Putnam settlement raises questions for fund industry

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April 25, 2004|By CHARLES JAFFE

WHEN THE Securities and Exchange Commission and Massachusetts regulators closed the book on Putnam Investments early this month, they opened a whole new box of troubling questions for fund companies, regulators and shareholders.

Putnam settled charges that it had allowed some clients and several of its fund managers to make improper trades in Putnam funds from 2000 until September last year.

Putnam will pay $110 million, split evenly between the SEC and Massachusetts regulators. Of that amount, $10 million is earmarked for shareholder restitution. The SEC's remaining $50 million is to go toward helping shareholders, and the Massachusetts money is to go into the state's general fund.

Therein lies at least part of the rub.

Here are some key questions raised by the settlement, answered with an eye on the impact on investors.

Why isn't Massachusetts giving all of its money to shareholders, and how will the SEC deal with its cash?

The key to the settlement is the amount of the damages.

Regulators were prepared to argue that the number was huge, but settled for a middle ground.

The likely figure on shareholder losses directly attributable to Putnam's allowing improper trades is $9.5 million. If the final number exceeds $10 million, regulators will turn more of the "fine" part of the punishment into the "restitution" part.

In Massachusetts, the law states that any money beyond restitution must go to the state's general fund, where, presumably, some of it pays the cost of securities litigation.

The SEC is under enormous political pressure to return everything possible to shareholders. How it allocates the penalty money will become a continuing saga.

The important thing to remember with both agencies is that investors in the funds will get back everything regulators think they lost. They are being made whole.

Investors should not expect regulators to make them a profit. And fund companies should not expect that they can return the money and walk away happy. There must be a penalty, and in this case it amounts to 10 times the loss, plus the repayment of those lost dollars.

If investors don't get back more than they lost to improper trading, what have they gained?

Investors who want more can jump in on the many class action suits filed against the companies identified as having troublesome trading deals.

The Putnam settlement didn't create a profit for investors, but it did the next best thing when it comes to those civil cases: It included an admission of guilt.

The standard regulatory settlement that a fund company agrees to amounts to: "We didn't do it, but we won't do it again." But Putnam admitted the facts of the Massachusetts case, and although that was done "solely for the purposes of resolution of this administrative proceeding," everyone watching agrees that the admission makes the job of the plaintiffs' attorneys a whole lot easier.

Investors also gain, in general, from the improvements made by funds as a result of these regulatory cases.

Would cutting fees have been a more appropriate punishment?

Regulators are split on this issue. The SEC won't make funds cut fees, but New York state Attorney General Eliot Spitzer has made fee cuts a big part of his strategy.

Fee cuts effectively deliver savings back to shareholders. They don't help investors who have bailed out on a troubled fund, but they are extremely efficient at making sure that shareholders get direct benefit from the penalties.

That being the case, especially given how some investors are reacting to Massachusetts keeping penalty money, fee cuts might leave investors liking future settlements more than this one.

Why haven't other states jumped in to get similar settlements?

In some securities cases, state regulators pile on after settlement, going after money for their state or investors. In this case, it appears that state regulators recognize that all shareholders will be made whole, and they are not going to muddy a process that most see as working.

Although some people in the fund business are saying settlement deals such as Putnam's are not fair to the companies, they should remember that fund companies operating in all 50 states might have had to settle in all 50 states.

There was talk that the damages could be calculated in a way to make them much bigger. Why didn't regulators push for that much larger damage calculation?

Because there was a strong potential they would have lost. If the liabilities had been determined to be a lot smaller - which the fund companies have been maintaining - it would have put big-dollar settlements on the endangered species list, and there are a few big fund companies that have yet to settle anything.

By settling now, regulators helped to ensure that investors in those fund companies also are likely to be made whole.

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