The Scandal That Walked in the Front Door

Sigh ... yet another fund scandal.

The latest is a growing scandal around kickbacks paid to fund companies by Bisys BSG, a third party that provides a wide range of mutual fund back-office services, such as accounting, shareholder report production, and transfer-agency services. Bisys settled charges with the SEC, but The Wall Street Journal reported that the SEC has now turned its attention to 27 mutual fund companies that may have accepted kickbacks. At this point, we don't know how many, if any, of those fund companies will actually face charges from the SEC.

Regulators say that the way the kickbacks worked is that Bisys would overcharge fund investors for its services and then kickback to the fund company money that rightly belonged to fund investors. Similar to other fund scandals such as market-timing, late trading, front running, and overcharging for transfer-agency fees, the amounts involved were small when viewed in terms of their effect on individual shareholders, but hefty when summed up. In this case Bisys paid $230 million in kickbacks from 1999 through June 2004, according to the SEC.

In addition, another service provider, SEI Investments SEIC, disclosed in its 10-Q filing that the SEC is investigating it for similar-sounding practices: "We have responded and are currently responding to various regulatory examinations, inquiries and requests. One of these regulatory requests and inquiries relate to the payment by certain of our subsidiaries of expenses related to the marketing and distribution of shares of certain mutual fund clients of our fund administration and distribution business. As a result of these examinations, inquiries and requests, we are generally implementing changes and reviewing our compliance procedures and business operations. These activities resulted in an increased level of general and administrative costs."

How'd they get away with it? Well, it appears that independent directors were kept in the dark on the matter. Perhaps inside directors knew about it but didn't share that information with independent directors. Or maybe Bisys kept the board in the dark. After all, one of Bisys' services is providing the chief compliance officer to a fund board. Talk about conflict of interest.

Regardless of who knew about the Bisys kickbacks, fund companies clearly violated their fiduciary duty to fundholders by pocketing money that belonged to them. Some of the market-timing was in a gray area, but this was not.

So far, the SEC has not named the fund companies involved, but The Wall Street Journal wrote that AmSouth Bancorporation ASO is Adviser A named in documents. Adviser A allegedly demanded millions in kickbacks in return for the contracts. In 2005, AmSouth received word that it was being investigated and shortly thereafter it sold its funds to Pioneer. Pioneer reports that only a few salespeople and a bond-fund manager were retained in the acquisition, so we don't believe that the AmSouth executives behind the deal are now at Pioneer.

We have found language similar to AmSouth's disclosure in filings from Pacific Trust Funds advised by the Bank of Hawaii: "In addition, the Funds' administrator, BISYS Fund Services Ohio, Inc., is currently the subject of an SEC investigation related to its past payment of certain marketing and other expenses with respect to certain of its mutual fund clients, including the Funds. Based on management's review and consideration of the matter to date, management does not believe the Funds' financial statements would be adversely impacted as a result of this investigation."