional money-management companies are trying to deal with the scandal.
The Newport Group, an Orlando-based firm that manages 401(k) retirement plans and other benefit programs for more than 500 corporate clients, has so far withdrawn its support for two mutual funds, which it wouldn’t identify, as a result of the scandal.
“We’re fortunate that there are only two funds we’ve recommended our clients exit during this time,” said Mendel Metzer, Newport chief investment officer. “What we are trying to assess is whether the allegations against various firms are likely to cause a substantial outflow of assets or loss of talent in the organization.
“While it would be easy to just say, ‘Let’s get out of any fund that is implicated in this investigation,’ our duty to our clients is to carefully determine exactly how serious each case is and how that may affect a fund’s future investment potential.”
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