Fund Cop

Jerry Wade is fed up with mutual funds. He’s become so leery of the scandal-ridden fund industry that he recently launched a Web site, www.fundpolice.com, to give investors a heads-up on which mutual funds have been “busted” or are being investigated by regulators. He’s now urging his clients to invest in ETFs and folios instead of mutual funds.

Wade, president of Wade Financial Group in Minneapolis (he also likes to be called the commissioner of Fundpolice.com), says investors are clueless “as to the ongoing conflicts of interest in the fund business, and are almost completely unaware of alternatives, such as ETFs and ‘stock basket’ trading,” also known as folios. He recently created a batch of folios available at www.wadefolios.com. “ETFs are a fantastic investment that investors haven’t really heard about,” he says. Wade’s firm has created 15 different folios, some comprising ETFs, others individual securities.

After New York Attorney General Eliot Spitzer exposed the after-hours trading activities of some funds last fall, Wade and his colleagues started keeping track of wrongdoers by clipping newspaper and magazine articles, Morningstar e-mail alerts, and by printing information found on the SEC’s and Spitzer’s Web sites. “We were tracking the problems for our clients, so that we knew which funds were doing the shenanigans and we could keep our clients’ money out of them,” Wade says. Soon, Wade was knee-deep in clippings on more than 90 financial institutions. So he hired a Web firm to design Fundpolice.com and appointed an in-house staffer to run it. “The heart and soul” of the site is its “Who’s Busted” database, Wade says. Updated weekly, it provides information on fund companies “that have gotten into trouble or have settled with the SEC.”

The database has three categories: Red light funds that investors should “steer clear” of, yellow light funds that require investors to use caution when considering them as an investment, and green light funds that have won Wade’s seal of approval. Don’t confuse Fundpolice.com with another popular Web site, FundAlarm.com, which tells investors to avoid what it calls “three-alarm” funds that have bad performance. Fundpolice doesn’t “pontificate about performance,” Wade says. “We tell people about funds that have been screwing them, so they can move their money out.”

The Fundpolice.com home page shouts: “Wake up America. Your financial future is at stake. You need to care.” Wade says he created Fundpolice.com for investors, but it’s also a great educational tool for advisors. They can log on to the site while meeting with a client, he says, to see whether any of the client’s mutual funds have been reined in by the SEC.

Fundpolice.com also exposes shenanigans in the 401(k), insurance, and annuity industries, and educates investors on what Wade says are the 12 sins of mutual funds. These include undisclosed brokerage costs, soft dollars, directed brokerage, and shelf space payments. The SEC in August banned directed brokerage, a quid pro quo arrangement under which brokerage firms received extra dough for selling certain funds. But Wade, like other advisors and analysts, believes the SEC’s ban won’t end the practice. “Most mutual funds will pass along the expense [of distributing their funds] to the investor in some buried form that will be lost in the prospectus,” Wade says.

Matthew Beinfang, a senior analyst at TowerGroup’s retail brokerage and investing unit, agrees that investors will get stuck with the bill now that directed brokerage has been outlawed. “In whatever new form or shape directed brokerage takes, if 100% of the cost is not borne by the fund companies, TowerGroup predicts that the $475 million that was spent each year on directed brokerage could be cut by as much as 50%,” Beinfang says in a recent report. Beingfang says that with fund companies’ margins being squeezed and pricing pressure increasing, directed brokerage payments will likely become “marketing assistance” payments or “training reimbursements.”

Most brokerage firms used the money they received from directed brokerage arrangements to pay for research. Beinfang predicts the new rule will have little effect on larger brokerage firms, since they have “robust research and capital markets capabilities.” The rule may actually have a positive effect on wirehouses, he says. “Orders once handled on a ‘step out’ basis, where the brokerage gave credit for the trade and a portion of the commission to another firm, may still be executed through the wirehouse as a normal course of business, with the credit for the trade remaining with the executing broker,” Beinfang says. “Even though these trades are likely to be executed at a lower-commission level, high-margin operators will be able to absorb the loss of revenue from directed brokerage more readily, offsetting that loss with the added trading volume.”