Fiddles from the mutuals

By Neville Bennett

Friday 19th September 2003

American mutual funds have been ripping off investors with undeclared charges. There is ample evidence too, in churning, that many managers run their funds in ways that maximise their income.

Subsequently another scandal has broken, which is undoubtedly the greatest in the history of the mutual fund industry. It provides new evidence that the culture in the industry needs remedial behaviour modification. Managers ignore clear rules when profitable opportunities arise.

The core of the latest scandal is the Canary Capital Partners, a hedge fund, which was permitted by Janus Funds to trade its shares after the closing bell, and when it knew by international activity that the fund was a "buy" or "sell."

This practice is called "market timing" or "international fund arbitrage." Here is how it works. A fund announces its price at 4 o'clock in New York. Before the next morning, there are trades in international markets, and "timers' are permitted to buy into the fund the next morning at the previous day's price.

It is money for jam. Managers do not always mind it because they get activity fees and greater turnover.

Janus admits to "discretionary market timing arrangements," and promises to reimburse shareholders for the losses they have incurred. The market has punished Janus' parent very severely in a price fall. Canary has offered a pre-emptive settlement of $US40 million.

The scandal came into the open on the initiative of Eliot Spitzer, New York attorney-general, who has also named the Bank of America and Bank One as being involved in timing.

The newspapers are having a field day. Reporters have contacted the biggest funds and asked if they permit market timing. A list of important funds have failed to return the calls of CBS includes American Express, Evergreen, Dreyfus, Oppenheimer, Pimco, and Smith Barney.

Mr Spitzer said Bank of America provided Canary with a computer setup that allowed the firm to trade shares after hours. Allegedly, "late trading" and "market timing" cost other fund holders millions.

Mr Spitzer also accused Canary of having a deal with the Security Trust Co. Security has access to 5200 funds including the biggest of all Fidelity, Vanguard, Pimco, Franklin etc. Mr Spitzer alleged Canary was able to conduct after-hours trading in these funds, likely without the fund's knowledge.

Another allegation is that funds provided an up-to-the-minute record of their portfolio to hedge funds.

Investors get told very infrequently what they have shares in. Hedge funds know immediately and this improves their trading opportunities.

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