- The Washington Times - Tuesday, May 13, 2003

Mutual fund shareholders who lost money on stocks that analysts pumped up in the late 1990s bull market might be hoping for a share of an investor restitution pool, but they should prepare themselves: They are likely to get nothing.

As part of the recent $1.4 billion settlement between 10 brokerages and government regulators, $387.5 million goes into a restitution fund, although the claims by investors who believe they were cheated are expected to surpass that amount considerably. The agreement settles claims by federal and state officials that the firms issued misleading stock research and ratings.

While the focus has been on repaying individual investors, just how and to whom the restitution fund will be parceled out is not clear, and an administrator to oversee the process must be named. But the early bets are that individual mutual fund shareholders won’t be among those who are repaid.

“If mutual fund investors want a piece of it, it is going to be one heck of a fight,” said Howard Schilit, president of the Center for Financial Research & Analysis in Rockville.

Fund companies themselves are still trying to decide whether they will apply for restitution, and some say they won’t know for sure until the criteria needed to make a claim are outlined.

It also has not been settled which stocks’ investors will be compensated for buying on analysts’ overly hyped recommendations. In complaints on the Securities and Exchange Commission’s Web site against the brokerages, which include Merrill Lynch, Goldman Sachs and Citigroup, about 35 stocks are mentioned.

Those stocks are mostly Internet, technology and telecommunications companies, including GoTo.com, Razorfish Inc. and Level 3 Communications. They had modest representation in mutual funds specializing in those sectors and the growth style of investment, according to fund researcher Morningstar Inc.

Level 3 Communications was held by 147 funds in mid-2000, according to Morningstar. Razorfish was in 57 funds and GoTo.com was held by 35 funds. At that point, the total number of U.S. equity funds was 3,075.

Whether any mutual fund investors can recoup money “will ultimately depend on the number of individual investors” who seek repayment, said Barry Barbash, a former Securities and Exchange Commission lawyer who now works for fund companies in private practice. “Those people would be more directly connected with the premise of the settlement … that smaller individual investors were misled.”

It would also be easier to identify and repay individual investors who were harmed by wrongdoing of brokers and analysts than fund shareholders, Mr. Barbash said.

The problem is this: Mutual fund companies are the investor of record, representing thousands of shareholders. If a fund company received compensation on behalf of its shareholders, the company could disburse the money as it saw fit. It could choose to simply add the money back to the assets of the appropriate mutual funds, which is what the Vanguard Group said it would do.

But consider that some fund investors, who may have been hurt by misleading analysts, have gotten out of the funds, while others have since bought shares. That means some shareholders who weren’t injured would, nonetheless, be repaid, and others who should be repaid would not be.

This sort of scenario could prompt the administrator of the restitution fund to favor individual investors, Mr. Barbash said.

“I think the practicality of the situation will work against mutual funds and their shareholders,” he said. “It is the mutual element of mutual funds that will present some obstacles.”

Regardless, the Investment Company Institute, the leading trade group for mutual funds, said funds should share in the restitution money and that fund companies should go after it.

“To the extent that funds have been harmed as a result of the improper actions of analysts, they, like other investors, should be eligible for restitution,” said ICI spokesman John Collins.

The Vanguard Group, widely represented in 401(k) retirement plans, intends to seek repayment. “If we are eligible, we would apply to receive payment on behalf of our shareholders,” Vanguard spokesman John Demming said.

Fidelity Investments, the nation’s largest mutual fund company, declined to comment on its plans. Munder Capital, whose NetNet Fund was one of the most prominent and highest-flying Internet sector funds a few years ago, also declined to comment.

Janus Capital said it hasn’t made a decision.

Some market observers say mutual fund companies would be better served focusing on current performance than by fighting for what is likely to be a small cut of the restitution fund.

“The potential payout is going to be tiny. And [funds] have much bigger problems to worry about, such as navigating this difficult environment and resuscitating performance,” Mr. Schilit said.

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