Posted on: Sunday, May 23, 2004

Scandal still haunts mutual funds

By John Waggoner and Christine Dugas
USA Today

If mutual fund executives think investors are ready to forgive and forget the trading irregularities and other indiscretions that have battered their companies for the past nine months, they had better think again.

"The time for blind faith is over," says Mary Audette, who works for a financial services company in Minneapolis.

Audette, 48, says she used to think she could relax and feel confident about her mutual fund investments. "The same way I would delegate my health care to my doctor, I delegated my investments to a fund manager. I've changed. I watch things more closely."

Despite proposed reforms, distrust seems to run deep.

Data from Lipper show 17 firms named in the mutual fund scandal had overall outflows of about $12 billion in March and $14 billion in February.

The problem exploded in September when New York state Attorney General Eliot Spitzer settled with Canary Capital Partners, a hedge fund, for mutual fund trading abuses. Four fund companies — Janus Capital, Strong Financial, Bank of America and Bank One — were linked to improper trading. Since then, nearly 20 mutual fund firms have been implicated in the scandal, and several fund company CEOs have resigned or been forced out.

But while many investors are upset, some evidence suggests that a mass pull-out of mutual funds has not been occurring.

Investors poured $85 billion into stock mutual funds the first quarter. The Spectrem Group says a poll of 402 mutual fund investors showed that 57 percent weren't concerned about the scandal.

However, Russell Kinnel, director of mutual fund research at Morningstar, points out that 92 percent of respondents to the Spectrem poll felt that the Securities and Exchange Commission should prosecute those found guilty. Another 62 percent said they would sue their fund company if it were found guilty.

Don Phillips, managing director at Morningstar, says the mutual fund industry's relatively clean record made it deaf to the warning signs of the scandal.

"The industry was foolish not to hear the drumbeats," Phillips says. But the attitude was, he says, "We can do no wrong."

The Investment Company Institute, the funds' trade group has endorsed most of the reforms.

To some extent, the industry had little choice. "They couldn't say, 'We don't need new rules because we're so damn trustworthy,'" says Kinnel. "They realized that they would look like tobacco industry scientists saying cigarettes don't cause cancer."

To regain investor trust, institute president Matt Fink says, "We need the whole industry to have a fiduciary culture, where every decision is made based on what's good for shareholders."

Some investors are unsure as to whether the changes are enough.

"I wonder if they are mild slaps on the wrists when what's truly needed is something bolder and more aggressive that addresses the underlying motives and instilled values that allow executives to think that their dastardly treatment is acceptable and justifiable," says David Pincus, an investor and business professor.

Others support Spitzer's demand that fund companies include fee reductions as part of market-timing settlement agreements. Many say investors have been nickeled and dimed by mutual fund fees for years.

According to Mercer Bullard, a former SEC lawyer and founder of Fund Democracy, an investor advocacy group, "fees strip a lot of the market's returns and leave fund investors the poorer."