Experts prescribe treatments to reverse the wearing effects of scandal
By Jim Connolly
The steady stream of mutual fund scandals in the last few months has taken a heavy toll on the confidence of investors and the advisors who guide them, not to mention the pressure on those funds that have been caught up in the swirl of unwelcome publicity. And if at times it seems like there is no end in sight, corrective actions are under way and more are being prescribed.
“The list gets longer each month,” says Robert Pozen, chairman of Massachusetts Financial Services Investment Services, the Boston unit of Sun Life Financial, Toronto. “I think this will run until the end of next year.”
MFS itself settled market timing charges and charges of using brokerage commissions to pay for marketing and distribution of mutual funds with the Securities and Exchange Commission and state regulators without admitting or denying wrongdoing.
Customers did walk when the scope of problems became apparent, he says. In the case of MFS, there was a net $1 billion outflow between Oct. 1, 2003 and April 1, 2004, although the trend reversed a bit in first quarter, he says.
Outflows were not limited to MFS. Filings with the SEC indicate that other mutual fund complexes with well-publicized problems such as Putnam Investments, a Boston-based unit of Marsh & McLennan; and Janus Capital Group, Denver, also experienced outflows. In Putnams case, assets under management declined $14 billion from first to second quarter 2004, while Janus suffered a decline of $9.6 billion during the same time frame.
Among the steps that Pozen says MFS is taking to rectify past practices is paying an extra $20 million to $30 million in hard money rather than paying soft dollars for brokerage commissions. Those commissions had been used to acquire third-party research and market data services and to recognize fund sales. (See sidebar.)
Pozen says it is critical to resolve questions about the companys practices and move on. It is better to come clean through disclosure and action to resolve questions about the companys practices, he adds.
One effect of these scandals on the industry, according to Pozen, will be consolidation of funds. The industry, he predicts, will look like a barbell with niche players and large players. Middle tier players will be squeezed out because of the costs associated with complying with regulation, including the technology needed to comply with regulation, he explains.
“It is only something that time and good behavior will heal,” says Thomas Lauerman, a partner with Foley & Lardners Washington office, of the effects of the scandals. The proposals put forth by the SEC will help achieve that healing, he continues.
Mutual fund companies need to be more proactive in prohibiting market timing and in refining fair value pricing procedures that ensure that funds fairly value their portfolio of securities, he says.
Lauerman says he believes that with improved technology, valuing fund portfolios will continue to become more sophisticated.
Barbara Roper, director of investor protection with the Consumer Federation of America, Washington, says that from a regulatory point of view, “a lot of what needs to be done has been done. The SEC has undertaken a pretty broad reform agenda in key areas.” Those areas include corporate governance, she continues.
What still needs to be done, according to Roper, is to “look beyond the scandals to other troubling sales abuse areas.” Among these, she says, are directed brokerage and revenue sharing payments and clarification of 12B-1 fees to make sure it is understood that payment of brokerage fees are among their uses.
The one area in which Roper says she is disappointed is the disclosure of costs in mutual funds. “There needs to be a pre-sale disclosure of costs,” she says. It should be made at the point that a recommendation is offered, Roper maintains.
There is a concern that financial incentives could be sought from mutual fund companies for shelf space, she says, which would create reverse competition.
Mutual fund families that want to restore investor confidence need to act in an investor-friendly fashion, says Roper, who adds that many companies are already doing this.
The recent problems that have surfaced are a wake-up call for the mutual fund industry, Roper says. “The fund industry has traditionally had a good reputation and I think many in the industry deeply regret these problems. Mutual funds continue to be the best way for many consumers to participate in the markets,” she adds.
Geoff Bobroff, a mutual fund expert with Bobroff Consulting, East Greenwich, R.I., says that “from a business standpoint, the industry is obviously dealing with multiple storms.” These include: performance demands, market timing issues and wholesale practices, he explains.
Regulatory changes are better than changes legislated by Congress because they can be revisited more easily if the need arises in the future, according to Bobroff.
In addition to maintaining investor confidence, he says the mutual fund industry faces changes to its business that include movement of investor money into a small number of funds that have the confidence of investors and that have not been affected by publicity over problems or scandals.
It also means adjusting to an environment in which brokers are more inclined to pull the trigger and scuttle funds that do not perform, Bobroff adds.
In spite of publicized problems, Bobroff remains confident in the continued viability of the industry.
“An $8 trillion industry is not going away,” he says. “Baby boomers are still embracing the product.”
Reproduced from National Underwriter Edition, July 22, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.