How Do The Mutual Fund Scandals Affect You?

What was once thought a safe investment is now under scrutiny. Here's what matters and why.

For investors like San Jose, California, resident Glenn E. Perkins, the latest mutual fund scandals have shaken his confidence. But the engineering manager still thinks mutual funds are one of the safest ways for individual investors to invest in the stock market.

Perkins is also financial partner of the South Bay Investors Club of the National Association of Investors Corporation (NAIC). He says that while being part of the investment club allows him to have some control over his stock selection, “I’m watching [the market] a little more closely than I had been before.” Perkins, who has placed most of his 401(k) savings into Vanguard funds, is “still fairly comfortable” with mutual funds because he hasn’t lost money as a result of the current scandals. He is also using his involvement in the investment club and some personal brokerage accounts to diversify his holdings.

While the scandal concerns him, Perkins feels there are few choices for most individual investors other than mutual funds. But he’s not so naive as to think scandals like this won’t happen again.

A GROWING SCANDAL
New York Attorney General Eliot Spitzer is inclined to agree. Spitzer, who launched the first mutual fund investigations in early September, has been quoted saying the scandal is bigger than just “excising a few bad apples from the industry,” suggesting that improper short-term trading may have skimmed more than $4 billion a year from investors.

Spitzer alleged that several companies, including Bank of America Securities and Janus Capital Management, had questionable dealings with hedge fund company Canary Capital Partners L.L.C. Hedge funds are unregulated investment pools for wealthy, financially sophisticated investors. Spitzer’s investigations alleged that Bank of America and Janus had engaged in market timing arrangements and after-hours trading deals that benefited certain large clients at the expense of individual investors. The scandal has spread like a virus across the $7 trillion mutual fund industry, with many of the big mutual fund companies coming under scrutiny. Those targeted by the U.S. Securities and Exchange Commission (SEC) for “market timing” violations include Janus, Bank of America, Prudential/Wachovia, BankOne, Pilgrim Baxter & Associates, and Strong Capital. Mutual funds suspected of late-trading or rapid trading include Alliance Capital Management, Charles Schwab Corp., Federated Investors, Loomis Sayles, and Putnam Investments. American Express allegedly withheld discounts on mutual funds to investors; Fred Alger Management was guilty of obstructing the fund-trading investigation; and brokers at Morgan Stanley are accused of recommending inappropriate share classes to investors.

The National Association of Securities Dealers (NASD), an agency charged with regulating securities trading, says market timing–taking advantage of price differences between international and domestic markets by rapidly shifting in and out of funds–is not illegal, but most funds publicly discourage it. NASD officials say market timing drives mutual fund costs up and waters down profits for those investing long term.

Late or after-hours trading involves buying and selling shares after the U.S. market has closed at 4 p.m. Eastern Standard Time. This is typically off limits to most investors. Some companies allow special clients to

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