Posted on: Sunday, November 2, 2003

Probes of mutual fund firms could dampen earnings

By Hope Yen
Associated Press

NEW YORK — Many mutual fund firms are enjoying strong quarterly earnings thanks to growing investor optimism and a rebounding economy. But a widening regulators' probe into shady trading practices threatens to cut into fund firms' profits.

Massachusetts and federal regulators filed civil complaints last week against Putnam Investments for alleged improper activity. It was the first formal accusation of wrongdoing against a mutual fund company.

That comes after New York Attorney General Eliot Spitzer accused hedge fund Canary Capital Partners LLC in September of illegal trading involving Bank of America Corp., Janus Capital Group Inc., Bank One Corp. and Strong Financial Corp. funds.

And several other companies, including Merrill Lynch & Co., Alliance Capital Management Holding LP, Prudential Securities and Fred Alger Management, in recent weeks have suspended or fired employees believed to have engaged in illegal trading.

But while some fund shares have taken a hit on the news, the overall stock market recovery has driven up mutual fund assets, leading to higher revenues and profits. Analysts say the probe's findings so far might have come too late for third-quarter earnings and the impact could be felt later.

"The probe could affect every single company in the industry," said Rachel Barnard, a stock analyst at Morningstar Inc. who follows asset managers. "There certainly could be more revelations which have to make investors cautious."

Still, analysts believe the probe shouldn't dramatically hurt fund firms' earnings as long as the price tag of the scandal remains in the millions. That figure would be just a fraction of the $7 trillion total in industry assets.

Spitzer's complaint alleges illegal late trading, which Stanford University professor Eric Zitzewitz has estimated costs investors about $400 million a year. It also includes allegations of market timing, a practice that is illegal only to the extent fund prospectuses prohibit it; that activity is estimated to cost long-term investors billions of dollars.

So far, Bank of America and Bank One have pledged to pay restitution to harmed investors but have not provided estimates on how much that will cost. Separately, Bank of America set aside $100 million to cover legal and consulting costs.

Meanwhile, the two banks reported better-than-expected profits, citing in part substantial stock market gains. Strong is a privately held company.

Janus said it swung to a third-quarter profit from a loss a year ago. However, it also posted a preliminary charge of $9 million for legal costs and refunds it planned relating to the mutual fund investigation.

But the average investor will likely get little compensation. Given that there are hundreds of fund firms and millions of investors, "anybody's restitutions will be pretty small and overall company liability will be pretty small," Barnard said.