Mutual Fund Scandals

1
Chapter 13

• Mutual Fund Scandals

2
After-hours Trading

• Mutual funds have many portfolio managers who
  handle a particular fund.
• Mutual fund values are determined at the end of
  the day.

3
After-hours Scandal

• Some firms were allowed to deposit or withdraw
  funds after the fund value was determined.
• Why? They waited to see how the Asian market
  performed.

4
After-hours Scandal

• If Asia was up, deposit more.
• If Asia was down, withdraw

5
After-hours Scandal

• Firm makes higher return than the rest of the
  mutual fund investors
• How does that hurt us?

• Portfolio manager doesnt know whether firm is
  going to withdraw huge amount of money so he has
  to keep a bigger of fund in cash.
• Cash lowers our return

6
After-hours Scandal
Funds Paid Big Fines
7
Better Disclosures

• Brokers may receive higher commission on one
  mutual fund than another. Gives broker wrong
  incentive.
• New NASD rule requires disclosure to client if
  brokers receive different compensation from named
  mutual funds and nature of arrangement.

WSJ 8/8/03 and 1/14/04
8
Better Disclosures

• Fund companies pay brokerage houses fees to be on
  the list of funds sold by the brokers (shelf
  space) called revenue sharing. Mutual funds pay
  1.5 billion in revenue sharing payments
  annually.
• Just 7 fund companies account for 90 to 95 of
  all mutual fund sales at Edward Jones Co.
• New NASD rule says broker must give client a list
  of revenue sharing mutual funds in descending
  order of payment to brokerage house.

9
Better Disclosures

• BUT NASD is o.k. with if prospectus says
  substantial amounts are paid to broker to sell
  fund.
• SEC proposes new rules to make relationship
  clearer.
• In Nov. 2003 Morgan Stanley charged by SEC and
  NASD with giving certain mutual fund companies
  preferences in exchange for the mutual fund doing
  its trading with Morgan Stanley. Morgan Stanley
  settled without admitting or denying guilt but
  paid 50 million to investors and promised better
  disclosure.

10
American Express Financial Plans

• Pay 500 for an independent financial plan.
• Get suggestions to cash out accounts with other
  firms and buy AmEx products.
• Open secret in the business is that it is a
  selling opportunity.

WSJ 2/9/04
11
Independent Financial Plans

• ¾ of AmEx sales generated by financial plans.
• About 9.5 million households received plans
  between mid-2000 and mid-2002 from brokers,
  insurance agents, and other financial advisors.
• AmEx gets revenue sharing payments from 11
  outside fund families. Not disclosed to clients.
• AmEx funds perform in bottom 1/3 of all fund
  families.

12
Source of Investment Advice
Search for Vanguard Diehard to get advice from
other investors to avoid fees
WSJ 5/14/04
13
Questions?