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Seeing Fund Problems Ahead of the Curve

Max Rottersman has been pointing out problems in the mutual fund industry, shedding light on inconsistencies in data, and trying to drum up business for, a mutual fund data analysis firm based in New York, for which he serves as president.

By analyzing data, Rottersman has unearthed some disturbing trends and corporate mistakes in the fund arena. However, there is a unique connection between the data and the actual problems facing fund shops individually and the industry overall.

Rottersman spoke with Money Management Executive Associate Editor Chris Frankie about the industry's woes, the disconnect between fund firm upper management and the mid- and lower-tier workers, as well as bureaucratic inefficiencies at the country's lawmakers and regulators.

MME:You have written about problems with Fidelity's performance fee model on your Web site and noted in a letter to the SEC an incorrect filing by Putnam Investments. You have raised questions of insider trading at Alliance Capital. These claims should raise red flags. Why do you think corrective action for some of the things you have shed light on has been slow going?

Rottersman: The problem is that the SEC is the only entity that any of the companies really fear. Lawyers that have strong relationships with the SEC really call all the shots. Funds think that the problems result from a bad relationship with the SEC and are not derived from the data and the analysis that I do.

MME: In a recent letter to the SEC, you write about how difficult the SEC makes it for firms such as yours to provide board trustees with information. Do you think if some of those barriers were not in place, the scandal might not have gotten this out of hand?

Rottersman: Absolutely. Like any organism, when you have a lot of inbreeding, it gets corrupted. There's really no fresh blood in the fund industry. You have the same people talking about the same things, and their knowledge gets old. They don't understand new technologies.

MME: What barriers need to come down to make the information flow better for trustees?

Rottersman: I think there needs to be more of a connection between disclosed problems in the press and action by the SEC or by the prosecutors. There just isn't enough responsiveness to criticisms. Why should the boards do anything about a bad report unless they have to?

MME: You have said that mid- and lower-tier management are the real losers in the whole scandal. Why?

Rottersman: Those in middle- and lower-tier management are losers because they're the ones who will ultimately lose their jobs because of the fund management abuses. In general, CEOs can go from one job to another and are independently wealthy. But the middle managers suffer most from the loss of investor trust. Once people stop trusting in companies, they cease moving their money around. Of course, the top executives just fire the middle managers until things change.

You are seeing some corporate officers stepping down across the board, but the middle managers look like they're the culprits. The people who would like to have pride in their work just can't have it because the whole company is tarnished. One of the reasons that many of these middle managers are running into problems is because there is no clear direction from the top as to which rules need to be followed.

MME: You have claimed that a small number of people, about 1,000, wield the most power in the fund industry and this is harmful to the industry. However, most industries have a core of decision-makers and leaders. Why is this particularly bad in the fund industry?

Rottersman: You're right in pointing out that most other industries have even higher concentrations of power within just a few different companies. However, in other industries, the consumer understands their products a little bit more. When you buy a TV, you understand whether it works or it doesn't. The same goes for a car.

Financial products are so complicated that the consumer doesn't have the knowledge that they have in other industries, even though there is tons of disclosure. The problem with the 1,000 people in power in the fund business is that there is a concentration of that power in a group that doesn't change. The end consumer has the least amount of knowledge about these products than any other product that they buy in their lives.

MME: SEC Chairman William Donaldson came into his job preaching the "tone at the top" mentality, asking financial service firms to own up to their fiduciary responsibilities. However, you recently criticized Fidelity's Ned Johnson, and have noted that upper management is sending its misguided thinking downwards. Do you think the fund industry has taken to Donaldson's message, or is it business as usual?