Fund Times: NASD Charges American Funds

The National Association of Securities Dealers announced Feb. 16 that it had charged American Funds Distributors (the principal distributor of American Funds) with violating NASD's "Anti-Reciprocal Rule" by directing approximately $100 million in brokerage commissions over a three-year period to about 50 brokerage firms that were the top sellers of American Funds. The payments were made to reward the firms for past sales and to encourage future sales of American Funds' 29 mutual funds, according to the complaint. Specifically, NASD's complaint alleges that, between 2001 and 2003, AFD calculated "target commissions" that it intended to direct to each of the top-selling retailers of American Funds according to a formula that was based upon each firm's prior year's sales of American Funds.

The NASD says its Anti-Reciprocal Rule, which first became effective in July 1973, is designed with three goals in mind: First, it is intended to prevent quid pro quo arrangements in which brokerage commissions, which are assets of fund shareholders, are used to compensate brokerage firms for selling a fund's shares. It is also designed to ensure that the execution of portfolio transactions by brokerage firms is guided by the principle of "best execution" and not by other considerations. And finally, NASD says, the rule is meant to eliminate the danger that a brokerage firm, when recommending mutual funds to customers, will base its recommendations on the additional rewards the firm may receive in portfolio commissions from the funds rather than on the investment needs of the customer.

Capital Research Management, the advisor to the American Funds, responded Thursday, Feb. 17, saying, "we have complied fully with both the spirit and the letter of the rule, and we intend to request a hearing before an NASD panel to defend ourselves against these allegations." Capital went on to say the NASD rule expressly permitted mutual fund sponsors to consider a broker-dealer's sale of fund shares in determining whether to use that firm when buying or selling portfolio securities for the fund.

In its response, Capital acknowledged that the NASD complaint does allege that American Funds Distributors violated a provision of the rule that prohibited "conditioning" brokerage allocations on sales of fund shares. But Capital said there are no facts that support this allegation.

"In every case, AFD used non-binding targets and never committed, either formally or informally, to direct a specific amount or percentage of portfolio transactions to any firm," Capital said.

Capital also said it has always complied with the most important consideration of the Anti-Reciprocal Rule: that the fund receive "best execution" in all its portfolio transactions. "We always sought and obtained 'best execution' and are pleased to note that the NASD's complaint does not allege that we ever failed to do so. Nor does the complaint allege that shareholders incurred any additional costs for transactions in which fund sales were a consideration," Capital said.

Although Morningstar does not yet know all the facts in this particular case, we suspect that regulators will have difficulty making their claims stick. As the rules are written, it appears that Capital may in fact have been acting within the rule's limits. We remain skeptical, however, of Capital's "best execution" claim, and by extension, the claim that best execution is ever likely to be achieved when directed-brokerage schemes are employed.

Even if, on the surface, commissions and price execution look reasonable, a firm's failure to shop trading business around, or otherwise aggregate order flow, strongly suggests--especially in the case of a large client such as Capital--that it may not have gotten the best deal for its trades.

Big Changes at Putnam
Putnam Investments announced that Steve Oristaglio has retired as head of investments, and Kevin Cronin has been appointed as his replacement.

Oristaglio, who started at Putnam back in early 1998 as deputy head of investments focused on the fixed-income team, will retire later this year, Putnam said in a press release.

Cronin has been deputy head of investments at Putnam since 2004; additionally, he has served as chief investment officer of the firm's fixed-income research group since 2001. Cronin will begin his new position immediately, and he will report to Putnam CEO Charles "Ed" Haldeman.

Meanwhile, Joshua Brooks, currently managing director and chief investment officer of large-cap equities, and Edward "Ned" T. Shadek Jr., currently managing director and chief investment officer of small-cap equities, were named deputy heads of investments. They will both report to Cronin, Putnam said.

Putnam is trying to remake its image and win back shareholders' trust after the firm suffered outflows in recent years, which were caused by charges of market-timing at Putnam as well as disappointing bear-market performance at some of the firm's growth funds. Most of the top people at Putnam under former Putnam CEO Larry Lasser have now left the firm. Others who left include Justin Scott (one of the portfolio managers accused of timing the firm's funds) and Deborah Kuenstner (who left Putnam at the end of 2004), said Morningstar senior fund analyst Dan McNeela. Lasser was removed as Putnam's CEO in October 2003 along with six investment professionals after news broke that some of Putnam's portfolio managers made short-term trades in the firm's funds.

Top World-Allocation Fund to Close
 First Eagle Global (SGENX) will close to new investors on Feb. 28, 2005, First Eagle Funds announced. Current shareholders may continue to invest in the fund.

The fund recently had approximately $11.7 billion in assets. Inflows into the fund have accelerated lately, and cash has reached nearly 25% of assets, said fund manager Charles de Vaulx in a press release. Although de Vaulx said he doesn't think the fund necessarily has to be fully invested at all times, he said he believes equity markets are somewhat richly valued, particularly in the United States. Because of this, it has been difficult to find good stocks at low prices, he said.

The fund's sibling, $7.7 billion  First Eagle Overseas (SGOVX), closed to new investors in February 2004.

Columbia to Streamline Lineup
Columbia Funds recently announced plans to merge several funds pending shareholder approval at a meeting scheduled for Feb. 16, 2005. The proposed mergers follow on the heels of a settlement over abusive trading that  Bank of America  (BAC), the parent of Nations Funds and Columbia Funds, finalized with state and federal authorities in early February.

If approved, the funds are expected to merge on or about Feb. 26, 2005. The mergers, detailed below, were first announced on Oct. 13, 2004.

$253 million  Columbia Common Stock  is scheduled to merge into $376 million Columbia Large Cap Core (LCCAX).

$48 million Columbia Contrarian Income  is slated to merge into $980 million Columbia Quality Plus Bond . The management team of Columbia Quality Plus Bond will run the fund following the merger, Columbia said. Originally, $193 million Columbia Corporate Bond  was slated to merge into Quality Plus Bond as well, but Columbia said it has since re-evaluated its position and no longer recommends a merger; rather, Columbia intends to liquidate the Corporate Bond fund later in 2005. 

$763 million  Columbia Growth  is scheduled to merge into $933 million  Columbia Large Cap Growth  (LEGAX). Both funds are managed by Paul Berlinguet and Alexander Macmillan; the pair will continue to run Columbia Large Cap Growth following the merger, according to Columbia.

$489 million Columbia International Equity  is slated to merge into $664 million  Columbia International Stock  in late December. Both funds are managed by Penny Burgess and Deborah Snee; the pair will continue to run Columbia International Stock Fund following the merger, Columbia said.

To further this streamlining effort, Columbia liquidated the following funds on Dec. 10, 2004: Columbia Tax-Managed Aggressive Growth, Columbia Newport Asia Pacific, Columbia Europe, Columbia European Thematic Equity, and Columbia Global Thematic Equity.

There were also some newly announced mergers. According to SEC filings released in February 2005, the following mergers will occur, subject to approval by shareholders at a meeting scheduled to occur in the third quarter of 2005.

$39 million Columbia Tax-Managed Growth II  will merge into $270 million Columbia Tax-Managed Growth . Both funds are managed by a team from Stein Roe Investment Counsel, the subadvisor to both funds. This team is expected to run the combined fund following the merger.

$69 million Columbia Florida Intermediate Municipal Bond  will merge into $200 million Nations Florida Intermediate Municipal Bond .

$422 million  Columbia Managed Municipals  will merge into $1.7 billion  Columbia Tax-Exempt (COLTX)

$633 million  Columbia Income (SRINX) will merge into $1.1 billion  Columbia Intermediate Bond (SRBFX). Both funds are managed by teams led by Mark Newlin. A management team composed of Newlin, Stephen Luetger, Thomas LaPointe, and Kevin Cronk is expected to run the combined fund after the merger.

$26 million Columbia Pennsylvania Intermediate Municipal Bond  will merge into $517 million Columbia Intermediate Tax-Exempt Bond (LITAX).

$357 million Columbia Intermediate Government Income  (LIGAX) will merge into $656 million Nations Intermediate Bond . Brian Drainville, who currently manages Nations Intermediate Bond, is expected to run the combined fund after the merger.

$508 million Columbia Short Term Bond  will merge into $1.1 billion Nations Short-Term Income  (NSTMX). Both funds are managed by Leonard Aplet and Richard Cutts, who are expected to run the combined fund following the merger.

$410 million  Columbia Utilities  and $75 million Columbia Tax-Managed Value  will merge into $1.9 billion  Columbia Growth & Income .

$873 million Columbia Large Company Index  is merging into $1.4 billion Nations LargeCap Index (NINDX). The management team of Nations LargeCap Index, led by Vikram Kuriyan, is expected to run the fund following the merger.

$1.8 billion  Columbia Mid Cap Value   will merge into $572 million Nations Mid Cap Value (NAMAX). Both funds are managed by David Hoffman and Diane Sobin, who are expected to run the combined fund following the merger.

$343 million Columbia Small Company Index  is merging into $1.1 billion Nations SmallCap Index (NMSCX). The management team of Nations SmallCap Index, led by Kuriyan, is expected to run the fund following the merger.

$341 million  Columbia Newport Tiger  will merge into Columbia International Stock, which has $664 million in assets. (Columbia International Stock is also scheduled to absorb Columbia International Equity, pending shareholder approval.) The management team of Burgess and Snee, who currently manage Columbia International Stock, is expected to run the combined fund after the merger.

In addition, Columbia plans to liquidate $14 million Columbia National Municipal Bond . The liquidation is subject to shareholder approval at a meeting to be held in September 2005.

PIMCO Capital Manager Leaves Firm; Merger Proposed for Two Funds
John Schneider, who managed  PIMCO OpCap Value  (formerly PIMCO PEA Value) for nearly five years, has left PEA Capital to start his own firm. The fund now will be managed by Colin Glinsman. Glinsman will also manage Schneider's other charge,  PIMCO OpCap Renaissance (PQNCX), along with Louis Goldstein and Lois Roman.

In addition, according to an SEC filing,  PIMCO RCM Innovation   will merge into  PIMCO RCM Global Technology (DRGTX). Both funds are subadvised by RCM Capital Management. The merger is subject to shareholder approval.

Ameristock Focused Calls It Quits
Ameristock Focused Value liquidated on Jan. 14, 2005, after manager Nick Gerber unsuccessfully attempted to convert the small-value fund into a publicly traded holding company whose stock would trade on an exchange. The conversion would have allowed the portfolio to buy bigger portions of companies than it could as a mutual fund and even to buy entire enterprises, similar to Warren Buffett's  Berkshire Hathaway (BRK.B). Gerber had planned to convert the fund after net assets reached between $50 million and $100 million. However, after the fund suffered a couple of years of subpar performance as well as investor redemptions, it appears that Gerber has abandoned the plan. We had been skeptics of the plan and had made it a Fund Analyst Pan.

AllianceBernstein to Rename Funds, Merge Away Another
According to a recent SEC filing, AllianceBernstein plans to change AllianceBernstein International Premier Growth's  name and investment strategy, if shareholders approve. Specifically, the fund's mandate would be changed to allow it to invest in more securities from a wider universe. It will also change its name to AllianceBernstein International Research Growth Fund.

In addition, if shareholders approve, AllianceBernstein New Europe  and AllianceBernstein All-Asia  will merge into AllianceBernstein International Premier Growth, according to SEC filings.

Another SEC filing outlined AllianceBernstein's plan for  AllianceBernstein Worldwide Privatization (AWPAX). Pending shareholder approval, the fund's name will be changed to AllianceBernstein International Growth Fund. Also pending shareholder approval, the fund's investment strategy will be altered so it no longer has to invest at least 65% of its total assets in equity securities that are issued by enterprises that are undergoing or have undergone privatization.

Etc.
Atlantic Whitehall will liquidate two funds, pending shareholder approval at a meeting scheduled for March 2005. According to a recent SEC filing, Atlantic Whitehall Income  will liquidate, along with  Atlantic Whitehall Balanced (WHGIX). The Balanced fund uses the Income fund as one of its underlying fixed-income holdings.

Victory Funds did away with the C share class of some of its funds. According to a recent SEC filing, on Jan. 28, 2005, the C share class of Victory Small Company Opportunity, Victory Established Value, Victory Convertible, Victory National Municipal Bond, Victory Ohio Municipal Bond, and Victory New York Municipal Bond were liquidated.

Rydex filed plans to launch a new exchange-traded fund that tracks the stocks of the 50 largest U.S. companies based on total market capitalization as represented in the Russell 3000 Index. According to the SEC filing, the fund will be called the Rydex Russell Top 50; no expenses were listed.

Pending shareholder approval at a meeting scheduled for March 10, $62 million Loomis Sayles Government Securities  will merge into $121 million Loomis Sayles Limited Term Government and Agency (NEFLX).

Transamerica Investment Management announced Feb. 2 that it launched three institutional funds: Transamerica Premier Institutional Diversified Equity, Transamerica Premier Institutional Bond, and Transamerica Premier Institutional Small/Mid Cap Value. The expense caps on the funds are 75, 45, and 85 basis points, respectively. All three funds have a $250,000 minimum investment.

On Feb. 1, ING announced a new line of targeted value-oriented mutual funds--the ING Value Choice line--consisting of three new funds and one existing fund all subadvised by NWQ Investment Management. The funds in the Value Choice line are ING SmallCap Value Choice, ING MidCap Value Choice, ING International Value Choice, and  ING Global Value Choice  (NAWCX).