ASHINGTON, Jan. 27 - Two people who blew the whistle
to state prosecutors about corruption in the mutual fund industry told
Congress on Tuesday about how easy it had been for the funds to execute
abusive trades that cost investors millions of dollars.
The two whistle-blowers - one from Putnam Investments and the other a
consultant for the Canary Capital hedge fund - were the star witnesses at
a daylong hearing before a Senate subcommittee that plans to adopt
legislation overhauling the regulations governing the industry later this
year.
One witness, James Nesfield, said he was able to find hundreds of
mutual funds that would be willing to execute improper trades with Canary
Capital Partners, the hedge fund run by Edward J. Stern. Mr. Nesfield said
Canary retained him to find funds willing to participate in market timing,
or rapid trading in and out of mutual funds.
"My motto was that if you heard no, you had asked the wrong person,"
Mr. Nesfield said.
When Senator Peter G. Fitzgerald, the Illinois Republican who is head
of the subcommittee holding the hearings, asked whether it was the lure of
big money from Canary that enticed the funds to participate in market
timing, Mr. Nesfield replied, "It was kind of like a pickup line at a
bar."
The second witness, Peter T. Scannell,
described how he had tried to turn over evidence of improper trading
practices at Putnam but was ignored by the Securities and Exchange
Commission. Mr. Scannell ultimately turned to Massachusetts state
regulators. Last year, Putnam agreed to settle
accusations of fraud filed by the commission and state officials.
In an effort to regain investors and restore confidence, Putnam
announced on Tuesday that it intended to both reduce its fees and make
them more transparent. The company said it would reduce its expense
ratios, or the percentage of a fund's assets that goes to fees, so that
they fell below the industry average. The company said it would also
reduce upfront sales charges, to 0.25 percent of an investment from about
0.75 percent.
Putnam's chief executive, Charles E. Haldeman Jr., said the
announcement was the latest step by the company "to restore investor
confidence." He said the changes were not made at the prodding of any
regulators investigating trading in Putnam's funds.
In recent weeks, the trading abuses and fees charged by the funds have
come under sharp scrutiny by Congress as well as state and federal
regulators. The S.E.C., after a slow start, has been moving swiftly to
adopt some of the most extensive changes to the rules governing the
industry since the passage of the Investment Company Act in 1940.
Those changes may make moot some of the bills under consideration by
the Senate, which as a body is not expected to take up any measures for
some time. Two months ago, the House overwhelmingly adopted a bill
overhauling the mutual fund industry that experts said was weaker in some
respects than the measures expected to be approved by the commission.
The hearing, before one of two Senate committees that has jurisdiction
on the issue, demonstrates that no consensus has yet emerged on how
Congress should proceed, and it may be months before the full Senate takes
up the matter.
Still, the agency has not gone as far as some of the industry's most
vociferous critics. The commission has rejected suggestions that it set
caps on the fees of mutual funds or directly intervene to lower the spread
between the higher fees the funds charge smaller investors and the lower
fees paid by institutional investors.
Eliot Spitzer, the New York attorney general, has criticized the large
spread as evidence that the funds are "ripping off" investors, an
accusation that the industry has rejected.
The industry's main lobbying group and its supporters say that fees
charged to smaller investors are higher because it is more expensive to
service their accounts.
Instead of directly setting the fees, the S.E.C. has begun an effort to
force the funds to give investors a better idea of the expenses in the
hope that market forces will bring fees down.
At the hearing, Mr. Spitzer defended his practice of requiring some
funds to lower their fees as part of civil settlements. He said that the
large fee spread demonstrated that mutual fund directors had violated
their legal duties to investors.
"Boards had breached their fiduciary obligation in a way that led
directly to excessive fees," he said. "Where a regulator finds a board has
breached its fiduciary duty, it is proper to seek a remedy to that
breach."
Mr. Fitzgerald appeared to concur with Mr. Spitzer's assertion. Mr.
Fitzgerald called it "scandalous" that members of Congress, their staffs
and employees of the federal government can save money in mutual fund
retirement accounts that have significantly lower expense ratios than
accounts offered to other investors.
"Members of the House and Senate have managed to protect themselves
from abusive fees which eat away at the investments of most Americans," he
said.
But one committee member, Senator John E. Sununu, repeated an argument
made by the industry, saying it was wrong to focus on expenses alone, and
that it was more important to look at the returns of funds including
expenses.
"The absolute level of the fee is not the most critical information the
investor can have," said Mr. Sununu, Republican of New Hampshire, who also
serves on the Senate Banking Committee, which may consider mutual fund
legislation later this year.
Mr. Sununu's comments were discounted by John Bogle, the founder of the
Vanguard funds and a leading industry critic. Mr. Bogle said that studies
had consistently shown that the funds with the highest fees generated
lower returns over time.
