Some good comes out of the scandals

Your Funds

May 30, 2004|By CHARLES JAFFE

THE mutual fund scandals may not be over, but it's clear that fund executives and investors are over the scandals.

At the Investment Company Institute general membership meeting in Washington, leadership was mildly contrite, mostly concerned with the future and definitely ready to move on.

"People have heard enough about the scandals," says Sheldon Jacobs of the No-Load Fund Investor. "They are back to asking which type of assets to buy now and which funds look good."

Indeed, for all of the money that flooded out of scandal-ridden firms, more than $150 billion of new money went into funds in the past year, during a time of modest performance.

While there are still some charges to be settled and more to be filed, the trading-abuses scandal has become old news. Regulators and lawmakers have filed more than 100 proposals for changing fund operations, but the resolution of those issues will simply be part of the industry's next phase.

Studies undertaken by research firms such as Strategic Insight and others show that the improper trading activities and market-timing trades have stopped.

And now, the question for investors is what has changed.

Ultimately, the changes fall into four areas:

Rules and regulations

Some of the changes are good, some dumb, many unnecessary. The fund firms that broke the rules had the proper barriers in place, they just ignored them while cutting special deals with top customers.

Mandatory short-term redemption fees, tighter trading controls, a compliance officer who reports directly to the board of directors and more will go a long way to stopping not only the recent abuses, but also a lot of potential problems.

One problem with the wide range of rules being proposed is that it may turn the prospectus from "hard to read" to "unreadable."

If the standard 40-page contract with a fund becomes an 80-page opus from fund lawyers, it will be more daunting, less informative and may actually discourage average investors from looking for crucial information buried in the paperwork.


"You can have all of those rules and regulations and they don't mean anything if the culture doesn't change," says Matthew Fink, who is retiring as ICI president.

"I think the lessons of what some big fund companies lost here - the damage to their reputation and the money that left - have convinced people that they can't ever afford to let this happen again."


Knowledgeable investors have clamored for additional disclosures for years. Even if the numbers are most likely to be used by firms like Morningstar, rather than by individuals picking funds, the idea has always been that more information leads to more tools that buyers can use to make a decision.

Look for data firms to use disclosures on management compensation and other information to come up with some way to grade the relationship between the person running the fund and the shareholder.


It's no surprise that most of the firms touched by the scandals were heavy into growth and momentum investing, and they were looking for ways to keep the dollars rolling while the growth was vanishing from the market. Investors who held onto their funds not only suffered from the wrongdoing but also were punished by the market.

In the future, anytime a fund's results sour, investors will start wondering what's wrong and will question whether there is more to it than just the market cycle.

It will put a premium on management discussing events with shareholders in order to keep them interested. That increased openness in communications may ultimately be the best thing investors get for all of their troubles.

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