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Published: Thursday, 11/13/2003

Mutual corruption

Now that abuse by mutual fund managers has emerged as the business community s scandal du jour, the average investor has to be wondering whether a safe financial harbor truly exists for the “little guy.”

This is a question of widespread interest since half of all American households now hold a piece of the $7.1 trillion mutual fund treasure trove.

Mutual funds have become the investment vehicle of choice for the average person saving for retirement and other purposes. Through 401(k) and similar accounts, they buy shares in these huge portfolios of stocks, bonds, and cash, which are supposed to be overseen by a management firm acting in their best financial interests.

Reassured by the admonition to invest for the long run, most people continue their 401(k) contributions even as the markets rise and fall.

But, as state and federal regulators have discovered, the reliable tendency of millions of investors to continue pouring their investments into mutual funds in good times and bad has produced a cornucopia of money vulnerable to several types of abuse.

One is excessive fees charged by some funds. Sen. Peter Fitzgerald, Republican of Illinois, calls mutual funds “the world s largest skimming operation.” The industry, Senator Fitzgerald said, fails to negotiate lower trading fees for its customers, leaving a “$7 trillion trough from which fund managers, brokers, and other insiders are steadily siphoning off an excessive slice of the nation s household, college, and retirement savings.”

The theory among mutual fund pirates seems to be that the fees are collected in such small increments per investor that no one will notice that robbery is taking place on an enormous scale.

Other abuses are less straightforward but no less pernicious.

Late trading, in which investors are allowed to illegally buy or sell shares after the daily market close, amounts to betting on a horse after the race is over.

Market timing is a legal scam in which investors take advantage of the time differential between U.S. and international markets to reap quick profits.

Both schemes, which experts say have become widespread in the industry, result in increased fees for managers but quickly soak up gains by a mutual fund s long-term investors.

Fortunately, such abuses are now being corralled and prosecuted by the federal Securities and Exchange Commission and a few state regulators, notably Eliot Spitzer, New York s attorney general.

Directors of mutual funds are supposed to protect their shareholder s interests, Mr. Spitzer told Congress, but too often officers of mutual funds also hold conflicting positions as fund investment advisers.

As a result, Mr. Spitzer said, mutual fund assets grew by 60 times from 1980 to 2000 while fees and expenses grew by an unconscionable 90 times.

Tapping the nation s nest egg, either illegally or by stealth, appears to be a growth industry. This insidious development must be met with aggressive enforcement of state and federal fraud statutes, plus new measures if necessary to thwart those who would steal the hard-earned savings of a generation.



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