Posted on: Sunday, December 21, 2003

Billions taken from investors' pockets

By Rachel Beck
Associated Press

Analysis — Not only were select investors permitted to frequently trade their fund — a violation of most fund companies' own rules — but illegal after-hours trading was taking place.

NEW YORK — As the saying goes, what you don't know may cost you. That's been especially true for mutual-fund investors this year.

First, they had their profits skimmed by the questionable trading practices taking place at many of the nation's fund companies. And now there are revelations about the costly deals that funds made with brokerage firms to push their products over others and kick back all sorts of goods and services their way.

Add it all together and it potentially totals billions of dollars taken unknowingly out of investors' pockets.

Maybe the only good to come from all this is that it has made investors — both big and small — more aware that there was a lot missing from what they read in a prospectus.

Most of the focus lately is on the trading abuses. Not only were select investors permitted to frequently trade their funds — a violation of most fund companies' own rules — but illegal after-hours trading was taking place.

Those late trades allowed some investors to cash in on after-hours news ahead of other investors, who would be forced to chance buying at the next day's closing price. Mutual funds are priced just once a day.

That exploitation of changes in prices can hurt other fund shareholders, especially those holding on for the long term, by diluting the value of their shares.

But that's not the only thing eating away at investors' money. Shareholders, especially individual investors, are just now finding out about other costs.

Take "soft dollar" arrangements, in which the fund companies steer stock- and bond-buying business to brokers who then provide research, computers and other services.

Fund companies are not required to report how much they pay their brokers in commissions — the cost of which may be increased to cover such items. A survey last May by Greenwich Associates of 289 financial institutions found that they expect to pay more than $1 billion in soft-dollar commissions this year, up from $820 million in 2002.

Fund companies also pay brokerage firms to get on a "preferred" list of investments, so the brokers push those funds, regardless of whether they are the best place for clients to put their money. Currently, the breakdown of those payments don't have to be disclosed.

Morgan Stanley last month agreed to pay a $50 million fine and change its practices for allegedly steering clients toward certain mutual funds in exchange for millions of dollars in commission payments from those companies.

The good news is that changes are on the way to make it a lot tougher for funds to cheat investors out of what they deserve to know.

While fund companies are cracking down on trading abuses within their own firms, the Securities and Exchange Commission is considering new rules that would impose a cutoff of 4 p.m. Eastern time for pricing of fund shares and require funds to clearly disclose their market-timing policies and procedures.

In addition, there is a push to make it more difficult for funds to hide other costs.

The Investment Company Institute, the trade group representing the fund industry, asked the SEC this week to put limits on soft dollars as well as ban the practice of steering stock transactions to brokerage firms that agree to push a fund company's products.

The SEC also last week asked for comment on proposals to improve disclosure in the mutual fund business.

Many major investors, including state pension funds and 401(k) plan administrators, are demanding greater disclosure throughout fund prospectuses.

So maybe down the road investors will know exactly where their mutual fund money is going. It's about time.