Posted on: Tuesday, January 13, 2004

Spitzer says fund probe continues

By Christine Dugas
USA Today

The scandal rocking the mutual fund industry is slowing in terms of the number of new fund companies under scrutiny but it's not winding down, New York Attorney General Eliot Spitzer said yesterday.

The investigation is entering a new phase as regulators build cases and pursue new avenues, such as financing of hedge funds, Spitzer said in a wide-ranging interview.

The scandal ignited in early September when Spitzer settled charges with hedge fund Canary Capital Partners that it engaged in illegal trading practices with four fund firms. Since then, the Securities and Exchange Commission and regulators from other states have joined the rapidly expanding probe, which centers on market-timing irregularities and illegal late trading.

Spitzer gave USA Today a progress report:

Q. Now, more than four months into the investigation, where do things stand?

A. We're entering the phase where every new revelation is not dramatic because they begin to imitate each other. I think there will be a slight slowdown in the number of companies that emerge, but there will be twists. It will go off into other areas.

Q. What's next?

A. We are entering the phase where we're trying to hammer out settlements and figure out what the proper remedies are.

And there have been some intimations that those who financed these trades (by hedge funds) actually understood what was going on. Therefore we have another layer of issues to pursue. ... So the investigation will go off into other areas. It may be the financing issue. It may be variable annuities.

Q. In the past you've mentioned that initial public offerings may be an area you'll look at. How does that relate to mutual funds?

A. It's an allocation issue. If you have a mutual fund and a hedge fund being run under the same roof and they have an IPO allocation, the question is how do they decide who gets them?

Q. Does the inquiry into the financing of hedge funds involve many companies?

A. We just don't know that. We are getting into that area, and it is one that deserves attention because we, as protectors of small investors and regulators, would have to be concerned if those who were financing these trades understood the impropriety.

Q. What can you say about the negotiations with MFS Investment Management, which last month said that regulators intend to recommend enforcement action, alleging misleading market-timing disclosures and breach of fiduciary duty?

A. Very little, other than we would always prefer to settle than to litigate. There have been conversations with MFS. This is again a context where I'm doing this with the SEC, and we are trying to navigate various issues. If we can reach a settlement, that would be wonderful. But there's still ground to cover.

Q. Are you continuing to investigate Strong, Janus, Bank of America and Bank One — the original four fund firms named in the Canary Capital case?

A. We began this last May, and in six to seven months we've covered such an enormous piece of the landscape. Inevitably there are going to be some pieces that we're still working on. ... Grand jury investigations take longer just procedurally. Criminal investigations take longer to put together. We have tried to focus and pick for first cases for settlements or litigation ones that would define the terrain. But the ones you listed are very much still out there.

Q. Will there be more charges against executives?

A. I think it's almost inevitable. What precisely those charges will be, either criminal or civil, remains to be seen.

Q. You were criticized by the SEC for negotiating a fee reduction with Alliance Capital. Do you still feel that is appropriate?

A. Just to make it eminently clear: Government should not set fees.

On the other hand, just as a doctor tries to address all the symptoms of the disease, we have to address all the harms that befell the investors — damages from late trading, from timing, from excessive fees. ...

And where you do the apples-to-apples comparison we are seeing vastly higher fees being paid by mutual fund investors — to the tune of billions of dollars. That's why we're saying that the fiduciary failure of the board has to be addressed by some form of giveback to the investors because that is simple theory of restitution.

Q. So you don't agree with the mutual fund industry, which argues that individual investors pay the same fees as big investors?

A. I'll give you one example. We went to Putnam Investments and said what is the differential between fees that you're charging institutional investors vs. mutual fund investors. We said you calibrate it and figure it out so that it's an apples-to-apples comparison. They came back with a 15 basis point differential. We're talking about a vast sum of money here.

Q. How should investors respond to the scandal?

A. Mutual funds are still probably the single best vehicle for most investors. Does this investigation demonstrate such a lack of integrity in the mutual fund industry that you should pull your money? No. It demonstrates that (there) were real management flaws, governance flaws that have to be addressed. ...

I've said ... make your judgment about what the best mutual fund happens to be for you.