Mutual fund scandal growing with Putnam now in spotlight

Your Funds

Dollars & Sense

October 26, 2003|By CHARLES JAFFE

FIRST, it was mutual fund firms allowing illegal trading by hedge funds, and allowing market-timing trades by big institutional investors.

Next, it will be mutual funds allowing market-timing trades by some individuals, but not all of their shareholders.

That scandal moves from the horizon to the business page Tuesday, when Massachusetts Secretary of the Commonwealth William F. Galvin plans to file civil charges against Putnam Investments, the nation's fifth-largest mutual fund company.

Those charges, according to sources close to the commonwealth's investigation, center on investors in some large retirement plans being allowed to make rapid-fire trades in Putnam funds that did not allow that kind of market-timing activity from the rest of its shareholders.

Putnam, a part of the Marsh & McLennan Companies, has issued a statement denying any "improper behavior related to market timing within our 401(k) client base."

The Putnam matter showcases the next wrinkle investors are likely to see in the ever-expanding federal and state investigations of trading activity by mutual funds.

It marks the first time a fund firm actually has to stare down civil charges borne of these investigations. To date, fund firms have been investigated in cases against hedge funds or have had executives tagged with charges.

The trouble being looked at with Putnam revolves around rules in place at its funds, specifically those prohibiting market timing. Timing trades are not illegal, but they can be costly to buy-and-hold investors.

Many fund companies try to stop them from happening, implementing short-term trading fees - where an investor who sells the fund within a short period after buying it must pay a fee - or by simply freezing an account's trading privileges once they see an investor making several quick round-trip trades in short order.

The case Massachusetts regulators reportedly are preparing - and they've been working with Securities and Exchange Commission officials on it - suggests that some of Putnam's 401(k) contracts allowed plan investors to make timing trades despite prospectus rules that prohibited ordinary customers from pursuing the same strategy.

In the investigations into trading activity at Janus, Strong, NationsFunds and One Group, the central issue has been "discretionary trading arrangements," where the fund firms allowed big institutions to make timing trades, and were rewarded for breaking the rules by having big slugs of money put into their bond funds for a long stretch of time.

In the case of Putnam, it appears regulators will maintain that Putnam made timing a selling point in luring a few big retirement plan sponsors.

Putnam's statement denying wrongdoing did note three retirement-plan clients where timing trades occurred and the action taken to stop the activity. Putnam noted that it "faced difficulties curbing excessive trading" in one of those plans, troubles which may have been caused by having signed a contract which allowed the trading.

Putnam officials did not return calls seeking comment on the matter.

If you're the average investor, you're still wondering if this is a big deal. After all, you can't see making rapid-fire transactions in your retirement plan and seeing them amount to much in a centimillion-dollar fund.

Chicago data-tracking firm Morningstar Inc. has been among the most outspoken of industry watchers on the subject, with its analysts recommending that investors avoid the firms thus far tainted by scandal.

If you own funds directly impacted by the allegations, moving out is a matter of principle (as is looking to join a class action suit). If you don't own funds with a firm implicated by scandal, you can simply stay away. If you own funds with the firms under investigation, or perhaps the firms to be charged next, that's where the decision gets murky.

"If the fund is performing well, I'm not making a change if they're not affected," says Walter S. Frank, chief economist at the Moneyletter newsletter.

Some observers go a step further than Frank, and believe the affected fund companies will be the place to invest going forward because outstanding performance will be the only way to be exonerated in the court of public opinion.

And for investors who haven't been drawn into the scandal yet, don't believe you are out of the woods.

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