Sept. 7, 2003, 7:28PM Fund scandal threatens very foundation of investing By SHANNON BUGGS Copyright 2003 Houston Chronicle BUY and hold. Own shares for the long haul. Only fools time the market. All orders received after 4 p.m. pay the next day's price. These are the mantras the mutual fund industry has taught investors to say and believe. Last week, investors learned some fund families have been living by a very different rule: "Do as I say, not as I do." Eliot Spitzer, New York's attorney general, revealed the hypocrisy when he announced a settlement with a hedge fund that received privileges not given to most other shareholders from four prominent fund companies in exchange for investing money in the funds, which generated fees for the companies. The funds -- Bank of America, Janus Capital Group, Bank One Corp. and Strong Capital Management -- gave Canary Capital Partners access to: · Closing-bell prices on share purchases made hours after the market closed, despite federal laws prohibiting such look-back pricing. · Up-to-date information on the stocks the fund owned and in what proportion, information that most funds steadfastly refuse to share with their shareholders or the public. · Fee exemptions, continued trading access or other privileges in violation of the companies' own stated rules discouraging or banning frequent traders from investing in their funds. Canary agreed to pay $40 million to settle the charges without admitting or denying wrongdoing. And Spitzer has not charged any of the fund families with a crime. But what he has uncovered so far raises the concern that the level playing field most Americans seek in education, employment and economic opportunities may just be a myth -- an ideal this country will never attain. Mutual funds are supposed to be the no-nonsense, safe and easy way to achieve your financial dreams. Want to send a child to college? Invest money each month in mutual funds held in a state-sponsored college savings plan. Want to retire early? Live on a smaller sum each month and put the rest of your paycheck into mutual funds held in your employer-sponsored retirement plan. The mutual-fund industry convinced 95 million Americans to entrust it with their savings and economic security because it promised we were all playing the same game with the same rules. The fund manager gave us the expertise and experience that we did not have the time to gain on our own. The other shareholders gave us the financial clout to buy large positions in stocks and bonds. That gave the children and grandchildren of survivors of the Depression the confidence to stop saving money in a mattress and start investing their way to prosperity. That's why it's a gut punch to middle-income America's stomach to find out the companies that fashion themselves as the small-investor's champions on Wall Street may be selling them out. "A mutual fund that sets up two sets of rules is a travesty," says George Ball, chairman of president of Sanders Morris Harris, a Houston-based private investment bank. "That violates the whole spirit of the industry." If Spitzer's scrutiny digs up more hypocrisy, the ensuing scandal could undermine investor confidence in the markets more than Enron's collapse, Arthur Andersen's accounting shenanigans and the Wall Street brokerage firms disingenuous stock research. If that happens, Congress would be forced to take drastic steps to rebuild investors' trust. One step might be to revive and bulk up the Mutual Funds Integrity and Fee Transparency Act, which passed the House Financial Services Committee this year but wasn't introduced in the Senate. The mutual fund industry lobbied hard against a provision that was removed from the bill that would have required fund companies to reveal how a fund's costs compare to index funds and the rest of its peers. Fees are a particularly contentious issue in the mutual fund industry. It's common practice for some funds to pay higher commission fees to brokerage firms that execute their trades in exchange for research and other services. Shareholders pay those higher costs, known as soft-dollar arrangements, even though shareholders pay management fees with the expectation that the fund managers research for themselves the stocks and bonds they buy for the portfolios they manage. Questions also have also been raised about why funds closed to newcomers continue to charge fees that are supposed to be collected to recoup some of the costs of attracting new investors. These 12b-1 fees no longer just pay for advertising but have evolved into profit generators for some funds. Lawmakers also may consider adding provisions that ban market timers from mutual funds not specifically set up to attract that kind of investor. This practice lowers long-term investors' returns by forcing fund managers to pay commission costs on the quick sales and to keep cash on hand for redemptions, which means that money cannot be used in other, more-profitable ways. We all have too much at stake to let the ideal of a level playing field remain a fantasy. Shannon Buggs has completed the personal finance planning certificate program at the University of Houston. While she invites comments and column ideas, she cannot offer specific advice about individual situations. E-mail her at shannon.buggs@chron.com or call 713-220-6834. http://www.chron.com/cs/CDA/ssistory.mpl/business/208533436 responses total.
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