by John M. Curtis
(310) 204-8700

Copyright November 13, 2003
All Rights Reserved.

etting a bad case of reflux, Securities and Exchange Commission Enforcement Director Stephen Cutler lunged for the Prilosec, watching the $7-trillion mutual fund industry rocked by the latest scandal. After watching markets limp back after the worst meltdown since the great depression, Wall Street was slimed again, exposing fraud in the once sacrosanct world of mutual funds. Leery about directly playing the stock market, ordinary investors gain access to big time investing through mutual funds, enabling the risk-averse to capitalize on a good economy. Filing suit in district court on Oct. 28, New York Atty. Gen. Elliot Spitzer charged some of the nation's most prestigious mutual funds with fraud and improper trading. According to Spitzer, 25% of brokerage houses illegally trade funds after markets officially close, raking in clandestine profits at the expense of hapless investors.

      Brokers sell mutual funds as safe long-term investments, touting meticulous research that goes into picking fund portfolios. Counseling investors against timing the market, fund managers insist that they avoid arbitraging, the practice of day trading, buying on dips and selling on bounces. Yet, these same fund traders typically move in-and-out of massive blocks of shares, driving prices up or down, something gurus attribute to extraneous factors. Whether stocks rise or fall, experts anthropomorphize vacillations, which, in reality, are caused by fund-managers constantly moving shares. “As my colleagues and I have gathered evidence of one betrayal after another, the feeling I'm left with is one of outrage,” Cutler told a senate Committee flabbergasted by glaring improprieties. Cutler and Spitzer were especially sickened by shenanigans at Boston-based Putnam Investments.

      Under duress, Putnam's CEO Lawrence Lasser resigned in disgrace, after spending 33 years building Putnam into a mutual fund powerhouse. With over $272 billion in assets, Putnam was the fifth-largest mutual fund, before the ongoing exodus from large public and private pension plans, withdrawing $4.3 billion in the first week after Spitzer announced his indictment. Charging Putam with civil securities fraud, federal and Massachusetts prosecutors allege that Putnam let preferred clients and fund managers engage in market timing, a practice strictly prohibited in the industry—but not technically illegal. Short-term trading manipulates exchanges by driving share prices up or down, depending on whether fund mangers buy or sell. As Spitzer found out, brokerage houses rake in big commissions, much the same way they profit when they take companies public.

      Settling quickly with the SEC Nov. 13, Putam tried an end-run around Massachusetts and New York regulators, now forced to deal with new corrective action. Stipulating to corrective action but not admitting wrongdoing, Putnam tried some fancy footwork, giving investors the impression problems have been resolved. Putnam agreed to pay some token penalties and restitution, but damages remained unspecified. Recent abuses at some of the nation's elite funds have shaken investor confidence, leaving investors dubious of the entire industry. Allowing certain privileged investors and fund managers “day-trade” unfairly left lowly investors with greater expenses and lowered values. Jumping the gun, the SEC's hasty settlement satisfies management's need to stem the damage and get back to business. Rushed settlements help the corporate elite but not small investors.

      Regulatory agencies like the SEC must do more than slap multibillion-dollar companies on the wrist. It's unrealistic to talk about penalties and restitution before investigators understand the extent of the abuses and fraud. “You don't expose wrongdoing by rushing into settlements before you know the extent of the abuses,” said William Galvin, Massachusetts secretary of the commonwealth and the state's top securities cop, blasting the SEC for cutting Putnam a sweetheart deal. Getting Putnam to stipulate to a remedy without admitting wrongdoing sends the wrong message to an industry unable police itself. Calling the SEC's ruling “groundbreaking reforms,” Putnam CEO Charles E. Haldeman insisted the changes would make Putnam “a standard-bearer for professional and ethical conduct in our industry,” failing to admit catastrophic damage to his company's reputation.

      Restoring investor confidence and the integrity of markets should be the highest priority to the SEC. In the wake of the latest scandal, regulatory bodies must do much more than cut sweetheart deals and slap multibillion-dollar companies on the wrist. Putnam's sudden enthusiasm stems not from the SEC's tough enforcement but from getting away with the most egregious abuse of the public's trust since Arthur Andersen, the nation's fifth largest accounting firm, was forced to close its doors because of the Enron mess. As long as CEOs avoid criminal prosecution and companies pay token fines, corporations won't clean up their acts. “Each fund company has to get its own house in order,” said Alan Lieberman, a securities lawyer, frequently defending corporations from SEC investigations. With platitudes like that, it's no wonder high profile scandals cause little real change.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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