Fund untainted? Watch it, too

Your Funds

Your Money

April 04, 2004|By CHARLES JAFFE

INVESTORS want very much to believe that if their mutual fund company has avoided the headlines, it has stayed out of trouble. But believing doesn't make it real.

As investigations into mutual fund wrongdoing continue, it is becoming increasingly clear that the real issues lie in the fine print.

The same transactions that lead one company to settle with regulators for hundreds of millions of dollars in fines go unpunished at the next firm, due almost entirely to the second firm's disclaimers.

A problem for investors

For investors, this is a problem.

The firms touched by the scandal have been at the forefront of changing their policies and improving their rules to help eliminate trouble spots.

While they should not be praised excessively for taking these steps - some of them got dragged by the hair into doing it - neither should anyone discount the value behind these better practices.

The firms that have not been tagged by charges, for the most part, certainly are not making any big pronouncements that they are stepping up to meet the highest new industry standards.

Consider Pioneer Investments, which was one of the dozens of firms subpoenaed by regulators over rapid-trading allegations.

In most of these cases, the central issue has been that fund management allowed special customers to move in and out of funds without facing restrictions and fees that it applied to ordinary individuals.

The Pioneer funds were widely rumored to have precisely this kind of problem, which is what the Massachusetts Securities Division went looking for when it began looking at the company.

A subpoena is an order to disclose information, and plenty of them are issued that never result in charges or complaints.

In the Pioneer case, however, people close to the case say that regulators found precisely what they were looking for, evidence that there had been special trading arrangements.

The reason you haven't heard Pioneer's name in the middle of the scandal is that the Boston-based company had a strong case that its actions were legal, even though similar actions put other firms in the soup.

The standard Pioneer prospectus from last year includes a heavy dose of "you can't engage in market-timing in this fund" language, but it also contains a clause that says the restrictions do not apply to "accounts that have a written exchange agreement with the distributor."

Who would have such an agreement? Hedge funds, big institutions and "special" customers.

So while regulators reportedly found such trading patterns at Pioneer, they didn't find a case they felt could be won.

Pioneer is not commenting. Neither are regulators.

Regulators might have ignored the fine print and made a case that management was breaching its fiduciary responsibility to protect investors.

The staff at the Securities and Exchange Commission is taking that tack in recommending a civil complaint against RS Investments.

But when a fund tells investors about its potential problems - even if it's in a document like a prospectus that few people read - regulators tend to back down.

That's why investors need to keep a close eye on how their fund firms are changing those rules.

Many fund companies - particularly those embroiled in the scandal - are clearing up their disclosure policies now but are leaving loopholes that protect them in the event of unforeseen or undetected trading problems.

In the case of Pioneer, new prospectuses are being written that strike the language about written exchange agreements.

That's an improvement, but one that investors aren't exactly hearing about. With the language buried deep in the prospectus - you have to slog through more than 25 pages of heavy fund jargon to get within a whiff of it - investors aren't exactly noticing the change.

So here's the logical solution to this disclosure problem.

Whenever a fund firm changes its prospectus language, it should note those alterations up front, in a special section placed ahead of the key financial information.

It's kind of like a sports rulebook, where annual changes to the fine points of playing a game are shown upfront, with the details in their proper place.

Until that kind of disclosure becomes common, investors should examine their funds closely, even if no wrongdoing was alleged.

Ah, yes, the footnotes

Look at the section of the prospectus that discloses any rules against market timing, and follow that data into footnotes or passages that describe "limitations" or "exceptions" to those rules.

Further, investors who see the good changes being made by any fund company - such as the elimination of soft-dollar transactions or improved disclosure of cost structures - should contact their fund manager to see if they can expect similar rules upgrades.

In the end, the only way for the entire fund industry to emerge from these scandals in better shape is for each of its participants - and not just the ones who have been charged with something - to step up and prove that they are putting an end to the shenanigans.

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