Trust vital to mutual fund industry

By DAVID MOON, Moon Capital Management, LLC
June 21, 2009


The Investment Company Institute estimates that 92 million individuals owned mutual funds in 2008, representing 45 percent of all U.S. households. That compares to less than 6 percent in 1980. The median size account was more than $100,000.

Much of the success of this industry is the result of trust. Investors send their money to companies about which they know little or nothing, who hire managers the investors have never met, who buy assets about which the investors are only told a few times a year – and well after the fact. The investor receives a monthly statement telling him that his proportionate ownership in all of the stocks or bonds owned by the fund is worth a certain amount.

Without trust, this industry wouldn’t work. Fortunately, the trust has existed and has, for the most part, been appropriately placed.

A recent case involving a well-known fund company bothers me, however. If it’s an isolated incident, it’s a terrible situation. If, instead, there are more situations like this, we could be looking at a self-inflicted wound on an entire industry

In 2007 and 2008, Evergreen Investment Management was a unit of Wachovia Corp, which have both since been purchased by Wells Fargo.

During those years, the Evergreen Ultra Short Opportunities Fund was one of the top performing mortgage-backed securities mutual funds.

The only problem, regulators say, is that Evergreen fabricated the prices of some of the assets it held in the fund. It made them up.

It made them up so badly that if it had priced the securities properly, the fund would have been near the bottom of the performers in its category.

The Evergreen Ultra Short Opportunities Fund was valuing one of the securities in the fund at nearly full value, even though a different Evergreen fund had just purchased a similar security at about 10 cents on the dollar.

To compound its sins, the SEC accused Evergreen of providing advanced notice to only some investors, including clients at its Wachovia Securities affiliate, that it was about to revalue these assets, allowing the favored clients to liquidate their holding prior to a drop in the fund’s share price.

Not a good thing for building trust, especially if you weren’t a favored client.

Evergreen and Wells Fargo agreed to pay $40 million to settle the matter, without either admitting or denying wrongdoing in the settlement.

Do big firms ever admit or deny wrongdoing when they settle these cases?

Many of the regulatory cases against mutual fund companies involve esoteric issues, such as language in the prospectus and other disclosures. These violations of trust are just as important as any other, but because they are much more difficult to understand, aren’t likely to prompt investor anger.

Perhaps this Evergreen case will fall into that category. For the sake of the entire industry, I hope so.

For the sake of Evergreen and its employees who cheated their shareholders, I hope not.

That is, allegedly cheated its shareholders. I almost forget; the company neither admitted nor denied the allegation.


David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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