participate in late trading, which lets them buy at the current day’s closing price and profit if the price rises when the market opens the next morning.
Why were certain investors allowed to play by different rules? Because of greed. Over the last three years, when the economy was limping along and many mutual funds were struggling, generating fees from trades became one way for companies to make money. By allowing big players to make special trades, fund managers stood to gain by taking an increased share of the profits of larger clients and by generating income from fees charged for executing the trades.
Some mutual fund executives made a pretty penny. For example, the board chairman of Strong Mutual Funds, Richard Strong, was caught trading within his own funds in ways that benefited him and his friends and family. Strong, who is under investigation by the SEC, Spitzer’s office, and Wisconsin financial regulators, has resigned in the wake of the multiple investigations.
Christopher L. Davis, executive director of Washington, D.C.-based Money Management Institute, a company that represents companies that handle individual managed accounts, says some fund managers took advantage of mutual funds because their activities weren’t seen by the rest of the investing public. Unlike individual managed accounts where clients see their holdings at all times, mutual funds are set up in such a way that there is little oversight. “The lack of transparency allowed these activities to go on,” says Davis. “The SEC needs to improve disclosure laws.”
HOW MUCH HAVE YOU LOST?
Tim Forde, vice president, Strategic Analysis with the Investment Company Institute, an organization that represents mutual funds, says individual mutual fund investors haven’t lost large dollar amounts like what has happened in the recent accounting scandals. However, “[investing in mutual funds] is an enormous leap of faith, and something like this raises serious questions about trust,” Forde says. “The larger potential harm is to mutual fund companies and how individuals save for retirement,” and Forde warns that investor confidence is again at risk.
The Investment Company Institute, whose membership manages about 8,672 mutual funds, reports that the nation’s 95 million mutual fund shareholders are typically pursuing long-term financial goals such as retirement security or paying education costs for children. The group says the typical shareholder is middle-aged, married, and college educated.
So what can investors do to safeguard themselves?
Ken Janke, chairman of the Michigan-based NAIC, says it’s best to look for a mutual fund that can weather the good and bad times. “Most funds have managers who have been there for some time,” says Janke. “It’s not a matter of jumping in and out.” (See “Before You Leave Your Fund.”)
Steven L. Sanders, president of Pittsburgh-based MDL Capital Management, speculates that unethical mutual fund companies will eventually be eliminated. “If investors punish fund families that are not playing by the rules, this will send a clear message that investors are the ones in charge,” Sanders says. “You can punish them by moving your money.”
Chicago-based Morningstar Inc., a global investment research firm, also