Outrage only building in mutual fund scandal

Posted: Friday, November 07, 2003

NEW YORK (AP) It was bad enough that mutual funds, the good guys of the investment world, got dragged into trading shenanigans. It's an absolute outrage that so many people knew about it and did nothing.

That's right, about 10 percent of mutual fund employees supposedly knew their customers were illegally trading.

That's right, some 30,000 letters were allegedly sent to Prudential Securities about its brokers' bad behavior.

That's right, the Securities and Exchange Commission got tipped off but took no action.

This scandal was so rampant and so widespread that it touched almost every corner of the business. But no one seemed to care.

Allegations of unfair practices and profiteering haven't stopped since New York Attorney General Eliot Spitzer announced his initial investigation in late summer. Now dozens of fund companies and brokerage firms are tangled in this mess, which has left a big stain on the whole industry.

But the wrongdoing taking place at these firms has been long in the making.

As Spitzer told Congress this week, the problems in the mutual fund industry are so pervasive that it is more than a matter of excising a few ''bad apples'' from the industry.

''It's beginning to appear that the entire crate is rotten,'' he said. ''The problems are structural, they are systemic.''

Preliminary data in a survey released this week by the SEC suggests that employees at about 10 percent of the fund companies knew some customers were violating the rules against ''late trading'' an illegal practice of accepting buy and sell orders at the 4 p.m. price well after the market closes.

Half of the 88 largest mutual funds surveyed had arrangements that allowed select customers to use ''market timing,'' which is short-term, ''in and out'' trading of funds that are intended to be longer-term investments. While market timing is largely legal, many funds prohibit it.

The SEC also examined records at 34 brokerage firms and found that almost 30 percent had assisted clients in performing market-timing trades and almost 70 percent were aware of customers who had tried to do it.

So hundreds, possibly even thousands of fund-company and brokerage employees knew about all this, yet most didn't come forward to put a stop to it.

Some say it simply has to do with greed.

''It's an attitude among employees. They think if the results are good, it doesn't matter how you got there,'' said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. ''For this and the other corporate scandals to continue on, it took a lot of people at the lower levels to say nothing about the wrongdoing.''

And those that did speak up often weren't heard.

Authorities allege that Prudential Securities received as many as 30,000 warning letters from at least 68 mutual-fund companies trying to halt rampant market timing in their funds, but no appropriate action was taken.

According to recent news reports, an employee of big fund company Putnam Investments who was seeking to expose abuses at the firm was brushed off by attorneys in the Boston SEC office earlier this year. He had to go to Massachusetts securities regulators to be listened to.

On Monday, Juan Marcelino, the head of the SEC's Boston office, announced he was leaving ''to minimize any further distractions for his staff.''

''These were practices that so many people knew about, but where was the SEC?'' asked Steve Thel, professor of securities law at Fordham University and former SEC lawyer. ''Why wasn't anyone's antenna up?''

Investors can thank attorneys general in New York and Massachusetts for doing what so many others didn't, or wouldn't: They took tips from whistleblowers seriously and dug into all the questionable trading.

Without them, this would have continued to be a big secret one that lots of people shared but no one did anything about.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org

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