Add this to your Capitalist Corruption file:

Chris Brady cdbrady at sbcglobal.net
Wed Nov 19 00:12:36 MST 2003


The mutual fund story is “the worst scandal we’ve seen in 50 years” —not
excluding Enron and WorldCom.


Funds and Games

By PAUL KRUGMAN
New York Times, November 18, 2003
http://www.nytimes.com/2003/11/18/opinion/18KRUG.html?th

You’re selling your house, and your real estate agent claims that he’s
representing your interests. But he sells the property at less than fair
value to a friend, who resells it at a substantial profit, on which the
agent receives a kickback. You complain to the county attorney. But he
gets big campaign contributions from the agent, so he pays no attention.

That, in essence, is the story of the growing mutual fund scandal. On
any given day, the losses to each individual investor were small — which
is why the scandal took so long to become visible. But if you steal a
little bit of money every day from 95 million investors, the sums add
up. Arthur Levitt, the former Securities and Exchange Commission
chairman, calls the mutual fund story “the worst scandal we’ve seen in
50 years” — and no, he’s not excluding Enron and WorldCom. Meanwhile,
federal regulators, having allowed the scandal to fester, are doing
their best to let the villains get off lightly.

Unlike the cheating real estate agent, mutual funds can’t set prices
arbitrarily. Once a day, just after U.S. markets close, they must set
the prices of their shares based on the market prices of the stocks they
own. But this, it turns out, still leaves plenty of room for cheating.

One method is the illegal practice of late trading: managers let favored
clients buy shares after hours. The trick is that on some days,
late-breaking news clearly points to higher share prices tomorrow.
Someone who is allowed to buy on that news, at prices set earlier in the
day, is pretty much assured of a profit. This profit comes at the
expense of ordinary investors, who have in effect had part of their
assets sold off at bargain prices.

Another practice takes advantage of “stale prices” on foreign stocks.
Suppose that a mutual fund owns Japanese stocks. When it values its own
shares at 4 p.m., it uses the closing prices from Tokyo, 14 hours
earlier. Yet a lot may have happened since then. If the news is
favorable for Japanese stocks, a mutual fund that holds a lot of those
stocks will be underpriced, offering a quick profit opportunity for
someone who buys shares in the fund today and unloads those shares
tomorrow. This isn’t illegal, but a mutual fund that cared about
protecting its investors would have rules against such rapid-fire deals.
Indeed, many funds do have such rules — but they have been enforced only
for the little people.

In some cases fund managers traded for their own personal gain. In other
cases hedge funds, which represent small numbers of wealthy investors,
were allowed to enrich themselves. In return, it seems, they found ways
to reward the managers. You make us rich, we’ll make you rich, and the
middle-class investors who trusted us with their money will never know
what happened.

And there’s probably more. During last year’s corporate scandals, each
major company that came under the spotlight turned out to have engaged
in some original scams. By analogy, it’s a good guess that the mutual
fund industry was cheating its clients in other ways that haven’t yet
come to light. Stay tuned.

Oh, and about that corrupt county attorney: last year it seemed, for a
while, that corporate scandals — and the obvious efforts by the
administration and some members of Congress to head off any close
scrutiny of executive evildoers — would become a major political issue.
But the threat was deftly parried: a few perp walks created the
appearance of reform, a new S.E.C. chairman replaced the lamentable
Harvey Pitt, and then we were in effect told to stop worrying about
corporate malfeasance and focus on the imminent threat from Saddam’s
W.M.D.

Now history is repeating itself. The S.E.C. ignored warnings about
mutual fund abuses, and had to be forced into action by Eliot Spitzer,
the New York attorney general. Having finally brought a fraud suit
against Putnam Investments, the S.E.C. was in a position to set a
standard for future prosecutions; sure enough, it quickly settled on
terms that amount to a gentle slap on the wrist. William Galvin,
secretary of the commonwealth of Massachusetts — who is investigating
Putnam, which is based in Boston — summed it up: “They’re not interested
in exposing wrongdoing; they’re interested in giving comfort to the
industry.”

I wonder what they’ll use to distract us this time?





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