• Boot the skimmers Boot the skimmers “The mutual fund industry is now the world’s largest skimming operation – a $7 trillion trough from which fund managers, brokers and other insiders are steadily siphoning off an excessive slice of the
• Boot the skimmers
Boot the skimmers
“The mutual fund industry is now the world’s largest skimming operation – a $7 trillion trough from which fund managers, brokers and other insiders are steadily siphoning off an excessive slice of the nation’s household, college and retirement savings,” says Sen. Peter Fitzgerald, R-Ill.
Sadly, he’s right. His description doesn’t cover all mutual funds. There are 6,000 of them, and plenty still keep the shareholders’ interest at heart. But scandals have now touched so many large fund families – including Putnam, Federated, Strong, Alliance and Bank of America – that his broad-brush indictment is apt.
To understand why, we turn to another quote from Mr. Fitzgerald: “The governance structure of a typical mutual fund is a study in institutionalized conflict of interest.” That is absolutely true.
Funds are run to enrich fund managers and management companies. Most do this the old fashioned way: by getting good returns for shareholders, thereby attracting lots of investment into their funds. That’s a win for everybody.
But when shareholders’ interests conflict with management’s, management can rig the game. That explains why big investors, who can line the pockets of management firms, were allowed to late-trade and market-time to the detriment of all other shareholders. Executives at some funds joined merrily in the cheating. Richard Strong, founder and chairman of the $43 billion Strong Mutual Funds, resigned after being accused of making perhaps $600,000 through improper trading in his own fund accounts.
So what to do about it?
First, we must punish the guilty by fining them and, when possible, tossing them in jail. This process is underway, thanks mainly to New York Attorney General Eliot Spitzer. We may have to tighten the fraud laws to explicitly cover the recent shenanigans at mutual funds.
Next, we must root out those conflicts of interest.
In theory, mutual funds are each run by a board of directors. In practice, the board is in the pocket of the management company. The chairman and several members are usually management employees. The so-called “independent” directors know they get their hefty salaries – often more than $100,000 per year – for little work through the largesse of the management company. That’s why managers can charge mutual funds much higher fees than they charge to pension funds and endowments.
This has to change. Mr. Fitzgerald, who chaired a Senate hearing into the mess recently, suggests requiring that 75 percent of directors be independent. That’s a good idea. John Bogle, former chief of the Vanguard Group and an gray eminence of the mutual fund business, suggests that managers get only one board seat. That’s also a good idea.
Federal law should be changed to make it clear that board members owe their allegiance to the shareholders, and hold them liable when they betray that trust.
Mr. Fitzgerald would require directors to competitively bid out management contracts. So a Strong fund could suddenly become a Fidelity fund. That’s an interesting idea, but it might be hard to implement given the mechanics of the fund business.
Funds should be forced to play straight on fees. Shareholders should know exactly how much they’re paying for management, marketing and trading, including commissions, compared to other funds. Stockbrokers who steer customers to certain mutual funds should have to disclose their compensation.
To nix late trading, a 4 p.m. Eastern time deadline for placing orders should be enshrined in federal securities regulations, with stiff penalties for violators. The Securities and Exchange Commission is considering doing just that.
This scandal was exposed largely by Mr. Spitzer and state regulators in Massachusetts. The SEC, the federal cop on the beat, missed finagling in the mutual fund industry just as it failed to spot last year’s corporate scandals before they exploded on the front pages. In fact, a Putnam employee tipped the SEC to strange goings-on at work, but the SEC failed to take the tip seriously.
This week, Putnam settled a securities fraud lawsuit filed by the SEC two weeks ago. The SEC called it a victory, but Massachusetts and New York regulators called it a capitulation that papered over problems.
In the wake of last year’s scandals, Congress nearly doubled the SEC’s budget. Now it’s up to the SEC’s new chairman, William Donaldson, to give us our money’s worth in enforcement.
St. Louis Post-Dispatch
