• Mutual funds Mutual funds The Securities and Exchange Commission added to its reputation as the Keystone cop of Wall Street this week by refusing to use its billy club on Putnam Investments. In the Putnam case, the criticism is
• Mutual funds
Mutual funds
The Securities and Exchange Commission added to its reputation as the Keystone cop of Wall Street this week by refusing to use its billy club on Putnam Investments. In the Putnam case, the criticism is a bit unfair.
The SEC has been incredibly inept. None of the recent mutual fund scandals was exposed by the SEC, and last year’s corporate scandals caught the agency flat-footed. It snoozed while all sorts of wingtip-wearing crooks ran off with bags of loot.
But the Putnam case is a little different. Once the SEC woke up, it did just what a good cop should do: It took the wrongdoer into custody and arranged to return the loot to its owners. The mutual fund company’s final punishment will be determined later.
Putnam committed the sin of winking while six of its executives did quick-and-dirty trades in Putnam mutual funds, earning themselves more than $1 million at the expense of other shareholders. When top Putnam officials learned what was going on, they didn’t fire the executives. They didn’t make up losses to shareholders. They just told the offenders to stop. Putnam’s reaction was so wimpy that four of the six execs kept trading wrongfully long after the warning. All the while, top management looked the other way.
In settling its fraud suit, the SEC required Putnam to put its mutual fund board in the hands of truly independent directors. To make sure that the shady dealings stop, a compliance officer will report directly to the mutual fund board, rather than the see-no-evil Putnam management firm. An outside consultant will determine how much shareholders lost and Putnam will have to pay up. The company also will pay fines to be determined later.
Basically, the SEC put safeguards in place for Putnam investors immediately, leaving punishment for later. The alternative was months of litigation with inadequate protection for fund shareholders.
That no doubt will seem like a wrist-slap to New York Attorney General Eliot Spitzer and William Galvin, secretary of the Commonwealth of Massachusetts. “They’re not interested in exposing wrongdoing; they’re interested in giving comfort to the industry,” snarled Mr. Galvin.
Mr. Galvin and Mr. Spitzer are the Wyatt Earp and Doc Holiday of finance, determined to run the varmints out of Tombstone. They broke the mutual fund scandal while the SEC slept.
Mr. Spitzer is worried that the SEC’s wrist-slap could set a pattern for settlements with the growing number of mutual fund companies enmeshed in scandal. He wants heavy fines, public admissions of guilt and much tougher controls.
There’s a strong argument to be made for throwing a necktie party for a couple of mutual fund management companies. Government prosecutors sent a very clear message to the accounting industry last year when they held a public execution for the Arthur Andersen accounting firm.
On the other hand, “the punishment must fit the crime,” said Joel Seligman, dean of the law school at Washington University and a noted historian of the SEC. What Putnam did was bad, but it isn’t on a par with what went down at Enron and Andersen. Investors in certain of its mutual funds probably lost a couple of percentage points in annual returns.
And Putnam’s suffering isn’t over. Mr. Galvin is suing the company and can demand more fines and reforms. Class-action lawyers across the nation are sharpening their knives. Putnam’s CEO, justly, lost his job.
Meanwhile, Putnam’s customers are getting in their licks. Since the scandal broke, investors have yanked $21 billion out of Putnam funds, equaling about 8 percent of the total. That directly cuts Putnam’s profits.
Stiffer regulations are needed to clean up the industry, and those are in the pipeline. The House of Representatives last week approved a fine bill toughening penalties for mutual fund abuse and forbidding in-and-out trading by insiders. The SEC will soon impose its own rules designed to forbid improper trading. The rules will also make fund boards more independent of management companies and more able to spot abuses.
Of course, regulations are no good unless they’re enforced. In the wake of last year’s corporate scandals, the SEC got a new chairman and more money to do its business. But it has yet to prove that it can track down wrongdoing in mutual funds. It’s a good thing real lawmen like Wyatt and Doc are still around.
St. Louis Post-Dispatch
