Fund settlements are minuscule for investors

Your Funds

Your Money

September 04, 2005|By CHARLES JAFFE

AS THE SECOND anniversary of the start of the mutual fund scandal rolled around last week, investors were not celebrating.

They can't afford to, at least not from the settlement monies that regulators have extracted from the wrongdoers.

The combined fines and restitution paid by management firms settling charges of allowing favored investors to get special treatment have run into the hundreds of millions of dollars. But the few payout plans that have been approved make it clear that fund firms won't be doing much more than buying shareholders a drink for their troubles.

At this point, it's a safe bet that on every anniversary of the scandal - three years, five years, a decade - the common thread will be investor frustration.

"Investors need to move on," says Geoff Bobroff, an industry consultant from East Greenwich, R.I. "If they still believe there is some big payday coming, they're fooling themselves."

To see why, let's revisit history and review some current events.

On Sept. 3, 2003, New York Attorney General Eliot Spitzer brought charges against several fund firms for allowing favored customers to have trading privileges that ordinary shareholders didn't get.

Within months, the investigations had spread, and the Securities and Exchange Commission was acknowledging a widespread problem with rapid trading, where firms went against their own rules that limited quick turnarounds by customers, allowing a few customers to make countless trades, passing the cost of that activity on to everyone else.

In February 2004, SEC officials testified that they had found problems in half of the companies they had surveyed. At that point, 80 companies had been surveyed, which meant that investigators had issues with more than three dozen firms.

Thus far, less than two-thirds of those firms have faced charges. The big names like Putnam, Strong, Janus, MFS, Alliance Capital and others pretty much raced to settle cases against them.

Most settlements required the bad guys to cough up some cash to repay shareholders for what they lost due to rapid trading.

Here's where things get tricky.

Every fund group making restitution establishes a holding account for the money, then submits a distribution plan for that cash to a special consultant. The SEC must approve the plan before shareholders get a dime. (If you are interested in seeing the status of SEC cases, or want to know if a firm has established a set-aside, check out www.sec.gov/divisions/enforce/claims.htm.

It's not speedy. While regulators quickly set the fine amounts - although they left the door open in some cases, on the chance they had not demanded sufficient dollars - they have been slow to use the same math to figure out what people are owed.

In the few cases where a payout plan has been approved - Putnam, MFS and, most recently, Morgan Stanley for a case that focused on conflicts of interest during the sales process rather than rapid trading - the distributions are tiny.

In the Morgan Stanley case, restitution came to $7.50 per account in most cases. An account with a half million dollars in the affected funds could wind up with about $400.

In the Putnam case, John Hill, chairman of the trustees for Putnam Investments, has said on several occasions that average investors will be getting just pennies in the settlement, and that the money will go back into the fund rather than coming in a check.

The small settlements accurately reflect just how little damage the scandals actually caused shareholders, but many investors were hoping for a lot more, if only because they felt abused by their mutual funds during the bear market.

The trouble is that the two situations were not connected; rapid trading added to the transaction costs for funds where it was allowed, but it did not cause the massive share price implosion that occurred when the Internet bubble burst.

Investors hoping for a bigger payback - or for bear-market retribution - have pinned their hopes on civil litigation, jumping into cases against the firms that got caught up in the trading scandals.

Fund firms have argued that they should not have to pay shareholders twice. Their lawyers argue that if the firm pays fines and restitution to regulators - and the regulators distribute that payout appropriately to shareholders - investors should not be able to double dip and get back more than their actual losses.

Most observers think that argument will work, taking most of the action out of the class action cases.

"While this whole thing is being settled, investors are standing in the corner with their pockets inside out," says Richard Booth, a University of Maryland law professor who has been watching the mutual fund legal proceedings. "Individual investors didn't lose a lot of money in this thing, but that doesn't make it easier to say, `I got cheated here, I have nothing to show for it and now I'm just supposed to move on.' "

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

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