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Fund Times: SEC Launches New Mutual Fund Probe

Plus, MFS' new not-for-sale sign, Tweedy looks for value abroad, and more.

Morningstar Analysts, 10/30/2006

The Securities and Exchange Commission recently launched an investigation into 27 mutual fund companies' alleged fraudulent arrangements with mutual fund administrative-service provider Bisys BSG, according to a report in the Oct. 26 edition of The Wall Street Journal. As we reported in late September, Bisys settled with the SEC for $21 million for its role in the alleged fraud.

The SEC alleges that between July 1999 and June 2004 Bisys and the fund companies participated in a fraudulent arrangement whereby Bisys returned a portion of fees paid to it for its services back to fund advisors, who in turn used the money to market their funds. In essence, fund investors, whose assets were used to pay Bisys, were paying not solely for fund services but also for marketing and related expenses, which should be paid for by the advisor, not fundholders. The SEC's original order in this matter suggests that Bisys may have paid as much as $230 million in kickbacks to fund firms in order to continue these business relationships.

The Journal article also suggests that one of the fund companies involved in the scandal, referred to in the SEC document as Advisor A, is AmSouth Funds, a unit of AmSouth Bancorp during the period under investigation. In 2005, however, the assets of the AmSouth Funds (roughly $5.5 billion) were purchased by advisor Pioneer Investments. The article states that Advisor A used $17 million "from shareholder accounts...to cover marketing costs that would normally come out of its own pocket. The advisor also used some of the money to pay the initiation fee and monthly dues at a country club."

Fund advisors are supposed to pay for marketing costs themselves or impose a more transparent 12b-1 fee to cover them, so this type of behavior is both outrageous and illegal.

Unfortunately, the fund industry has seen its share of scandals in recent years, with a series of stinging settlements coming from New York Attorney General Eliot Spitzer's investigations of industry practices such as late-trading and market-timing. While these have been the headline-grabbing problems in the industry in recent years, fraud in the back-office operations of fund companies in nothing new.

In June 2005, Smith Barney Fund Management and then-parent Citigroup Global Markets (Legg Mason since has taken over the Smith Barney asset management business) defrauded fund investors by charging inflated transfer-agent fees. And although the firms in question did not admit or deny any wrongdoing, they did agree to pay roughly $180 million in disgorgements and fines. At the time, we suggested that we wouldn't be surprised to see more scandals of this nature, and it seems that they've finally arrived.

Therefore, we strongly encourage investors to look closely at our fund Stewardship Grades when making a decision on whether to invest in a given fund.

Sun Life Takes MFS Off the Auction Block
Ending weeks of speculation, Sun Life Financial Services SLF recently announced it will continue to own fund advisor MFS Investment Management and is no longer seeking the sale of the firm that it had announced in September. Sun Life CEO Donald Stewart said in a statement that "MFS is a valuable strategic asset. With one of the strongest brands in asset management. (it is) poised for continued growth."

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