Scary Fine Print in Fund Company Filings

Mutual fund SEC filings are rarely interesting and very few people read all of their funds filings. Funds aren't even required to send shareholders all their filings, so this requires quite a bit of perseverance.

In fact, it's a good bet that some fund companies are betting that certain fillings will fly under investors' radar, but our analysts have found some strange stuff when they delve deep into the filings. Today, I'll give a few of the more unusual footnotes a little airing out.

Sitcom Follies
Have you ever seen that Brady Bunch episode in which Peter Brady has two dates on the same night? It's classic sitcom shtick as he tries to keep the girls from finding out he's seeing them both at once. That's what I thought of when I saw the Statements of Additional Information (485bpos) for Evergreen and Phoenix Funds. Phoenix's SAI says that director Leroy Keith, Jr. oversees 68 Phoenix funds and an additional "6 Evergreen fund portfolios." Go to Evergreen's SAI, and you'll see that it says he oversees 90 Evergreen funds and 51 Phoenix funds.

So is he trying to make Evergreen and Phoenix think he really gives them all his time, or do the fund companies know and they're trying to make fundholders think he focuses on them? I'm sure it's the latter. The Phoenix filing might even be technically correct because Evergreen groups its funds into six main groups. However it's a stretch to imply that he is overseeing only six strategies at Evergreen.

A New Definition of Independent
Meanwhile, Frontier MicroCap  has some doozies in its filings. First, we learn that the firm is counting the brother-in-law of the fund president as an independent director. Amy Siesennop is co-owner of the adviser that manages the fund in addition to serving as the president, treasurer, compliance, and anti-money-laundering officer for the fund. However, her brother-in-law, Thomas Siesennop, is listed as an independent director.

Rest assured, though: These directors and the management have shareholders' interests at heart. The annual report says that the management contract "provides an 18.4% cap on expenses, so the advisor has an incentive to keep expenses of the fund to a minimum, which also benefits the shareholders." Comforting isn't it?

You Don't Mind Paying the Tab, Do You?
CSI Equity Fund  acquired Matterhorn Growth Fund, and it turns out that fundholders were kind enough to pick up the legal bill for the merger: "During the year ended August 31, 2006, the Fund incurred $33,248 in legal fees associated with the acquisition of assets as discussed in Note 6, herein."

Where the Bodies Are Buried
Maybe the most obscure and least interesting fund document is the N-SAR. Consider this exciting passage from  Vanguard 500 Index's (VFINX) N-SAR:

028 A010900 90230
028 A020900 0
028 A030900 0
028 A040900 34904
028 B010900 176369

However, a couple funds recently stowed away some rather juicy news in the N-SAR. Take the Shaker Fund, for instance. In June 2006, that fund's board informed shareholders that it intended to convert the fund's A, B, and C shares to Intermediary shares. The disclosure clearly stated that shareholders would not be taxed on the conversion. So imagine their surprise when, five months later, the fund provided the following update on the conversion: "Shareholders were taxed as a result of the share class conversion." And where might shareholders have found this update? You guessed it--in Form N-SAR.

As if that placement wasn't obscure enough, the fund's legal counsel apparently saw fit to bury the disclosure in an exhibit at the bottom of the N-SAR. No word on why fundholders were taxed on the conversion after being told it was tax-free. In fact, shareholders weren't even offered an explanation in a prospectus filed three days after the conversion was made. (The prospectus simply notes that the conversion took place, without describing its tax effect.) And while it's possible that the board's subsequent decision to liquidate the fund may have informed the way the conversion was made or made it inevitable that the conversion would be treated as a taxable event, no information has been forthcoming from the fund or its administrator, Forum Fund Services (which is a Citigroup unit). In any case the information probably won't dawn on the fund's shareholders until they sit down to figure their taxes.

Then, there's the unsettling surprise in a QCM Absolute Return NSAR filing. It turns out that the QCM fund's auditor found controls were lacking at the firm responsible for performing mundane back-office tasks like recordkeeping, Unified Fund Services. Here are the specific deficiencies that the auditor noted in its letter to the fund's board and shareholders (which was tucked away in an exhibit to the N-SAR):

1)Control procedures were not in place to ensure that interest income, interest expense and dividend expense on short sales related to short sale broker activity were properly recorded.

2) Control procedures were not in place to ensure compliance with regulatory requirements relating to custody of securities.

Unified, which has already had a run-in with the SEC concerning its accounting and recordkeeping practices, agreed with the auditor and pledged to shore-up its controls without delay. But shoddy recordkeeping should be the least of investors' worries.

Conclusion
The Enron scandal and the market-timing scandal have led to greater disclosure for mutual funds and corporations alike. However, fund companies that want to hide news in plain sight can bury disclosure in the depths of paperwork where almost no one will see. Perhaps the next wave of reforms should focus on cleaning up the filings and forcing companies to place all vital disclosure at the top of a simpler, more readable document.