Two Suspect Firms Fly Under the Radar

What are the lasting memories of the mutual fund scandal? Is it revelations of Dick Strong’s personal trading? All the late trading engineered by Nations Funds? Or maybe the rapid trades by two of Putnam’s international managers?

Much less memorable are the mundane but still serious market-timing problems at Federated and Fremont. That’s part of why both have gotten very little attention in the scandal. While other fund companies quickly made a clean breast of the situation, or had Eliot Spitzer do it for them, questions remain about these two. Each has come clean on some issues but not on everything.

Both firms are likely waiting in line for their chance to settle, but they really haven’t given a compelling reason to believe they’ve cleared up their problems. (For what they’ve made public, check Federated's statement and Fremont's statement.)

Federated
Federated said it allowed hedge funds to market-time its funds, including  Federated Kaufman  (KAUFX), in exchange for sticky assets, even though it had publicly stated that it would deter frequent trading because it was detrimental to shareholders.

In addition, Federated said that part of its oversight of frequent trading wasn’t functioning from May 2003 to September 2003. Specifically, the firm monitored retail activity, but no one reviewed the institutional client reports over that time span.

The firm also said that its employees had accidentally allowed a number of late trades to be entered.

In February, the firm revealed that late trades were being made by Federated employees. In fact, one employee made frequent late trades over the course of four years. That employee was fired. However, a second senior employee who made one late trade was merely sanctioned and ordered to reimburse the funds. Federated has created a fund to reimburse shareholders for their losses related to these activities and has made changes to prevent market-timing and late trading, including outsourcing its transfer agent function to Boston Financial. The firm also fired two senior salespeople in connection with the timing arrangements.

However, they’ve been quiet on the subject of whether these deals were known to anyone above those salespeople.

Fremont
Fremont’s case is more typical, though it’s tough to piece together given the firm’s reticence. Fremont simply posted one statement and then added paragraphs as new revelations have come out. It said that it had market-timing arrangements with a few parties. There may have been a sticky-money deal as compensation, but the firm isn’t saying. It also appears that some of these market-timing deals may have enabled a third party to enter some late trades, though Fremont says it didn’t knowingly allow any.

Fremont says those responsible for these timing deals have been cut loose. However, it won’t say which funds were timed. An earlier statement said it was  Fremont U.S. Micro-CapFUSMX and  Fremont GlobalFMAFX, but fund-specific references have been removed.

Our Take on Fremont
Fremont recently agreed to sell its funds to Affiliated Managers’ Group. The firm says all those responsible for market-timing are gone. That’s encouraging, but we’ll have greater certainty when regulators have signed off on those remaining at the funds. It’s disappointing that shareholders whose funds were subject to inappropriate timing and possibly late trading haven’t been informed. In addition, the deal isn’t set to close until the end of 2004, so we don’t see a need to rush in until after a settlement and the completion of the sale to AMG.