Is The Scandal Over Yet? Not a Chance
June 21, 2004
The notion that the fund scandal is all but over has been gaining steam in the general press and among some in the industry recently, but the reality is that while it has been a long, hard nine months, the mutual fund industry is far from out of the woods. Disinterest should not be mistaken for inactivity.
The general press has apparently grown tired of the steady flow of fund abuse cases coming through the pipeline. In fact, New York's pit bull regulator Eliot Spitzer may even be starting to yawn at the prospect of attacking more fund complexes. Spitzer has said that the scandal may have peaked, and Stephen Cutler, the Securities and Exchange Commission's director of the division of enforcement, indicated the worst of the market-timing and late-trading portion of the scandal is likely past.
However, Cutler recently told The Washington Post that he believes the SEC has "broken the back" of timing and late trading, but since the investigation extends to all areas of the mutual fund business, the SEC is "not yet through the middle innings when it comes to some of the other mutual fund issues."
While the industry is obviously not free and clear yet, the media coverage of the remaining complaints may understandably dwindle, as it has already trended with the Janus and Strong settlements. It is the nature of the news business to chase the next hot topic.
Everything is relative. The worst may be behind us because it hardly seems it can get any more disastrous for an industry that once, not-so-long ago, prided itself on its squeaky-clean image. When Spitzer unleashed his bombshell on the industry last September, many originally theorized it was a matter of a few bad apples spoiling the bushel. But that notion was quickly quashed when more and more firms were revealed to have been involved in illegal or, at best, questionable deals.
The fund industry has seen half of its top 25 houses involved in regulatory actions and more than $2.3 billion in fines, restitution and in agreements to lower fees. A large number of the heavy hitters in the industry, including Bank of America, Putnam, MFS and Alliance, have settled. One fund executive, James Connelly, formerly with Fred Alger Management, is in jail for destroying evidence. Countless industry representatives have been paraded before Congress, which itself has a number of fund industry reform proposals pending. The initial shock value of Spitzer's highly inflammatory comments and the revelations of the callousness with which average investors were treated is hard to surpass.
But let's not forget five key facts that will ensure the scandal will continue to remain relevant and loom over the industry for some time to come.
Timing, Merely Phase One
The first and most obvious is the conclusion of the remaining cases from the initial phase of the investigations into market timing and late trading. It is expected that Bank One, one of the initial four firms named in Spitzer's case against Canary, will settle soon. Conseco and Invesco Funds are also reported to be nearing deals, as well. However, there are other cases that could potentially drag out, such as Pilgrim Baxter, and Cutler noted there is a backlog of cases at the agency.
While it appears that Spitzer's new focus is recouping the excessive salary paid to former NYSE head Dick Grasso, there are other state regulators who may throw their hats in the ring, and this could prolong the initial phase of the scandal. For example, in a May regulatory filing, Putnam indicated that it had received subpoenas from the Florida department of financial services, a pair of regulators in West Virginia and the securities division for the state of Vermont in relation to market-timing activity, charges the firm has already settled with the state of Massachusetts and the SEC.
Sales Practices, Phase Two
Secondly, the investigations opened the door for regulators to take aim at all the things that are wrong with the fund industry. Pay-to-play practices, as well as directed-brokerage and side-by-side management of mutual funds and hedge funds are all areas that are sure to get increased attention once market-timing and late-trading abuses have been put to bed.
Some expect the second wave of the scandal to shift from the East Coast to the West Coast. As well, many of the probes are largely expected to look at deals between the brokerage community and fund firms.