Related Articles
How mutual funds stole your money
Front-running threatens to widen the fund scandal
Power Poll: Mandatory fund holding period?
Related Resources
Find Top-Performing Funds
Easy Fund Screener
Today's big trends
Related Sites
Complete text of the SECs administrative proceeding
Jubak's Journal
Recent articles:
• 5 stocks to love -- that everybody hates, 11/14/2003
• Will the Dow hit 11,000? Ask the Fed , 11/11/2003
• 3 stocks to own as turmoil grips Russia , 11/7/2003
More...
| | Jubak's Journal
We need a new guard dog at the SEC
The half-hearted Putnam settlement -- where mutual fund executives got off almost scot-free, despite picking customers' pockets -- shows we need a change at the top. And I've got just the man for the job.
By Jim Jubak
William Donaldson has got to go as head of the U.S. Securities and Exchange Commission.
Lets turn the job of cleaning up the mutual fund industry, custodian of $7 trillion that belongs to average Americans' saving efforts, over to New York Attorney General Eliot Spitzer.
For me, the SECs announcement of a settlement with Putnam Investments is the last straw. This is how Donaldsons SEC cracks down on mutual fund companies that rip off their own investors?
On Nov. 13, the SEC let Putnam, one of the key scandal participants, off with a slap on the wrist. Putnam, whose egregious misdeeds we'll explore down below, didnt even have to apologize or admit that it had done anything wrong.
By moving so quickly to a settlement, the SEC has chosen to put its own bureaucratic need to look like a leader above the interests of investors who have been, or will be, robbed.
Thats not the kind of tough independence that Donaldson promised when he took over as chairman of the SEC from the compromised Harvey Pitt. You can wait longer if you want to, but Ive got all the evidence I need that Donaldson isnt a man willing to take on the mutual fund industry. Or for that matter the New York Stock Exchange, or CEOs who behave as if they own the companies they really just work for.
Time for immediate change
Get him out of there.
I dont care if Spitzer is, indeed, an ambitious publicity hound, as his detractors claim. Spitzers undisguised design on higher office -- governor of New York, according to most political insiders -- gives him a personal stake in building a record of financial reform. And its about time that average investors had someone on their side who's motivated to go for the financial industrys jugular.
If youre not mad yet about the mutual-fund scandals, I challenge you to read the SECs administrative proceeding of Nov. 13 and keep your cool. (You can read the complete text of the SECs administrative proceeding on the SECs website.)
The Putnam settlement very clearly lays out the so-called "market-timing" of fund managers and managing directors at Putnam. Through this practice, they used inside information and rapid trading of fund shares of the sort explicitly denied to the average fund investor to reap millions of dollars in profits for themselves. The SEC settlement says that after 2000 Putnam clearly knew that this kind of trading was taking place and failed to take adequate steps to stop it. In fact, according to the SEC, Putnams management kept information about this short-term trading from the boards of directors and public shareholders in its funds.
And the punishment for all this wrongdoing thats so clear to the SEC? Putnam has promised never, never, never, ever to do this again. And its going to hire some outsiders to make sure that it doesnt. (Theres a promise of restitution, amount unspecified, and a big fine from the SEC, amount again unspecified.)
Inside the Putnam scandal
Want some specific examples of how these guys picked their customers' pockets? The administrative proceedings provide plenty.
Theres Omid Kamshad, chief investment officer of international equity since early 2002. He managed seven portfolios with international holdings. Between 1998 and 2003, Kamshad engaged in at least 38 round-trip trades of Putnam fund shares, according to the SEC. On average he sold the shares only 13 trading days after buying them. Senior Putnam management learned of Kamshads market-timing in January 2000, the SEC concludes, and asked him to stop. Despite saying he would, Kamshad kept on trading. In March 2003, for example, he bought $850,000 in shares of Europe Equity, a fund he managed, and sold that position days later for a gain of about $80,000, according to the proceedings documents.
How did such short-term trading in mutual funds lead to profits like that? Heres how it worked: Mutual-fund companies all say they discourage quick in-and-out trading of their funds. U.S. mutual funds calculate their daily net asset values -- what a share of the fund is worth based on the closing prices of the investments it holds -- at 4 p.m. But because so many stocks and bonds trade infrequently and, because, thanks to round-the-clock trading, international stocks trade at such different times of day, those 4 p.m. closing prices are often stale. That is, they dont reflect the up-to-the-minute prices of the assets held by the funds.
So any investor, like the fund managers at Putnam, who had detailed knowledge of precisely what stocks the funds held could make big bucks by trading on the difference between current prices and the "stale" prices of international stocks.
Of course, all that trading hurt the other investors in the fund because they had to pick up the cost of those frequent trades. Moreover, fund managers had to keep more of their assets in cash so that they could handle those big sell orders. And of course, a part of the profit from all those stale prices should have gone into all shareholders pockets instead of into the wallets of just a few.
Total damage across the fund industry, according to the academics whove studied the problem, is somewhere around $5 billion annually.
The SEC's dubious victory
Now, of course, this being a typical SEC settlement, Putnam didnt admit that it had actually done anything wrong. But it still agreed to make changes in its procedures. Heres what the SEC won for mutual-fund investors:- At least 75% of the members of the board of trustees for any Putnam fund must be independent as defined by the Investment Company Act of 1940, the basic enabling legislation that governs the fund industry. Unfortunately, the acts definition of independent is rather lax. For example, Neal Malicky counts as an independent director for Strong Capital Management, according to the acts definition. But the year he joined the board of the mutual fund, Malicky was the chancellor of Baldwin-Wallace College, the alma mater of Richard Strong, Strong Capitals CEO until his recent resignation for market-timing Strong funds. In 2000, Malickys first full year as a board member, Strong gave between $2,500 and $5,000 to the college. Strong at least doubled his contributions in the next two years. Fact is, Strong Capital already had been forced to increase the size of its board from three to six, with at least five of six members to be independent, as a result of a 1994 settlement with the SEC. Yep, that worked.
- Putnam employees have to hold shares of any Putnam fund they buy for at least 90 days. (If its a fund where the individual has portfolio management responsibility, the shares have to be held for a year.) Well, at least thats less vague than the mid-2000 warning from Putnam to senior investment managers not to engage in excessive short-term trading. At a minimum, any individual caught violating this rule would be forced to give back any profits. The settlement doesnt spell out any further or maximum punishment, and it gives Putnam a reasonable time to use reasonable best efforts to design an automated system to prevent such market-timing trades.
- Putnam will hire, within 30 days, an independent assessment consultant to determine the compensation due Putnam shareholders. The consultant must be acceptable to the SEC.
- Putnam also will hire an independent compliance consultant within 30 days to conduct a review of Putnams policies, including but not limited to procedures designed to prevent market-timing. Putnam has to implement the recommendations of the independent consultant. This is certainly a step forward from the days when employee trading compliance was the purview of the human resources department. (As part of the settlement, it will now switch to the legal department.)
- At some point in the future, Putnam will have to pay fines to settle the civil charges brought by the SEC.
Whats missing? Oh, how about:- An admission of guilt or some expression of contrition.
- A promise from the SEC to address the problem of stale prices that made this scandal possible to begin with. (The mutual-fund industry actually has been asking for regulations on this issue.)
- A definition of an independent director that has some meaning.
- Securities-fraud charges against individuals and the company for saying in regulatory filings that they didnt permit market-timing when they did.
- Jail time for the individuals who violated their fiduciary duty to investors.
- At least some consideration of whether Putnam, or any other fund company involved in these scandals, should be allowed to continue as an investment company. If that were even on the table, I think the settlement would look very different.
But dont take my word that this is a crummy deal for investors. Listen to the reaction from Spitzer, as well as William Galvin, who oversees securities regulation in Putnams home state of Massachusetts.
Blasting the agreement
Galvin blasted the agreement. For all the discussion about enforcement, when it comes to being serious, the SEC is more interested in hastily reaching accommodations with the industry than in resolving problems," Galvin told reporters. I believe the industry is breathing a great sigh of relief.
Galvin also announced that he was weighing a decision to file charges against Putnams head lawyer, general counsel William Woolverton, for allegedly market-timing Putnam funds. (Putnam on Friday denied Woolverton had engaged in prohibited market-timing.) Spitzer, who hasnt filed charges against Putnam, was unusually concise: If the SEC thinks this is adequate, then clearly they don't understand the issues.
Maybe thats because the issues that concern investors about the mutual fund arent those that are at the top of the SECs list of worries. This deal has all the trappings of a bureaucracy deeply embarrassed at being caught asleep at the wheel trying to one-up its enforcement competitors. After all, the initial complaints against Putnam were brought to the SECs Boston office, which proceeded to do nothing, until Galvin moved. A settlement with Putnam, even before the investigation is completed, would help bury that failure and asserts that the SEC is the agency really in charge of fixing this scandal.
Bush, are you listening?
Good luck. Galvin isnt going to let the Putnam case fade away without completing his work, even if the SEC is ready to close the book on Putnam. Id expect more charges out of his office.
Spitzer, meanwhile, has brought down two more big names in the world of mutual funds. On Nov. 13, Gary Pilgrim and Harold Baxter, founders of the PBHG family of funds, resigned in the face of Spitzers investigation into market-timing in fund shares by hedge funds, including one where Pilgrim himself was an investor.
Its just one more example of a complete breach of fiduciary duty by the most senior executives in a mutual fund, Spitzer said.
At least theres one guy that gets it. Unfortunately, he doesnt head the SEC. But that can be fixed.
President Bush, Sen. Paul Sarbanes, Rep. Michael Oxley, are you listening?
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: GameStop. He does not own short positions in any stock mentioned in this column.
|
