It's time for the bad mutual fund guys to take responsibility

Your Funds

Your Money

February 13, 2005|By CHARLES JAFFE

If you ever commit a crime and are facing justice, you'd be wise to ask for punishment similar to what mutual fund companies get.

Throughout the mutual fund scandals of abusive trading practices and double-dealing to give favored customers privileges ordinary investors can't get, punishment almost always has boiled down to a fine and no admission of wrongdoing.

It goes something like this: "We didn't do it, and we won't do it again."

Wink, wink.

"Oh, and that enormous payment to settle? The regulators were overzealous in pursuing us."

It's hardly a satisfying end for fund shareholders who want the bad actors drummed out of the industry, held responsible for their actions and liable to pay in civil litigation.

That's what makes the case that Massachusetts filed against the brokerage A.G. Edwards Inc. this month so interesting, because the likely end of the case will be a confirmation that regulators are as tired of the run-around as consumers have been.

William F. Galvin, the Massachusetts secretary of the commonwealth, charged A.G. Edwards with permitting illegal rapid trading at the firm's Back Bay office in Boston. Galvin said the moves defrauded fund shareholders, and he is seeking restitution, plus an administrative fine, in part because A.G. Edwards had a policy that prohibited its representatives from making rapid trades.

In this case, however, the firm allegedly directed the reps involved to get "an indemnity agreement" from the favored clients. This, says Galvin, shows that the firm knew that what was going on was wrong "and management sought to protect itself through indemnity, rather than protecting fund shareholders by sticking with the rules."

The complaint alleges that of nearly 35,000 mutual fund trades executed through the Back Bay office from January 2001 through late October 2003, about 31,000 were timing trades. Galvin believes those trades moved more than $2 billion, racking up transaction costs that were paid by other shareholders in the affected funds.

A.G. Edwards issued a statement noting that the complaint involved "one branch, two clients and a financial consultant who was terminated by the firm in October 2003."

While vowing to "defend ourselves vigorously," no one at the firm actually came out and said, "We didn't do it."

And if Galvin gets his way, this case won't end until A.G. Edwards at least acknowledges that regulators have their facts straight.

"The usual effort on most cases has been to try to find the way to reimburse someone who has been harmed," Galvin says, "but in the mutual-fund timing cases, it has been difficult to figure out an exact amount of reimbursement. The result has been settlements that many people have felt are insufficient, coupled with no admission of guilt.

"We have to stop the merry-go-round of accusations and settlements with no admission of guilt, because what financial firms have been saying is `We won't do it again until we can think of some new way to do it that you regulators haven't figured out yet.' "

Up to now, regulators have been willing to accept settlements without an admission of wrongdoing for a few reasons, most notably the ability to get investors' money back quickly. Financial firms are more willing to do that when they don't leave themselves open to civil suits filed by shareholders; an admission of guilt would make things pretty easy for plaintiffs' lawyers.

In addition, some regulators have focused their attention elsewhere: New York Attorney General Eliot Spitzer has pushed for fee reductions, which give investors a future savings.

But it is clear that regulators are looking for something better.

Already, Galvin has gotten "admissions of fact" in two high-profile mutual-fund cases, settling with Putnam Investments and Franklin Templeton only after the firms conceded the regulators' facts were correct.

Technically it's not an actual admission of guilt, even though it amounts to, "We DID do it, but won't do it again." That distinction is designed to keep the civil attorneys at bay.

To the rest of us, however, it seems like the bad guys may actually have to fess up.

Galvin compares what fund companies have done to street crimes, where first offenders sometimes are issued a continuance without any finding of guilt, which means that if they stay out of trouble the charges will go away.

"But you don't come back time after time and get another continuance," Galvin says, "and the recidivism rate for these companies is high, because we see them again and again and again. We should not be treating these people as a higher class of criminal when they are stealing much more money from individuals.

"If we want to foster investor confidence, then someone has to take responsibility for what has happened, and that starts when they admit the facts of the case. ... I think that is going to be a big part of most settlements from here forward."

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