Lasser Out at Putnam

Hold off on sending new monies to Putnam for now. While the actual wrongdoing by six investment professionals is among the worst offenses to emerge as yet in the fund scandal, we see some strong positives that lead us one step short of recommending that investors consider selling.

Putnam has removed CEO Larry Lasser and replaced him with current chief investment officer Ed Haldeman. Haldeman came on board in 2002 after the inappropriate trading occurred. Click here for the press release. Putnam has also dismissed the six investment professionals who made short-term trades in their personal accounts.

Putnam has also hired former SEC enforcement chief Barry Barbash to review two separate compliance reports by outside law firms and recommend actions to strengthen compliance.

In addition, Putnam has announced steps that should fill some of its key compliance gaps: They will create an ombudsman position to create an additional channel for employees to report wrongdoing, and fund board chairman John Hill says that the board is also interested in raising redemption fees and bolstering fair value pricing in order to ward off timers. Another crucial step that Hill has implemented is that any compliance issues regarding personal trading will go straight to general counsel rather than human resources. This is welcome change. In 2000, Putnam's HR group and its then chief investment officer handled the short-term trading issues, but HR clearly lacked the expertise to appreciate what those trades said about the managers' fiduciary obligations.

Putnam's board appears to have played an important role in the quick action we've seen from Putnam. Unlike most fund boards, 11 of the 13 members are independent, including chairman John Hill.

What Went Wrong
We had planned to issue a "consider sell" recommendation on Putnam had Lasser remained at the firm, even though we were pleased with the actions Haldeman had taken since coming aboard.

What happened at Putnam was absolutely appalling, and it happened under Lasser's watch. The firm failed to obey Justice Samuel Putnam's Prudent Man Rule: "Those with the responsibility to invest money for others should act with prudence, discretion, intelligence, and regard for the safety of capital as well as for income."

Indeed, on Oct. 24, Putnam said six investment professionals were conducting foreign-market arbitrage by making short-term trades in Putnam's own funds, to the detriment of fund shareholders. When Putnam initially got wind of the trading abuses back in 2000, the firm did nothing but tell those involved, five of whom were portfolio managers, to cut it out. Although the dollar value of the trading abuses is small, the whole incident--and Putnam's handling of it--amounts to a betrayal of trust.

Not only did the firm not fire the managers when the abuses first came to light, but Putnam didn't notify the funds' boards of directors, and it didn't set up additional monitoring of those employees' trades. Nor did it provide restitution to the fund shareholders who lost money. As a result, more questionable trades took place after 2000, according to William Galvin, secretary of the Commonwealth of Massachusetts, who has brought civil fraud charges against the company and two of the managers involved.

Where the Buck Stops
The architect of Putnam's systems and culture is outgoing Putnam president Larry Lasser. While many fund managers have come and gone, Lasser was the constant. He hired many of the top people throughout the organization and set the firm's strategy. While some Putnam investors lost money, Putnam funds have been quite lucrative for Lasser, who pulled down one of the most generous pay packages in the industry.

With regard to the inappropriate manager trading that has emerged, the most charitable interpretation would be that Lasser chose the wrong people to handle such a situation and was uncharacteristically uninterested in the details. In short, while we've seen no evidence Lasser broke the law or approved of the wrist slap for the portfolio managers in 2000, the broader problems of culture and poor investment results are at his doorstep.

The Outlook for Putnam Funds
Putnam is in the early stages of a restructuring effort aimed at providing better, more reliable performance. Since coming over from Delaware Investments in October 2002, co-chief investment officer Ed Haldeman has placed a welcome emphasis on attracting and retaining better managers and improving the firm's culture so that its investment professionals really do embrace the Prudent Man Rule. Head of research Josh Brooks has focused his efforts on improving analyst retention and upgrading the quality of research. Haldeman and Brooks have been successful before, having improved results at Delaware after they took charge there in 2000. In addition, performance at Putnam has improved in 2003.

Still, the scandal and charges brought against two Putnam portfolio managers as well as Putnam itself are a setback to their efforts. One manager charged with trading infractions, Omid Kamshad, ran the firm's international group, the one standout area at Putnam. Thus, our view of Putnam's international funds has fallen. Whereas they had been above average, now they're mediocre.

Likewise, we're particularly wary of Putnam's growth funds. Justin Scott had been moved there to lead the turnaround of Putnam's specialty-growth funds, but he's now gone amid the trading scandal. In addition, Putnam has brought in an almost entirely new management team, so it will take time to get everyone working together smoothly, and even then, we'll want proof in the form of strong performance before we'd recommend sending a dollar their way.

It may be years before Putnam funds have a lot of appeal. Stock-picking skill and experience aren't changed overnight. Even if Haldeman and Brooks succeed, it will be years before their changes can markedly improve investment results. History has shown that turning around a fund company is a difficult and arduous task. Firms like Scudder and Credit Suisse are proof.