Scandals leave funds' `fans' little to cheer

Your Funds

Your Money

April 24, 2005|By CHARLES JAFFE

NOW THAT the baseball season has started, I am starting to believe that there is a link between the steroids problems the sport has been having and the scandals that have been besetting the mutual fund business.

The connection involves the customers, the ones who don't quite know how to react to seeing their favorite players making unsavory headlines.

Some people believe the problems - in baseball and in mutual funds - are overblown, others see overzealous enforcement of rules, and still others are disgusted by wealthy players seemingly taking short cuts to gain an edge.

And fans - and investors in good funds certainly qualify as such - are left with mixed feelings.

That has never been more evident than in the charges that have surfaced during the past two months against American Funds, the family that has become a darling of consumers and the media for its consistently strong performance, low-cost leadership among load-fund companies and its squeaky-clean image.

Now the American Funds family is dancing with several regulatory agencies. The tune is at nowhere near the serious level of the more-famous rapid-trading cases that have been at the core of the fund industry's problems for the past 20 months, and Capital Research and Management Co., which oversees the funds, seems to have plausible answers for most of the concerns.

But that doesn't mean investors aren't as confused as the average pre-teen fan upon learning that his favorite home run hitter has been branded by some as a cheat. A lot of nervous investors have written, wondering whether the news about American Funds means they should switch investing allegiances.

In February, the National Association of Securities Dealers charged American Funds with breaking the "anti-reciprocal rule" by directing $100 million in commissions to the brokerage firms that most aggressively sold the company's funds from 2001 to 2003.

The regulatory group's complaint suggests that American Funds didn't pursue "best execution" - the lowest-cost, or fastest and most-efficient completion of a trade - because it directed traders to do business primarily with the firms that pushed the product most heavily.

The Securities and Exchange Commission is looking into American Funds for similar reasons. The California attorney general's office has also been investigating.

American Funds has cooperated with the investigations, but it doesn't believe the case should be adjudicated in state courts because the National Securities Markets Improvement Act of 1996 preempted regulation by individual states.

American Funds' official statement on the issue (available on the www.americanfunds.com Web site) notes that the funds' distributor, not the funds themselves, made additional payments to brokerage firms but did so in accordance with federal disclosure rules.

The company does not deny that it was part of the common practice of sharing revenues and even directed brokerage commissions, the latter a practice that was made illegal last year by the SEC.

Think of it the way you would a baseball player using a steroid to increase his power before the drug showed up on the banned-substances list.

The company's position is that it didn't break the rules here, at least not the ones it believes funds are supposed to be playing under.

For shareholders, it raises the question of how to cheer for the home team.

In rapid-trading scandals, where it was clear that funds put their business interests ahead of those of customers, you could make a case for dumping the bad guys.

Still, some investors stuck around with funds that had always been strong performers, and they were rewarded for that patience.

If the ends - performance since the scandals - had been up to par, investors who stuck it out could feel vindicated in their choice. Many people have told me they did not want to give up a favorite fund and have had their faith restored.

In a case like that of the American Funds, investors can only play wait-and-see. In a world filled with players who could go to the penalty box, these look like touch fouls, not much to worry about.

But in a world where a reputation can be besmirched by association, investors have at least a mild reason to be concerned. You want your fund company to make the performance headlines, not the regulatory police blotter.

To that end, there is only one path for most investors to take if their favorite fund company gets tagged in this secondary round of regulatory issues: Stay the course, cautiously.

In the end, the issue might be less about investing with firms untouched by these types of issues than it is about investing in specific funds that have not been directly involved. You can still root for the home team, even if an individual player no longer earns your cheers.

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

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