No easy answers in mutual fund case

Civil action could bring small return for investors

June 16, 2005|By Laura Smitherman | Laura Smitherman,SUN STAFF

Nearly two years after New York Attorney General Eliot Spitzer shocked mom and pop investors by accusing the once-unsullied mutual fund industry of cheating them, a battery of lawyers has been quietly liti- gating a huge civil action brought on behalf of those investors in federal court in Baltimore.

Both sides have filed hundreds of pages of legal documents, most of them electronically to save office space; they've had countless conference calls; and they predict it may take several more years to work it all out.

And still, legal experts say that any money recovered for investors wouldn't buy most of them a hot dog and soda from a vendor outside the downtown courthouse.

"In the end, you have the prospect of thousands of people getting a check for $1.29 each," said Richard A. Booth, a University of Maryland law professor who has been tracking the litigation. "That's not going to mean much at all to anyone but the person who has to write those checks. The lawyers will get some money from it, but the investors won't get much."

The stakes in the case demonstrate the complexity of the so-called "market-timing" and "late-trading" scandals and the difficulty of determining how to punish those involved.

While the mutual-fund industry and regulators have yet to agree on new rules to prevent future abuses, companies say they have already atoned for wrongdoing by agreeing to pay more than $2 billion to investors in settlements with the Securities and Exchange Commission and other regulators. Plaintiffs' lawyers say that the companies haven't paid enough and that damages awarded in the lawsuits, however small, would serve as a deterrent.

Defendants, including Alliance Capital Holdings, Bank of America Corp. and Putnam Investments, are accused of pocketing billions of dollars in fees and trading profits from the schemes. One study, by a Stanford University business professor, pegged the cost to regular mutual-fund investors at more than $5 billion a year.

But out of the roughly 90 million individuals who own mutual funds, a single investor might have lost a fraction of a penny per share on any given day. The math makes potential payouts to investor plaintiffs seem "paltry," although "it's clear somebody is liable here," Booth said.

"Did Spitzer and the SEC trump up the issue? Absolutely, but there's no doubt that at its core, this was something that was undeniably wrong," said Don Phillips, a managing director at Morningstar Inc., an investment research firm. "A lot of people in the industry may downplay this, but ethically it was a very big deal."

The investor lawsuits have been consolidated in U.S. District Court in Baltimore; lawyers are set to begin arguing today over which ones should be thrown out and which should be allowed to advance to the next stage of interviewing witnesses and gathering documents in preparation for trial.

Lawyers call this the "gatekeeper stage," when a panel of three judges will decide the breadth and scope of the case. Eleven hours of argument have been scheduled for the two-day hearing to be held in a stadium-style courtroom.

The trading shenanigans surfaced when Spitzer took to the podium at a news conference in September 2003, a moment known in Wall Street lore as when the "canary sang." Spitzer announced that Canary Capital Partners, a hedge fund manager, had settled charges it engaged in unlawful trading with several mutual fund companies, including Janus Capital Group and Strong Capital Management. Within days, the scandal widened, and civil lawsuits were filed around the country.

The allegations were widely reported, but perhaps little understood. Mutual funds gave moneyed investors advantages when buying and selling their funds, which are pools of investments in stocks or bonds, at the expense of ordinary investors.

In general, the investors were allowed to manipulate the system of pricing mutual fund shares and to profit from day-to-day market swings, which at times were dramatic during the heydays of the late 1990s.

With the arrangements, mutual funds were able to boost their assets under management, and in turn the fees they charged. Brokers are accused of carrying out the illegal trading and arranging for hedge funds to get into the action.

Lawyers say the civil lawsuits seeking restitution for the unfair trading practices may be the first test of how securities laws are applied to mutual-fund companies; judicial rulings on those issues may be weeks away.

In the meantime, the case has expanded, drawing in more traders, brokers and others who allegedly had a role.

Plaintiffs also tried to subpoena the Investment Company Institute, a trade group that represents more than 8,500 mutual funds, for virtually every document in its files on market timing and late trading. But U.S. District Judge J. Frederick Motz blocked enforcement of the subpoena.

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