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To Your
Wealth/Michael P. Haubrich, CFP November,
2003 Mutual
Fund Scandals |
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Once again, it appears the
financial service industry is experiencing another scandal at the expense of
clients and shareholders. A number of mutual funds along with several hedge
funds have been charged by the attorney general in Another activity going on is
market timing, in which traders make rapid trades in and out of specific
mutual funds to lock-in gains. Again, this is prohibited in most mutual fund
prospectuses because they hurt long-term investors—like you and me. This
activity increases trading costs for the mutual funds, which are then passed
on to shareholders not even involved in the practices. The real issue is the mutual fund
companies betraying their fiduciary responsibilities to a trusting
public. And, unfortunately, it doesn’t
look like that breach is limited to a single company or to an isolated incident.
Rather, we’re learning more and more every day about the depth and breadth of
this latest attack on confidence with much more of the story yet to be
revealed. Last week saw accusations of
securities fraud and federal and state securities regulators filing civil
lawsuits against one of the top five mutual fund companies in the country,
Putnam Investments, and two of that company’s recently fired fund managers.
By Friday, a local company, Strong Financial Management and it’s chairman,
Richard Strong, were similarly called to task for potentially making improper
trades resulting in a relatively insignificant personal gain for Mr. Strong
when compared to his $800 million net worth. Mutual fund companies, like other
financial service companies, have a fiduciary responsibility to place the
interests of their shareowners above their company’s interests and certainly
above the personal interests of their fund managers or executives. Putnam and Strong have both
indicated that they will repay any ill gotten gains to their respective
company’s shareowners. But that alone
will not restore confidence or excuse the egregious failure to live up to
those company’s fiduciary responsibilities. There are several implications as
a result of the self-serving actions of mutual fund companies accused of
buying and selling shares contrary to the best interests of their
clients. Unfortunately, none of them
are pleasant. Not only do the shareowners suffer due to reduced confidence
and increased expenses, but the employees of those companies also suffer to
say nothing of the serious scar to those company’s reputations. Since Putnam was accused last Tuesday of
securities fraud, more than $4 billion has been withdrawn from Putnam by
public pension funds and university endowments and Lawrence Lasser, the chief executive of the funds has resigned. Richard Strong has indicated that
he will personally repay the $600,000 in profits he’s realized and has
stepped down as the fund company’s chairman in attempt to restore confidence.
But this noble, after-the-act gesture may be a case of too little, too
late. The ability of the company to
survive this scandal could be in jeopardy as mass redemptions are likely to
occur, similar to what Putnam has experienced in recent days. As redemptions increase, costs to the
remaining shareowners also rise as the company spreads the management
expenses across a diminishing population of shareowners. The spiraling effect to both Putnam and to
Strong could result in reduced employment and the potential for irreparable damage
to remaining employee morale. In terms of investors who hold
Putnam or Strong mutual funds, my advice is to seek the objective counsel of
a financial advisor. Choices on what best to do will vary and may have tax
and transaction cost considerations to weigh.
Your advisor may indicate that the best course for your situation is
to do nothing beyond monitoring the outcomes of these cases for now. Another investor may be advised to transfer
shares to a company that accepts and respects their fiduciary
responsibilities. Unfortunately,
Strong’s EdVest is the only option for this state’s
529 college savings plan—at least for now. Stay tuned, there will doubtlessly
and sadly be more to this story as it continues to unfold. Michael P. Haubrich,
CFP is President of Financial Service Group, Inc., a Registered Investment
Advisory Firm in |