- The Washington Times - Wednesday, October 8, 2003

As more financial firms are implicated in shady mutual fund trading, many investors are starting to worry about the extent of the abuses. While they have no reason to panic, they shouldn’t be surprised if they see an industry shakeout with more revelations of wrongdoing.

In the past few weeks, Merrill Lynch & Co., Alliance Capital Management Holding LP, Prudential Securities and Fred Alger Management have suspended or fired nearly two dozen employees believed to have engaged in illegal trading.

The steps were taken after New York Attorney General Eliot Spitzer on Sept. 3 accused hedge fund Canary Capital Partners LLC of illegal trading involving Bank of America, Janus, Bank One Corp. and Strong Financial Corp. funds.

“There seems to be a lot more coming to the surface as a result of Spitzer’s initial investigation,” said Phil Edwards, managing director of funds research at Standard & Poor’s. The funds “have enough respect for Mr. Spitzer to uncover the dirt themselves rather than let him, so you have more people coming forth.”

The charges focus on late trading, in which investors are improperly allowed to trade after the close of markets at preclosing values, and market-timing, or short-term “in and out” deals, a practice that is illegal to the extent fund firms discourage it in their prospectuses.

Mr. Spitzer has said late trading and market timing are widespread and could be unfairly costing everyday investors billions of dollars.

Investors appear to be taking notice.

The average weekly inflow into stock mutual funds dropped by half from $4.9 billion at the end of August to $2.2 billion at the end of last month, according to AMG Data Services. That sharp drop-off can’t readily be explained without taking into account investor concerns about the mutual fund probe, said AMG Data President Robert Adler.

“The charges are a serious matter,” said Brian Portnoy, mutual fund analyst at Morningstar Inc. “What’s being brought to light is a series of situations where regular long-term investors are being shafted or being given secondary priority to a fund company’s profitability.”

Still, analysts say it might be premature to draw comparisons with Mr. Spitzer’s last investigation. That probe, into purported widespread conflicts of interest among Wall Street analysts, led to a $1.4 billion settlement with major investment banks.

The analysts note that the financial damage in the mutual fund probe doesn’t appear to be as great. Instead, what appears to be more at stake is the fund industry’s reputation as a trustworthy haven for ordinary investors.

“It’s not an Enron or WorldCom situation where investors lost all of their money,” Mr. Portnoy said. “The major story for the scandal is one of ethical missteps and whether fund companies are prepared to treat shareholders the way they deserve to be treated.”

The industry has started scrambling to restore investor confidence as the probe continues by Mr. Spitzer’s office and the Securities and Exchange Commission. Several fund firms, including Strong Capital Management, have hired auditors to examine accusations of wrongdoing.

Bank of America has established a restitution fund for shareholders who lost money after one of its former brokers was charged with larceny and securities law violations.


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