Posted on: Thursday, September 4, 2003

EDITORIAL
Scandal now touches major mutual funds

Less than six months ago, 10 of Wall Street's biggest brokerage firms, including Merrill Lynch and Morgan Stanley, agreed to pay about $1.4 billion in penalties to resolve allegations that they issued biased ratings on stocks to lure investment-banking business.

It was a major scandal because millions of ordinary investors were getting "buy" advice from their brokers for stocks that their firms knew were on the skids. We noted then that it was a lucky thing New York state's attorney general, Eliot Spitzer, was on the job, because it appeared federal regulators had been asleep at the switch.

The last thing investors need to hear now is that Spitzer has uncovered what may become another scandal. He charges that several major mutual fund companies have been engaged in fraudulent after-market trading practices with privileged institutional investors.

Spitzer says a hedge fund, Canary Capital Partners, had set up an operation with Bank of America's mutual fund division that allowed it to buy and sell mutual fund shares after the market had closed and then trade them the next day for a substantial profit.

Canary Capital has agreed to a settlement involving the return of $30 million in profits and a $10 million penalty.

More worrisome is that Bank of America's fund not only encouraged such activities but financed them by extending credit lines to Canary Capital. Moreover, Spitzer said Bank One, Janus and Security Trust Co. were providing similar trading benefits to institutional clients.

"Mutual funds are the quintessential vehicle for mom-and-pop investors," Spitzer said.

President Bush assured small investors in May that legislation following the brokerage scandal would protect their holdings. Now it's clear that the investment community must do far more to clean up its act, and government must ensure that it does.