State securities agency aids in mutual fund probe
The New Hampshire Bureau of Securities Regulations has jumped into the growing national mutual fund scandals in a big way, helping to investigate and negotiate a tentative settlement — reportedly in the $200 million range — with Boston-based MFS Investment Management, one of the largest mutual funds in New England.
“We have seen evidence of securities fraud,” said Mark Connolly, director of the bureau, which had earlier threatened to issue a cease and desist order against MFS.
Since that threat, MFS has resumed negotiations with the bureau, and a settlement could be announced in a matter of weeks, Connolly said.
The New Hampshire bureau was involved in the MFS investigation and negotiations along with the U.S. Securities and Exchange Commission and the New York attorney general’s office.
Connolly said New Hampshire volunteered to help out the Massachusetts securities regulation office, which has been swamped with other mutual fund investigations.
State and federal regulators have been investigating abuses in the mutual fund industry for several months, largely focusing on accusations of favorable treatment for large investors or of mutual fund executives trading for their own benefit with potential losses for customers.
Connolly would not go into details of the MFS negotiations, but sources close to the investigation confirm published reports that the company allegedly allowed favored investors to use so-called “market timing” and late trading on 11 funds while telling long-term investors that it did not allow the practice.
Late trading involves purchasing mutual fund shares at the price after the market closes. “Market timing” is an investment technique involving short-term, “in and out” trading of mutual fund shares, which has a detrimental effect on long-term shareholders. The technique is designed to exploit market inefficiencies when the “net asset value” of the mutual fund shares — set at the markets’ close — does not reflect the current market value of the stocks held by the mutual fund.
New York Attorney General Elliot Spitzer — a key investigator in the mutual funds scandals — has likened the practices to “allowing betting on a horse race after the horses have crossed the finish line,” said Spitzer.
Such timed trading can be extremely profitable, diluting the price of the average long-term shareholder. One study says that such trading shaves an average of as much as 1.14 percent off an investor’s return. In other words, an investor would make a 5 percent profit off of a $100,000 investment using late trading practices, but only make 3.86 percent by playing by the rules.
A ‘lucrative’ state
While “timed” trading is not illegal, it must be disclosed to the shareholder. But MFS allegedly did the opposite, while steering certain investors to these funds, even when such excessive trading was taking place, according to a Jan. 23 report in The Boston Globe.
Late trading, however, is illegal — and has the potential to be very profitable. But to engage in it, a mutual fund would actually have to participate by setting a false time of sale.
According to The Globe, citing documents in the investigation, at least $1.9 billion of such “timed money” was being invested in the funds, constituting about 5 percent of the value of the 11 MFS funds.
If true, this would be unfair to long-term investors who didn’t know of such trading, Connolly said.
“Mutual fund investors should be on a level playing field. There shouldn’t be two classes of investors. It shouldn’t be those in the know making money at the expense of those who are not in the know,” Connolly said.
MFS did not return comment on the charges. Its Web site did confirm that it didn’t monitor such trading at the 11 funds, but that was because most of the funds were domestic large-cap stock and high-grade bond funds.
“MFS believes that the daily monitoring with respect to these large and highly liquid funds was unnecessary because MFS concluded that frequent trading in these funds would not be disruptive to portfolio management and harm fund performance,” the statement said.
But MFS has since started monitoring the funds, and is fully cooperating in the investigation, according to the Web site.
Connolly won’t release details of the proposed settlement, but said the bulk of the money would go to repay shareholders and a small percentage would be used to reimburse the bureau. In past settlements, Spitzer has insisted that the funds cut fees charged to investors, while the New Hampshire bureau has mainly focused on corporate governance issues.
The bureau isn’t only involved in the investigation to help out its counterpart south of the border. Although the state is small in size, it has a relatively large number of investors in the stock market, judging by the 65,000 registered representatives (mostly out of state) of brokers or mutual funds.
“We are a very lucrative state for fund managers,” Connolly said. “We want to make sure everybody gets it that we don’t allow fraudulent securities firms in our state.”
On the other hand, he said, he didn’t want to frighten investors away from mutual funds.
Funds are a very good deal, he said, and only a small minority play on the edge of the law.
“The majority are doing the right thing and have the appropriate controls in place,” Connolly said. “We are just trying to get the others to clean up their act.”