NEWS ANALYSIS

Don’t count on restitution in mutual fund scandals

By CHET CURRIER Bloomberg News

Sunday, December 7, 2003

You know those promises you hear so often about restitution payments to investors wronged in the mutual-fund scandals?

Keep your expectations modest. Sorting out who should pay what to whom, and how, is going to take a while. Once that finally happens, the typical sum to be paid may be too small to mean much.

For a case in point, look at a complaint filed the other day by the office of New York Attorney General Eliot Spitzer. It alleges that three individuals formerly employed by a soon-to-be-dissolved Arizona company, acting on behalf of a hedge fund, defrauded six mutual funds of more than $1 million each.

Let’s focus on one of those funds, the Milwaukee-based Artisan International fund, whose five-year return of 8.2% a year ranks in the top 15% of all international stock funds, according to Bloomberg data. It gets a top five-star rating from Morningstar Inc., and with the help of its robust record boasted assets of $8.9 billion at last report.

The complaint says abusive trading cost Artisan International “in excess of” $1 million over 3 1/2 years. For the sake of argument, let’s suppose the total damage came to $1.75 million, which works out to $500,000 a year.

When you figure the fund’s net asset value per share to the penny, the amount rounds off to zero. For each $1,000 in the fund, by my back-of-the-envelope math using the latest asset total, it comes to roughly 20 cents.

If there is to be a payment of any size, we certainly don’t want it to originate from the fund’s assets. “Such payments, if made by the funds themselves, would hurt current shareholders,” points out a letter to last Sunday’s New York Times, from Robert Adler of Port Washington, New York. “The payments, in effect, would be wash transactions — or worse, if lawyers carve out a chunk of any settlement.”

How about simply taking the money from any and all offenders, as determined by the workings of the law, and putting it into the funds involved without trying to distribute it to investors?

That presents a different problem, since today’s owners would get what rightfully belonged to investors of the past. We’re assuming the offending parties have the means to pay in the first place.

If you set up a separate entity somewhere to handle reimbursement payments, the administrative costs might overwhelm the sums to be paid out. Making taxpayers foot the bill for such an enterprise would merely nick an already beleaguered public one more time. As an old axiom tells us, an additional wrong never helps to make a right.

Any way you look at it, there’s no pot of gold at the end of this rainbow. That doesn’t mean, though, that fund investors should abandon the whole idea of restitution.

One prime goal of the investigations ought to be that no chiseler keeps a penny skimmed from any fund. Another should be to deter, as emphatically as possible, all temptations to abuse the system the way it has recently been abused.

So whatever is done with the proceeds, make the miscreants pay. Even more important, establish once and for all the idea that scrupulous cleanliness is the only option for fund managements henceforth.

“They didn’t realize what they were doing was wrong,” must be clearly seen as an unacceptable alibi. Ditto for “more sloppy controls than egregious behavior,” to borrow a phrase from a recent Wall Street analyst’s report.

Any fund company serious about earning investors’ trust can publish a formal code of ethics that clearly defines what is right and wrong, and establishes solid controls where they might have been “sloppy” heretofore.

Some managers already have such codes, or at least bits and pieces of them. Give us more, and better, of that stuff.

“Reforms may be encouraged by regulatory action, but ultimately only mutual-fund companies themselves will win back investors’ trust,” wrote former Securities and Exchange Commission Chairmen Richard Breeden and Arthur Levitt Jr., now a director of Bloomberg News’s parent company Bloomberg LP, in the Wall Street Journal this week.

Time for some to pay up, and all to shape up.