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State Treasurers in Quandary Over 529s

Think mutual fund investors are the only ones trying to decipher which sponsors have been naughty and which have been nice?

State treasurers, charged with running their 529 college savings plans, are in a quandary of their own. In light of the ever-broadening industry scandal, some are busy trying to decide whether the investment managers they diligently hired within the last few years should be shown the door.

Several states' 529 plans have been managed, distributed and marketed by Bank of America, BancOne Investment Advisors, Putnam Investments and Strong Capital Management.

As fiduciaries, "state treasurers are really in an awkward position," said Richard Feigenbaum, an estate-planning attorney in Wellesley, Mass., and founder of College Savings Consultants.

"It's not the State Treasurers' fault," Feigenbaum added. Greed drove them to squeeze fund companies so as to generate new revenues, he said. "Maybe they should have struck a deal to offer three or four of these firms and leave the choice to participants," he counseled. "Whenever you pick a partner, you are hanging yourself out there."

At least one treasurer has taken swift and decisive action in the wake of allegations of personal short-term trades executed by Richard Strong, the now deposed chairman of Strong Capital Management in Menomonee Falls, Wis., and another Strong executive who reputedly allowed Canary Capital to market time some of Strong's proprietary funds.

Oregon to Strong: Take a Walk

On Nov. 13, the Oregon College Savings Board voted to fire Strong as the sole manager of the plan, which was launched in 2000. Strong manages $134 million of the plan, which also offers investments in U.S. Bancorp's First American Funds. One week earlier, Oregon State Treasurer Randall Edwards had made a public recommendation that the board oust Strong.

"We took swift and decisive action today because our priority is to maintain investors' trust," Edwards said. "Strong has violated that trust. And while we have no reason at this time to believe that Strong has harmed investors financially, when it comes to safeguarding Oregonians' money, we have high standards and a low tolerance for wrongdoing.

"This does not appear to be an isolated incident, and it goes to the very top, calling into question the firm's long-term stability."

Edwards reassured plan participants that their money was safe, but vowed to quickly find a replacement manager that offered highly rated mutual funds with lower fees and expenses. Strong will continue to manage assets during the transition. Calls to both Treasurer Edwards' office and Strong were not returned.

Wisconsin's Big Cheese

Strong also manages the EdVest 529 plan in its home state of Wisconsin. On Nov. 5, State Treasurer Jack C. Voight, who serves as the co-chair of the Wisconsin College Savings Program Board, wrote to update participants. "The board is taking the allegations [against Strong] very seriously," Voight said.

The board has since hatched a three-part plan of action including: receiving Strong's commitment to reimburse investor losses related to improper trades, and ensuring that Strong take remedial compliance and corporate governance measures to safeguard investors. The plan also calls for the board to add more non-Strong mutual fund choices for investors.

The board also sought to sooth investors' concerns by stating that it had authorized an independent legal audit of the investigations against Strong and would be watching the results of the independent internal investigations ordered by Strong itself.

But the Wisconsin college board stopped short of recommending that Strong be fired.

In an interview, Treasurer Voight said that the board has made no final decisions, but would be considering its options and how to add other investment managers' funds.

"The board met on Sept. 23, which was to be a day of celebration as the plan had just reached the $1 billion investment mark. But it became a day of solitude," Voight noted. "Our legal counsel is still working on the legal audit of Strong," he added.

Breakthrough Legislative Bill

Voight pointed to a bill recently introduced into the Wisconsin State Assembly that would allow Wisconsin residents more freedom of choice in choosing to invest in the 529 plans of other states. If passed, this bill would likely be the first of its kind in the nation, and would allow Wisconsin denizens to contribute, up to a maximum of $3,000 per year per child, to any state's-sponsored 529 plan - but still be allowed the full state personal income tax deduction.

"We will probably be the first state to allow investors to invest in other states' 529 plan and still take the deduction," Voight said. "There are really compelling arguments."

Voight predicts that his state's potential passage of this bill could fuel federal regulatory changes allowing home-state income tax deductions for all 529 plan contributors no matter what state plan they choose to invest in.