Some Fund Improprieties You May Have Missed

In September 2003, Eliot Spitzer said the market-timing scandal reflected pervasive problems throughout much of the mutual fund industry. He wasn’t kidding.

Unless you've been living under a rock for the past several months, you've no doubt heard about regulators' investigations of improprieties at firms like Janus, Putnam, and Strong. But other, lower-key revelations continue to surface about dubious trading activity at a number of fund companies. About the only way to keep track of it all is with a scorecard, so we've created one to serve as an easy reference. Click here to read the latest on each scandal-tainted shop in our Fund Industry Investigation Update.

In the meantime, let’s get you caught up on the allegations at some firms that may have flown below your radar. In each case, the potential misdeeds are serious enough that it’s prudent to hold off on making new investments with these firms at least until the complete story is out.

MFS
News reports indicate that MFS may cut a deal similar to AllianceBernstein’s, which called for restitution and cuts in expense ratios. MFS’ case is a little unusual. They allowed market-timing, but in this case they might not have cut any special deals. MFS apparently just decided that 11 of its funds could withstand a lot of short-term timing money, so they switched off anti-market-timing systems to for those 11 funds. According to news reports, MFS even went so far as to tell brokers which funds they could make short-term trades in. A deal is supposed to be just around the corner, so stay tuned.

Beyond the scandal, MFS’ record has been mixed. Returns have been average, but the firm was a big fan of incubator funds in the 1990s. Incubator funds are funds that are launched quietly so that they can build a track record. If the record is good, the firm will make the fund available to the general public; if it isn't, they’ll get rid of it. The problem is that this allows firms to exaggerate their stock-picking prowess because you only see their winners.

Scudder
Scudder has acknowledged there were market-timing arrangements in five of the funds formerly labeled under the Deutsche name. (One of those funds has since been liquidated.) The firm is quick to point out that the timing deals were the work of the former management team in charge of the company--most of whom are not in the current regime. Scudder said the timing occurred in international funds, so presumably the timers were doing stale-price arbitrage--a practice in which traders take advantage of the fact that a foreign fund's prices haven't been adjusted to reflect U.S. market movements.

Scudder also has a mixed record. The firm's most serious lapse occurred a couple of years ago when, according to the SEC, a Deutsche investment banker who did business with  Hewlett-Packard (HPQ) leaned on the firm's fund proxy committee to change their votes in support of the HP-Compaq deal. (Deutsche consented to a $750,000 fine, but did not admit or deny the SEC's findings.) Maybe Mr. Spitzer can look into that while he's at it.

Excelsior
Excelsior, a unit of  Charles Schwab (SCH), said that previous management had allowed market-timing in eight of its funds. Unfortunately, Excelsior has kept mum on some vital details, such as which funds were timed. The firm said it plans to issue a report on the problems at a later date.

We don’t have other issues with Excelsior’s ethics. As for performance, it’s middling.  Excelsior Value & Restructuring  is a standout, but some of the other funds have lousy records.

Columbia
Columbia is set to take control of Nations Funds, so maybe they can find synergies in negotiating a settlement with regulators. Columbia said that in a Wells notice the SEC alleged "certain fund prospectuses did not accurately disclose certain trading activity in fund shares."  The firm said it uncovered a "limited number" of market-timing arrangements in one international fund and two domestic funds between 1998 and 2003. Most of the trading arrangements were with three unnamed entities, and the "substantial majority of the trading had ended by October 2002," according to the filing. There are no more trading arrangements, Columbia said.

On the positive side, Columbia’s fund board highlighted a number of improved corporate governance steps that it took. Many were implemented before the scandal broke last September. Specifically, they addressed a key sore point that some fund boards don’t have an independent chairman and that fund boards aren’t getting the complete story from fund companies. In their role of representing fundholders, it’s vital that boards not have a conflict of interest between fundholders and shareholders of the company. So, Columbia named an independent chairman. They also better aligned the funds’ interests with fundholders’ by requiring that investment professionals and trustees hold shares of the funds for a minimum of one year and they doubled the amount that board trustees are required to invest in the funds. They also hired a compliance officer who reports directly to the board. Finally, they added 2% redemption fees to some foreign funds. Those are good first steps. Now if they can just cut those high expenses.

Seligman
The picture is a little fuzzy at Seligman. The firm admitted one timing arrangement that was terminated at the end of September 2003, and three more in the prior three years that had been terminated by September 2002. It said it would compensate investors if returns were harmed, but that Seligman thinks any damages would turn out to be "minimal." It hasn’t said which funds were affected, but it did say that one employee was dismissed as a result of its investigation.

On the whole, Seligman funds’ performance has been unimpressive.