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Steer Clear of Nations Funds

Actions investors can take in light of the Spitzer complaint.

Russel Kinnel, 09/05/2003

<P>While the investigation into late trading and fund arbitrage continues, mutual fund investors face the challenge of figuring out what to do with their money now. </P> <P>At this point, four fund companies have been named <A href="http://www.oag.state.ny.us/press/2003/sep/canary_complaint.pdf" target="_blank" >in the complaint</A>, but none has been found guilty or even settled with New York Attorney General Eliot Spitzer. However, investors are always in the position of acting on incomplete information. You have to pick stocks or funds based on the news, data, and facts that are available. Therefore, it makes no sense to ignore the details of Spitzer’s complaint. </P> <P><STRONG>Our Position</STRONG></P> <P>Given the seriousness of the charges leveled against Bank of America <?XML:NAMESPACE PREFIX = MSTR /?><MSTR:SECURITY>BAC</MSTR:SECURITY>, it's prudent for investors to avoid the firm's in-house Nations Funds. If true, Spitzer's charges against Nations Funds would indicate a serious breakdown of compliance and a culture that placed sales ahead of fund shareholders.</P> <P>Subadvised funds run by Marsico Asset Management (including Nations Marsico Focused Equities <MSTR:SECURITY>NFEAX</MSTR:SECURITY> and Nations Marsico Growth <MSTR:SECURITY>NMGIX</MSTR:SECURITY>) and by Brandes (Nations International Value <MSTR:SECURITY>NIVLX</MSTR:SECURITY>) were not named in the complaint, so we'll take some more time to review the implications for these funds before weighing in on whether they should be avoided, too. </P> <P>We'll also take a little more time to go over the evidence on Janus <MSTR:SECURITY>JNS</MSTR:SECURITY>, Bank One <MSTR:SECURITY>ONE</MSTR:SECURITY>, and Strong, also named in Spitzer's complaint. However, we are deeply concerned about these allegations and would like to see the firms implement systems to ensure that fundholders have been returned to their rightful place at the top of the priorities list.</P> <P>It seems that in all the cases Spitzer detailed, sales people were running roughshod over investment professionals, and we'd like to see them reined in. Indeed, the allegation that sales people were allowed to violate fund prospectuses is one of the most striking features of Spitzer’s complaint, and something we haven't seen in past scandals.</P> <P><STRONG>What Should Investors Do?</STRONG></P> <P>Spitzer made it clear that other firms would likely be named in this inquiry, too, so this may prove to be a worrisome scandal even for investors who don't own funds from the above-mentioned firms. Should other firms face allegations, the key will be to determine if they encouraged or willingly allowed some investors to profit at the expense of others.</P> <P>Many hedge funds and individual investors market time funds, and most fund shops go to great lengths to prevent the practice. A problem arises when fund shops allow or encourage timing by favored clients. That’s a clear-cut violation of their fiduciary duty. </P> <P>Thus, it’s best to seek out firms that have shown they take their duty as stewards of shareholder capital seriously. If you look at an array of signs that firms are shareholder-oriented, you increase the odds that the firm will do right by you on many levels, though there are no guarantees that the firm won't pop up in the current probe.</P> <P>Some things to seek out are: </P> %<UL> <LI>Firms that strictly adhere to their mandates. American Funds, for instance, treats its prospectuses like Moses brought them down from the mountain. <BR> </LI> <LI>Firms such as Fidelity and Vanguard that practice fair-market pricing, which makes fund arbitrage plays next to impossible. <BR> </LI> <LI>Firms that have not introduced a bunch of trendy funds that are buying at the market top just so they can make a fast buck. Dodge & Cox, American Funds, and Longleaf Partners are good examples.<BR> </LI> <LI>Firms where principals have very large sums of their own money at stake. Davis/Selected; Longleaf Partners; Tweedy, Browne; and American Funds qualify on that score. <BR> </LI> <LI>Firms that charge low fees because they believe fundholders are owners, not consumers. Vanguard, American Funds, and TIAA-CREF lead the way on this front.</LI></UL> <P><STRONG>What Should the Industry Do?</STRONG></P> <P>The scandal will likely lead to greater regulatory scrutiny of mutual funds and hedge funds. Regulators will likely watch for after-market-close trades and market-timing patters among mutual funds. We hope they will also take steps to strengthen fund boards, require disclosure of fund-manager incentives and investments in the funds, and become more forceful with requirements for fair-market pricing. </P> <P>Hedge funds, too, should be in for greater regulation. They are the source of most fund arbitrage money and therefore are the ones trying to line their pockets with money that rightfully belongs to long-term fund investors. It’s shocking that the SEC has so little knowledge of these practices and is not acting to protect fund investors.</P> <P>In addition, it’s a sure thing that fund companies everywhere are reviewing their compliance procedures and beefing up internal oversight to ensure that these activities couldn't happen at their firms. </P> <P>Finally, investors will most likely lead a flight to quality as they seek out the most ethical firms to manage their money. Fortunately, there are quite a few firms around that haven't lost sight of their fiduciary duty.</P>


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