Finally, Strong Funds Gets a Management Upgrade

"Throughout my career, I have considered it to be my sacred duty to protect my investors; and yet in a particular and persistent way I let them down. In previous years, I frequently traded the shares of the Strong funds, at the same time that the advice which we gave our investors was to do the opposite and to hold their shares for the long term. My personal behavior in this regard was wrong and at odds with the obligations I owed my shareholders, and for this I am deeply sorry." -- Dick Strong

One thing is clear from the settlement reached by Strong Capital and regulators and the subsequent sale of the firm to Wells Fargo: Strong fundholders are better off with Wells.

 

Though Strong had some good fund managers, it was a poorly managed business. There was remarkably little management above the portfolio managers. Really, it was just Dick Strong and a couple others. Individuals such as Brad Tank, who became a rather powerful number two, were eventually shown the door. Even before the scandal broke, the low quality of business management was apparent from the frequent launching of trend-chasing funds and a prior run-in with the SEC. In addition, the firm operated without centralized research, risk management, or even a core investment strategy.

 

Trading, Trading, and More Trading

However, two aspects of the settlement that haven’t gotten much attention highlight just how poor Dick Strong’s judgment was.First, there’s the trading.We learned for the first time that in his personal account Strong was rapidly trading the fund that he managed in the 1990s. Strong should count himself fortunate to have escaped criminal charges. Other portfolio managers who made rapid trades in funds they managed could go to jail if found guilty.

 

The number of trades is also staggering. New York Attorney General Eliot Spitzer said he made 1,400 redemptions in Strong funds over a six-year period and made 500 in 2001 alone. “On some occasions, he sold shares only one trading day after a purchase,” the SEC said in its finding. “He typically traded hundreds of thousands of dollars worth of fund shares per trade, and on at least one occasion, the value of a short-term round trip trade exceeded $1 million.”

 

When he ran  Strong Discovery , Dick Strong used a high-turnover style that involved lots of bold macroeconomic bets, so I’m not surprised to learn he’s a fast trader. Obviously, there's nothing shady about rapidly turning over a fund's portfolio, but the fact that even his unethical trading happened at such a furious pace shows that Strong desperately needs to discover decaf.

 

The Cost of Stonewalling
While Strong’s atrocious trading ensured that he and the firm were eventually going to suffer regulators’ wrath, his response to the probe may have been even more damaging to the business. Regulators asked for information on all market-timing in the funds on September 5, but the firm didn’t fess up to Strong’s personal trading until October 10, even though Strong and the firm’s general counsel knew about his trading on the day the request was made. Spitzer revealed on October 30 that Strong had been rapidly trading Strong funds.

 

Initially, it appeared that the problem was just that Strong had allowed Canary Capital to time its funds. That’s serious because it implies that profits went before fundholders’ interests and that fundholders were not treated fairly.The firm either offered denials or silence in response to Spitzer’s initial charges. Fundholders were entitled to a thorough explanation but none was forthcoming. 

 

On the day of probe was announced, Dick Strong sent a note to clients with the following gem: "We have good reason to be proud of our firm and what we stand for…. You should also know that we have been asked to provide information to the Attorney General’s office. We have done so and will continue to cooperate with them.”

 

On September 18, Strong wrote: “We believe that market-timing is a complex issue that requires the consideration of multiple factors in its evaluation…. We are cooperating with regulatory agencies.”

 

On September 26:  “You may rest assured that our actions related to issues arising out of complaint will be consistent with our fiduciary responsibility and in the best interests of our clients.”

 

The picture fundholders got in September was that Strong Funds may have been guilty of the financial equivalent of jaywalking, but that it was being very open and nothing serious would come out. Not surprisingly, fundholders stayed with the firm. Then in October, when the public learned from Eliot Spitzer, not the firm, that Dick Strong had been trading Strong funds, things changed.

 

At that point, you had damning accusations that rightly caused fundholders to lose faith in Strong Funds. Yet the firm still had very little to say. While the other firms caught in Spitzer’s web had already begun to fire those responsible for wrongdoing, make greater disclosure of the misdeeds, and adopt sweeping reforms, Strong said little and did even less.

 

It wasn’t until the bad news came out and Strong still refused to give fundholders much to go on, that the torrent of outflows began. Had the firm quickly made full disclosure of the problems, cleaned house, and implemented reforms, the business would have been in far better shape. Instead, it has suffered billions in outflows.

 

This stance had to damage the firm’s position with regulators, too. If you want to enrage an attorney general or the SEC, you profess your innocence while withholding crucial evidence the way Strong did. I’d encourage you to read through both the SEC’sand Spitzer’s findingsto get a true sense of what went wrong.

 

Nowhere to Go but Up
New owner Wells Fargo should provide much-needed oversight and support to Strong Funds. No fund company should have all its departments and its checks and balances reporting to one person the way Strong did, so the new structure is sure to be an improvement. In the coming weeks, we’ll be watching to learn more about what happened at Strong and what will become of Strong Funds’ managers and funds. We’d advise investors to stay away until there’s more clarity on these matters. Our "consider selling" recommendation remains.