Price tag on Strong trading awaited

Accountants’ analysis on costs of market timing might come in January

By PAUL GORES pgores@journalsentinel.com, Journal Sentinel

Tuesday, December 30, 2003

An analysis of how much market-timed trading might have cost long- term investors in Strong mutual funds probably will be completed sometime in January, a source familiar with the process said.

Accountants for Strong Financial Corp., the Menomonee Falls company that oversees management of the funds, continue trying to assess any losses that might have resulted from timed trades the firm is accused of allowing a New Jersey hedge fund to make.

At the same time, accountants hired by the independent board of Strong mutual funds still are analyzing the effects of transactions made by former Chairman Richard S. Strong. The board’s accountants also have been checking whether any other transactions by employees might have raised concern.

The accountants are attempting to determine the most accurate way to calculate any harm done to investors by the frowned-upon-but- legal practice, the source said.

About two weeks ago, the Denver-based Janus funds became the first company to put a number on losses its investors sustained because of market timing — a trading maneuver in which certain clients were able to take advantage of differences between the share price of the funds and the actual value of the securities in those funds.

Market timing, which involves quick trades, is considered potentially harmful to the interests of long-term investors, which is what most mutual fund shareholders are.

The independent board of Janus said the price tag for market timing by 10 investors in its funds was $31.5 million — an amount the board pledged would be repaid to its customers. The figure, which was calculated by the accounting firm Ernst & Young, included nearly $23 million in net gains realized by market-timers.

Janus is much bigger than Strong, with assets of $147.5 billion as of Nov. 30. Strong had assets of $40.1 billion at the end of November.

Janus, a publicly traded company, hurried to come up with a grand total because it had pressure not only from people who invest in its funds but from those who are shareholders in the company itself, said Paul Herbert, a fund analyst from Morningstar Inc. in Chicago.

“As far as I know, Strong has no such deadline to meet,” Herbert said.

Nonetheless, the Strong leaders are concerned about net outflows of money from Strong funds in light of the allegations of improper trading by New York Attorney General Eliot Spitzer. Since Sept. 3, when Spitzer first named Strong among mutual fund firms that might have allowed improper trades by the Secaucus, N.J., hedge fund Canary Capital Partners, Strong has had net outflows of about $3 billion.

Spitzer has not filed civil or criminal charges against Strong.

Richard Strong, who has admitted making “a small number” of next- day transactions in his company’s funds over the years, has pledged to personally compensate the funds for any financial losses resulting from those transactions. But he also has said he does not believe the trades were “disruptive” to the funds.

Strong spokeswoman Stephanie Truog said the company “has committed to make the appropriate reimbursement if it is determined that the Canary transactions adversely affected investors” in the funds mentioned by Spitzer in his complaint.

Joseph L. Kociubes, a partner in the Boston law firm Bingham McCutcheon, which is representing the Strong funds’ independent board of directors, said the board also has promised that investors will be paid back any money lost in market-timing transactions.

“Their intent is one way or the other to make sure no shareholder sustains a loss as a result of this, and everybody is made whole,” Kociubes said.

On Dec. 19, Strong Financial said it would adopt three policies for its mutual funds, including a 2% fee that would be imposed for most shares sold within 30 days of purchase. The moves are intended to stop frequent trading and market timing.

The new policies were recommended by David S. Ruder, a former Securities and Exchange Commission chairman who was hired in October by Strong to review procedures. Under the new policies:

— Shares bought and then sold less than 30 days later would be subject to a 2% redemption fee. People who trade so quickly more than once would be banned for at least two years from investing in any Strong fund.

— A third party would set the price of some domestic securities held in Strong funds, other than money market funds. Currently, the company uses a third party when deemed appropriate.

— The holdings of each Strong fund would be made public at least monthly, instead of quarterly.

Morningstar’s Herbert called the moves “steps in the right direction.” But he said the company still must strengthen the wording in its prospectuses to make it clear that market timing won’t be tolerated.

“That the prospectus needs to be followed is really more important,” Herbert said.