Mutual Funds

Mutual Funds Launch Damage Control

In a swift effort to reassure and retain investors, three firms under investigation for improper trading have announced plans to reimburse shareholders.

By Erin Burt, Contributing Editor, Kiplinger.com

September 10, 2003

Three of the four mutual fund companies ensnared by allegations of unfair trading practices are telling shareholders that they are conducting their own investigations and offering reimbursements.

The moves by Bank of America, Janus Capital and Bank One are seen as an attempt to keep fund investors from jumping ship.

Largely viewed as squeaky-clean investments, investor confidence in the mutual fund industry took a hit Wednesday when New York Attorney General Eliot Spitzer accused BofA, Janus, Strong and Bank One of illegal trading arrangements with hedge fund Canary Capital Partners. Spitzer alleges that the hanky panky cost investors millions of dollars over four years.

In exchange for large deposits in money market and bond funds, the fund companies allegedly told Canary exactly what stocks they owned on a daily basis -- information that individual investors and fund trackers like Morningstar have long been denied.

It is believed that Canary would then buy the fund and simultaneously sell short a basket of stocks that mirrored the fund's holdings. Selling short is a way of betting that the stocks will decline. When companies released earnings reports after the market's close -- reports that would move their stock prices the next morning -- Canary would be able to lock in trading profits by selling the fund or closing out its short positions.

Canary was also allowed to buy the funds after their 4 p.m. close, taking advantage of after-hour announcements that could have moved share prices.

"In essence," Spitzer's complaint says, "the late trader is being allowed into the fund after it is closed for the day to participate in a profit that would otherwise have gone completely to the fund's buy-and-hold investors."

The fund companies say they did nothing wrong and are cooperating fully with the investigation.

Accusations and assurance

Bank of America, which owns the Nations funds, and Janus are hiring independent firms to evaluate if there were any financial repercussions to the allegations, and promise to make "appropriate restitution." They also vow to return management and advisory fees received for any market-timing activities.

Bank One announced Wednesday it is launching its own investigation, will make restitution with affected shareholders and will discipline employees for involvment in any misdeeds. BofA officials said Monday that it will also take steps to punish staff members who may have been involved, even if that means firing them.

None of the firms have yet determined whether reimbursement would go directly to individual investors or to the assets of the affected funds.

Starting in 2001, the Bank of America set Canary up with a state-of-the-art computer system to allow the hedge fund to trade after hours without going through typical investment channels, Spitzer's complaint alleges. The system allowed Canary to trade late in the hundreds of mutual funds that the bank offers to its customers, the complaint says. Also, the document states, Bank of America

• Gave Canary permission to time the Nations Funds.
• Provided Canary with approximately $300 million of credit to finance this late trading and timing.
• Sold Canary the derivative short positions it needed to time the funds as the market dropped.

None of these facts were disclosed in the Nations Funds prospectuses.

"The board of trustees of the Nations Funds has always taken its fiduciary obligations to its shareholders as the fundamental and guiding principle of all our activities," the BofA statement says.

"We're trying to do the right thing," says spokesman Bob Stickler.

Janus CEO Mark Whiston said in a company statement released Friday that the company's "management team holds itself accountable and we're working hard to retain the trust and confidence of our investors and business partners."

"We hope this action demonstrates that Janus is committed to living up to the high ethical standards that our shareholders expect of us," Whiston said Friday.

Canary allegedly timed the Janus Mercury and Janus High Yield funds during 2002 and 2003.

Investor reaction

The promises of restitution and investigations have not been enough to stop shareholders from seeking legal advice. Lawsuits have already been filed against Janus and Strong.

Attempts to contact Strong were unsuccessful. But in a statement, Dick strong says Spitzer's allegations "came as a surprise and caused understandable concern to us." He does not mention anything about financial restitution to shareholders.

Investors are obviously also concerned about the allegations. Janus reported increased call volume at their customer service centers, while Bank of America and Bank One said they have seen little change.

"Shareholders have called in and asked about it," Bank One spokesman Thomas Kelly said. "We have told them that we are cooperating fully and are looking into it, and they seem satisfied with that answer."

According to Spitzer, Bank One allowed Canary to time two international funds, a small cap growth fund, and two mid-cap funds for close to a year.

"Nothing is more important to us than maintaining the highest ethical standards," said chairman Jamie Dimon. "I promise we will do the right thing in this situation."

Wall Street seems to have taken the most interest in Janus. The stock lost 13% in two days following Spitzer's report. Bank of America lost 3% and Bank One's price dropped only 2%.

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