Recapping the Mutual Fund Scandal Fund by Fund

What follows is an attempt to consolidate as much as possible all of the available public information regarding the current state of the "mutual fund scandal" as of October 30, 2003. This compilation is not an opinion on the validity of allegations made, on actions taken by the parties involved, on the guilt or innocence of any individual or company, nor an opinion regarding the suitability of these mutual funds. This compilation should not be the basis for retaining or removing a fund or fund family from a retirement plan or investment portfolio. It is simply provided in an effort to put together a mosaic of relevant public information about each of the fund companies involved. Although statements and other material contained here have been obtained from public sources believed to be reliable, the statements and other material are not guaranteed as to accuracy or completeness by 401khelpcenter.com, LLC or Sentinel Fiduciary Services, Inc.

To frame the issues it should be recognized that there are several levels of questionable practices at work here, some of which are to some extent inherent in the investing industry as it currently exists.

The first level and most serious is the issue of illegal activity. This can occur through trading at pre-close prices after the market closes or trading on inside information not available to others. Fiduciaries first have an obligation to act in the best interests of those investors they represent and could be acting illegally if they knowingly put their own interests first. This can happen by generating additional fees or profiting personally through activities that, while not illegal in themselves, cost their investors money.

Another level is acting contrary to stated policies for selected investors, especially if it generates additional revenue for the firm. This can occur when the fund's prospectus states that short term trading is not to be tolerated but exceptions are made for certain clients with large balances such as hedge funds or large retirement plans. In some cases this can be in the form of an explicitly stated policy of the fund company, or a management group within the company, and is a highly questionable practice. In other cases it may be lax oversight where the fund's sales department is encouraging it without management's knowledge and the compliance department fails to catch it. Many prospectuses are vague regarding the company's policy with statements like market timing "may be rejected" or may only be enforced when "management believes" it is detrimental. This can make it difficult for employees to decide when they should or should not execute suspicious trades. Some funds have no policy on short term trades.

A third level is where the funds themselves are unwitting participants as it can be difficult for a fund company to spot market timing trades. Often, in retirement plans, trades are bundled by a third party administrator and timing by individual participants is therefore disguised. In some cases cited below, brokers disguised market timing trades by using several identifying numbers and breaking them down into smaller units.

It should be noted that approximately 80 mutual fund companies have been subpoenaed by various authorities. That, in itself, is a request for information and does not imply guilt. However, it appears that about half of them have stated that some form of market timing has occurred in their funds. So the information below is a work in progress and should not be considered complete.

Alliance Capital Management Holdings. (AllianceBernstein Funds)

• Suspended two employees for conflicts of interest that benefited Alliance's hedge funds at the expense of mutual fund holders. One was Gerald Malone manager of the AllianceBernstein Technology fund who allegedly allowed market timing in the fund in exchange for investments in a hedge fund run by him.

Bank of America Corp. (Nations Funds)

• Cited in Spitzer's probe of Canary Capital partners as engaging in special trading arrangements in exchange for large investments in mutual funds managed by BOA.
• Theodore C. Sihpol III, BOA broker, charged by Spitzer with felony for illegal late trading; SEC filed civil case alleging securities fraud.
• BOA dismissed several employees (including Sihpol, his boss, Charles Bryceland and the head of mutual funds, Robert Gordon) who knew about the illegal trading and says it is cooperating with the investigation.
• Pledged to reimburse shareholders if harmed and hire independent experts to evaluate damages and corrective actions.
• Morningstar no longer recommends BOA funds.
• Named in class action lawsuits, by law firm Wolf Popper LLP and others, alleging illegal or improper trading.
• Has set aside $100 million for legal and consulting fees and restitution.

Bank One Corp. (One Group Funds)

• Cited in Spitzer's probe of Canary Capital partners as engaging in special trading arrangements in exchange for large investments in mutual funds managed by Bank One.
• Pledged to reimburse shareholders if harmed. Reevaluating policies and processes.
• Morningstar no longer recommends Bank One funds.
• Named in class action lawsuits, by law firm Wolf Popper LLP and others, alleging illegal or improper trading.
• Mark Beeson, president of One Group and John AbuNassar, head of the institutional asset management group have resigned.

Citigroup, Inc. (Smith Barney Funds)

• Fired a broker for canceling mutual fund trades after the market closed.
• Four additional brokers fired for inappropriate behavior related to market riming.

Federated Investors (Federated Funds)

• Disclosed at stockholders' meeting that there may have been market timing or late trading in some of its funds but provided no details.

Fred Alger Management, Inc. (Alger Funds)

• Suspended three employees (including James Connelly, the firm's Vice Chairman and head of mutual fund sales) for possibly allowing a client to trade Alger funds after the 4 p.m. close of trading.
• Connelly pleaded guilty to civil charges of obstructing the investigation and allowing select investors to time the Alger funds from the mid 1990s until 2003.

Janus Capital Group, Inc. (Janus Funds)

• Cited in Spitzer's probe of Canary Capital partners as engaging in special trading arrangements in exchange for large investments in mutual funds managed by Janus.
• Janus stated it had timing arrangements with 12 separate clients.
• Said certain employees involved are no longer with the firm (though were not fired).
• Pledged to reimburse shareholders if harmed and hire independent experts to evaluate damages.
• Morningstar no longer recommends Janus funds.
• Merrill Lynch reduced rating of Janus stock as profits could be impacted by scandal for some time.
• Named in class action lawsuits, by law firm Wolf Popper LLP and others, alleging illegal or improper trading.
• Key management turnover in last 12 months; Helen Young Hayes, Warren Lammert, Sandy Rufenacht and most of High Yield team.
• Internal e-mail references Janus developing a policy for market timers.
• Net withdrawals of $2.4 billion in September.

Merrill, Lynch & Co. (Merrill Lynch Funds)

• Fired three brokers for allegedly helping a hedge fund (Millennium Partners) improperly trade mutual funds.
• Merrill did not have an agreement with Millennium allowing the trading.

Prudential Securities (Prudential Funds)

• Twelve brokers resigned under pressure for suspicion of market timing in mutual funds including the managers of the downtown Boston and Garden City offices.
• Trading by offshore hedge funds took place in more than 10 fund companies including Prudential funds.
• No evidence that funds approved trading as brokers used multiple identification number to disguise trades.
• Firm is under investigation by the Massachusetts Securities Division and Elliott Spitzer's office.

Putnam Investments (Putnam Funds)

• First firm to be charged in civil suit with failure to take adequate steps to prevent several of its funds' managers from improperly trading Putnam funds. Charges brought by SEC and Massachusetts Securities Division. Firm knew of the activities and had instructed managers to stop however no disciplinary action was taken. Managers could also face charges of insider trading.
• Two international fund managers (Justin M. Scott and Omid Kamshad) face civil charges for breach of fiduciary duties. Complaint alleges they continued making short-term trades after the firm told them to stop.
• Four other managers also engaged in excessive short-term trading of Putnam funds.
• Manager are "on leave" from Putnam during the investigation.
• Firm is also charged with civil fraud for allowing market timing in certain retirement plans, violating prospectus terms, to retain assets in the funds and for future business. This was allowed despite efforts to discourage it in retail accounts. Allegedly ignored reports that a retirement plan was engaging in market timing.
• Will reimburse clients for any losses related to market timing.
• Some market timing appears to have come through Putnam Variable Trusts - products used in variable annuities.
• Has indicated it will make restitution of approximately $1 million to the affected funds and instituted new early redemption fees to stop market timing. Putnam says it never had explicit agreements with client for market timing trades.
• Massachusetts state pensionis moving $1.7 billion from Putnam; Vermont teachers plan $91 million, St. Olaf College $22 million, George Washington University $28 million, others likely to follow.

Strong Capital Management, Inc. (Strong Funds)

• Cited in Spitzer's probe of Canary Capital partners as engaging in special trading arrangements in exchange for large investments in mutual funds managed by Strong.
• Firm has stated that Richard Strong, chairman & founder, engaged in improper trading in his firm's mutual funds over several years gaining at least $600,000 in profits for himself and others. This could be a violation of securities laws as fund executives are required to protect the interest of shareholders.
• Conducting internal review with assistance of outside professionals.
• Morningstar no longer recommends Strong funds.
• Named in class action lawsuits, by law firm Wolf Popper LLP and others, alleging illegal or improper trading.
• Net withdrawals of $69 million in September.

Statements and other material has been obtained from public sources believed to be reliable, but are not guaranteed as to accuracy or completeness by 401khelpcenter.com, LLC or Sentinel Fiduciary Services, Inc. This article is for informational purposes only and is not intended as legal, tax or investment advice.

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