By DAVID MOON, Moon Capital
September 14, 2003
Maybe we're scandal weary. If you see enough litter on the highway,
eventually it becomes part of the landscape.
Someone dumped a bunch more garbage on the street this week - Wall Street -
and hardly anyone noticed. And it was some pretty filthy garbage.
New York Attorney General Elliot Spitzer made headlines again when his office
forced a hedge fund to pay a $40 million fine for inappropriate trading in
several mutual funds. No mutual fund companies were charged with wrongdoing.
Just wait. The smelly stuff has not yet hit the fan.
These fund companies entered into agreements with a hedge fund to allow
trades that were clearly detrimental to the other shareholders. The mutual fund
companies involved are big names. Janus, Strong, Bank of America and Bank
One. The hedge fund was allowed to trade mutual fund shares long after the
4:00 PM market close, allowing the hedge fund to take advantage of after-market
news about stocks in the funds' portfolios. These mutual funds also allowed the
hedge fund manager to do daily market timing trades, in explicit contradiction
to the funds prospectuses - the agreement between the mutual funds and
shareholders. Every dollar of profit the hedge fund made from these trading
strategies came directly from the pockets of the other mutual fund shareholders.
In exchange for letting the hedge fund take money from the pockets of the
unsuspecting shareholders, the hedge fund agreed to invest tens of millions of
dollars in other funds managed by Janus, Strong, Bank of America and Bank
The SEC is now questioning more than 80 fund companies about such
Although the mutual fund companies haven't been charged with any wrongdoing,
they appear concerned about the issue. Janus and Bank of America have already
promised to make restitution to their shareholders, once they figure out how to
determine how much their shareholders lost.
"Whoops. You caught us. We won't do it again. Here is some money to make it
According to Elliot Spitzer, the fund companies' actions were not the result
of a few low level, rogue employees. The executives of these companies knew of
the arrangements. In some cases, the top executives approved of the
arrangements, over the objection of lower level employees.
With a couple of exceptions in the 1960s, the mutual fund industry has
managed to avoid any significant scandal. Like all of the financial industry,
mutual funds are based on trust. But unlike much of the financial industry, a
mutual fund shareholder has to trust someone he never sees or knows. There are a
lot of risks you must evaluate before you stick that check in the mail to your
mutual fund company or make a change in your 401(k) plan. You have to
decide to put money into the market. Then you have to decide what segment of the
market you want to buy. Small cap? Large cap growth? International? How about
And now, it seems, you have to try and determine if the fund company is going
to try and cheat you.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).