Restitution won't enrich fund holders

Your Funds

Your Money

May 09, 2004|By CHARLES JAFFE

SUE FROM Palm Beach saw her individual retirement account lose $50,000 during the bear market. Leon from Philadelphia lost $10,000. Teena in Fort Worth says simply that she "lost half," which is huge regardless of the dollars involved.

What these investors have in common is that their losses occurred in Putnam funds.

They read about fines Putnam paid to regulators for allowing improper trading, and they want part of the restitution monies that will eventually go to shareholders.

Many inquiries

Hundreds of investors have written me since I explained Putnam's settlement, or have inquired after the more recent Janus settlement, wondering how to get some money back.

Truth be told, the fine details of restitution from the fund companies are months from being complete.

But some of the issues are becoming clear, and one thing is for sure: Sue, Leon, Teena and the vast majority of people like them won't get much satisfaction.

To see why, let's look at the likely dynamics of restitution made from all of the fund companies that have settled with regulators.

The first thing you need to understand is what this restitution is for.

The paybacks exacted by regulators are designed to cover only those losses created by illicit trading deals, the back-room machinations that got fund companies into hot water.

The Putnam case

In the Putnam case, for example, the anticipated losses from allowing special customers to trade frequently will amount to about $9.5 million.

But that money - the Securities and Exchange Commission and the Massachusetts Securities Division each got $5 million to disburse to investors - will go only to investors in affected funds.

With millions of shares in the affected funds, investors will be due fractions of a penny per share.

No kidding.

The restitution amounts in these cases are so small that you'll be lucky to buy a gumball with the proceeds, so minute that regulators actually will have to decide whether to pay individuals whose checks are smaller than the postage costs to mail them.

"We are looking to hold accountable companies that are committing fraud in relation to how they manage money; we are not looking to have companies meet specific returns and hold them accountable for not judging the market well," says David Bergers of the SEC's Boston office.

"People need to make the distinction between their losses and the cases they read about in the paper. Someone who lost a lot of money because they owned a fund that went down during the bear market is not going to be satisfied here.

"But if they lost money because their fund allowed frequent trading - something that shaved a small amount off their returns - they should get something back."

Exactly how the distribution process will work is not clear, but in most of the regulatory cases a distribution consultant will look into just who owned the affected funds at the time the wrongdoing occurred.

Ideally, all shareholders of those funds - even if they subsequently unloaded the fund - will have a shot at some money.

About six months

The distribution consultant will determine, in conjunction with regulators, whether itty-bitty checks will be sent, and will prorate the payback pool among all affected investors. The payout should occur roughly six months after the settlement was made.

The SEC also took other monies from the fund world's wrongdoers and has promised that all of that money will be returned to shareholders.

Again, there is no clear picture of how that will work, but one likely scenario is that officials will simply put the penalty money into the affected funds. But unlike an investor - whose deposit results in an increased number of shares - the payback money simply raises the net asset value of the shares.

It's simple and effective, but it doesn't do a blessed thing for investors who have bailed out, which is why it might not be the final answer. (Reduced fees, which state regulators have gotten in some cases, help investors who stick with the funds, but give nothing back for past wrongs.)

Simplicity is goal

In any case, regulators will try to make the restitution process as simple as possible, hoping to make it that Sue, Leon, Teena and the others get anything they might be entitled to without having to file paperwork.

"There's a possibility people will be annoyed when they start getting checks," says Matt Nestor, director of the Massachusetts Securities Division. "There's not much doubt they will be hoping for more.

"But if they are hoping that regulators can get all of their market losses back, they're hoping for something that's not going to happen."

Chuck Jaffe is senior columnist for CBS MarketWatch. He can be reached at or Box 70, Cohasset, Mass. 02025-0070.

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