Investors can learn when a fund is in the sights of a class action

Your Funds

January 20, 2002|By CHARLES JAFFE

ANY TIME a fund company is the target of a class action suit, investors can learn something.

It doesn't matter whether the suit is fruitful or frivolous, there's always a lesson about how funds work and what investors need to know buried in these legal conflicts.

This month, Van Wagoner Capital Management became the target of at least three class actions alleging that it misled investors about the value of shares in its Emerging Growth fund.

No matter how the cases turn out, the entire saga should prompt investors to look more carefully into what they own.

The lawsuits arose after a Wall Street Journal article last month questioned the way the fund valued "private placements," investments in companies that are not public and whose shares are not priced on any stock exchange.

The Journal, relying on documents filed by the fund firm, reported that 23 private placements purchased by the Emerging Growth Fund did not change in price from the time of the investment through the end of the year 2000. All were purchased prior to the stock market's peak in March 2000.

It might be reasonable to assume that the private placements - mostly in small technology companies - should have had lost some of their value before the end of the year, even if their thinly held shares never traded during themarket decline.

But Van Wagoner didn't revalue many of the private placements until 2001, according to company filings. By June 2001, nine private stocks that accounted for $28.6 million on New Year's Eve 2000 were valued at a mere $9 in total.

Truth be told, the over-valuation alleged by the class action suits helped investors who were in the fund. If they sold out, they got out at a price that was artificially high. They won't have to give back excess profits, even if it is determined that the fund was mispriced.

If they didn't sell, riding Van Wagoner Emerging Growth through a horrendous 2001, their shares now reflect the current, lower value of those private placements.

The class action suits are open only to investors who bought the fund from the end of April 2000 through June of 2001. Those buyers, attorneys argue, were misled into thinking the fund was more valuable than it really was.

Neither the fund nor the plaintiff's attorneys will say how many investors were affected. The fund gained almost 300 percent in 1999, so it's possible there was a rush of investors throughout 2000. However, given the dismal performance of Emerging Growth in 2000 and 2001, it's also possible that the fund did not attract many new investors.

The lesson here is to know what is in your fund. Plenty of fund firms buy private placements; few put as much emphasis on them as Van Wagoner, for which such purchases can often represent more than 10 percent of the assets at any of its five funds. Whenever you see a fund with private placements, remember that it is usually the manager who is charged with computing the value and determining what those private stocks are worth. That is one reason why they make a fund more volatile.

Private placements may stand still in value for long stretches until a "liquidity event," such as the issue of new shares or news of a key product development, forces the manager to adopt the price change. Those moves can, in turn, make a fund jump or stumble suddenly and violently.

Van Wagoner spokesman Peter Kris said the firm has valued private stocks consistently throughout its history, and that such pricing determinations are independently audited. He would not discuss the class action suits.

The Van Wagoner tale is a reminder of the need for shareholders to examine how a fund invests and what it owns, particularly if it has a history of volatile moves up or down.

Relying on a fund's stated investment objectives without examining its portfolio is a mistake.

The more high-flying the fund, the more scrutiny its investments deserve. Pay particular attention to a high-flier's prospectus - where it lays out what the fund is allowed to do - and its portfolio, where you can see if it is leaving the mainstream to achieve its results.

Van Wagoner investors who read the prospectus should have known that the funds are allowed to go heavily into the private-equity market. (Many funds don't do private placements or limit them to no more than 5 percent of total assets.) That kind of speculation can fuel huge gains or trigger huge losses.

The wrong time to say "I didn't know my fund could do that" is when performance falters and you have to hope for a class action suit to make you whole again.

Chuck Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378,Boston, Mass. 02107-2378.

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