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Mutual Fund Scandal Glossary

  • Late trading:  Placing a buy order for a mutual fund after 4 p.m. ET and getting it at that day's closing net asset value.
  • Forward pricing:  Law that states mutual fund shares bought after 4 p.m. ET are priced at the next day's closing net asset value.
  • Timing:  Trading in and out of a mutual fund to exploit short-term moves in the securities they own.
  • Timing police:  Officials at a mutual fund company who watch for investors trying to violate rules against short-term trading in and out of mutual funds.
  • Timing under the radar:  Placing trades in mutual funds through intermediaries or in other ways that make the trading difficult to spot.
  • Stale prices:  When a fund's net asset value doesn't reflect the changed value of its holdings.
  • Sticky assets:  Money that is invested in a fund for a long period of time and generates fees for a fund company.
  • Time zone arbitrage:  Buying a mutual fund that owns securities in a foreign market at the previous day's net asset value, knowing events that occurred since that market closed will create an automatic profit.

Other Benefit Terms & Acronyms

DOL - EBSA  Media Release

Release Date: 11/25/2003

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Federal and State Agencies Announce Actions Against Security Trust Company; Phoenix Bank will Undergo Orderly Dissolution and Close by March 31, 2004

The Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the New York Attorney General today jointly announced a series of actions against Phoenix, Arizona-based Security Trust Company, N.A. (STC) and three former executives, arising from their participation in mutual fund late trading and market timing schemes.

The NYAG announced criminal actions against STC’s former chief executive officer, Grant D. Seeger; its former president, William A. Kenyon; and its former senior vice president for corporate services, Nicole McDermott.

The SEC announced the filing of civil fraud charges against STC, Seeger, Kenyon, and McDermott.

The OCC announced that STC will begin a process that will result in an orderly dissolution of the bank by March, 31, 2004. An order signed today by the OCC, which is the bank’s primary regulator, requires the bank to take steps to ensure that the trust accounts and investment plans it administers experience the minimum disruption possible. The OCC also took an enforcement action against STC last month requiring the bank’s controlling shareholder, Capital Management Investors Holdings, Inc. (CMIH), Chicago, Illinois, to provide a substantial capital infusion and make a general pledge of its assets that ensures the bank will have sufficient funds available for an orderly dissolution.

The Labor Department’s Employee Benefits Security Administration, which enforces provisions of the Employee Retirement Income Security Act that are designed to protect retirement and employee benefit plans, also participated in the OCC investigation.

An investigation by the New York Attorney General's office implicated Security Trust in certain improper and illegal activities, including late trading and market timing, and triggered an investigation by the other agencies.

“I want to thank the OCC, SEC and Labor Department for their excellent assistance and cooperation on this case,” said New York Attorney General Eliot Spitzer. “Coordination by regulators is imperative in ensuring that individuals and corporations are held accountable for misdeeds, and this case shows how that can be accomplished.”

“This action is an impressive example of cooperation between state and federal government agencies,” said Comptroller of the Currency John D. Hawke, Jr. “Everyone involved displayed a high degree of professionalism and dedication, and acted in the best interests of the American people.”

“Financial intermediaries who illegally permit their customers to trade mutual fund shares at the expense of long-term investors violate the securities laws and will be held accountable,” said Stephen M. Cutler, Director of the SEC's Division of Enforcement. “Today's important action was a product of swift investigation and effective cooperation by federal and state agencies alike.”

Media Contacts
Contact Name: Bob Garsson (Office of the Comptroller of the Currency) Phone Number: 202.874.5770
Contact Name: John Nester (Securities and Exchange Commission) Phone Number: 202.942.0020
Contact Name: Darren Dopp (Office of the New York Attorney General) Phone Number: 518.473.5525
Contact Name: Ed Frank (U.S. Department Of Labor) Phone Number: 202.693.4676

NEW YORK -- A former executive with Security Trust Co. pleaded guilty Tuesday to securities fraud in connection with illegal late trading of mutual- fund shares. Nicole McDermott, formerly STC's senior vice president of corporate services, "admitted to directing STC employees to place numerous orders for mutual fund shares on behalf of two hedge fund clients after the 4:00 p.m. cutoff," New York Attorney General Eliot Spitzer's office said in a news release. The crime is a felony, punishable by a maximum of four years in prison, according to Mr. Spitzer's office. In November, Mr. Spitzer and the Securities and Exchange Commission brought coordinated actions against Ms. McDermott and two other STC executives -- Grant Seeger, the chief executive, and President William Kenyon -- and all were charged with securities fraud, grand larceny and falsifying business records.

The Office of the Comptroller of the Currency, which had regulatory oversight over STC, also brought an enforcement action that will result in the dissolution of the company. An SEC official was not immediately available to say if the commission had reached any agreement with Ms. McDermott or Messrs. Seeger or Kenyon.

The regulators accused STC and the three executives of facilitating hundreds of illegal after-hours trades in nearly 400 mutual funds by hedge fund Canary Capital Partners LLC over a period of more than three years.

Attorneys representing Ms. McDermott and Messrs. Seeger and Kenyon were not immediately available for comment. A spokesman in the attorney general's office declined to comment on whether any of the charges were dropped, or whether the guilty plea was the result of a plea bargain. He said Ms. McDermott is scheduled to return for sentencing in June.

Based in Phoenix, Security Trust Company manages $13 billion in retirement and pension assets for about 2,300 retirement plans, making it the largest of the independent trust companies. The U.S. Treasury Department's Office of the Comptroller of Currency will force Security Trust to be dissolved by March 31, 2004. The Securities and Exchange Commission simultaneously filed civil charges against the former executives and Security Trust.

NY AG Eliot Spitzer filed felony charges against Security Trust Co. N.A., (STC) accusing three former senior executives of “pervasive misconduct” in helping in the late trading of mutual funds and the “larceny” of more than $1 million. In addition, the SEC filed a civil suit against STC and its executives and the US Treasury Department's Office of the Comptroller of Currency (OCC) announced it had started efforts to dissolve STC. The OCC announcement said that in October, it had forced STC's controlling shareholder, Capital Management Investors Holdings, Inc., to provide a capital infusion so that the company will have enough money to carry out an orderly corporate dissolution.

Timing and late trading charges are only the tip of a massive iceberg, they merely exposed the cancer that has been festering for a long time -- toxic expenses yet fund industry leaders don't think they did anything wrong!

  • Senator Peter Fitzgerald, R-Ill., says funds are "the world's largest skimming operation."
  • Eliot Spitzer called it a "cesspool."
  • Morningstar's Don Phillips said the industry "has lost its moral compass."
  • Former SEC chairman Arthur Levitt says "the ethical loss is cataclysmic."

Expenses are a huge problem - The industry skims a third off the top of average fund's winnings. Even the past three years, as investors lost over 40 percent on equity funds during the bear market, fund managers were giving themselves an average 35 percent increase in pay.

How do they do it?

  • By hiding transaction costs. Actively managed equity funds currently report an average expense ratio in the range of 1.5 percent. But that doesn't include transaction costs.
  • Sales commission. Most actively-managed funds are sold by brokers who get a commission in the six percent range. Regardless of what they do or do not do, managers give the broker a commission to hustle assets. So deduct at least 0.5 percent to account for the annual impact of the commission.
  • Cash drag. Actively managed funds have much higher cash reserves than an index fund. The effect of this "opportunity cost" or cash drag is a deduction of another 0.6 percent.
  • Transaction costs. Fund managers have lots of fun buying and selling stocks, playing big-shot with your money. The typical turnover ratio is about 100 percent annually -- i.e., they're turning over their entire portfolio every single year.
  • Management fees and expenses. Now subtract another 1.5 percent for the reported fees and expenses that the fund managers charge investors, including misleading 12(b)1 marketing fees.
  • Taxes. But that's not all. Now Uncle Sam wants his cut of the profits in your taxable accounts. And since that depends on an individual's bracket, it could be anywhere up to 2.7 percent. But let's be ultra-conservative at 0.7 percent.
  • Gross, pretax and after-tax investor return. Let's suppose your fund is generating a nice average gross annual return of 12 percent on total assets over the long term. The commissions, costs, cash drag and fees reduce that to 8.7 percent pretax. In short, the manager has already cost you 3.3 percent. Or to put it another way, the fund is underperforming the market by 3.3 percent. After-tax, what's left for the investor? No more than 8 percent of the original 12 percent is left. Less than two-thirds of your fund's returns get into your pocket, probably much less.

Lately the news media has put most of the focus on the hot breaking news about the latest indictments by the state attorneys general and the SEC. Please don't be mislead - the real problem is expenses, and unfortunately that message is being overshadowed by the indictments. Stay focused ... or fund managers may rob you blind.

In fund prospectuses, the fees charged to investors are stated as a percentage of assets. At around 1 percent a year, these costs look benign. In dollar terms, however, the fees are staggering; some estimate >$35 billion for the last 12 months or 0.86 percent of assets not including sales charges on broker-sold funds. The fees fall into four groups. The largest is adviser fees, which totaled $21 billion or 0.52 percent of assets. Other fees, including the self-serving 12b-1 charges fund companies use to attract new money, totaled $9.2 billion, or 0.23 percent of assets. Shareholder servicing fees added $5.6 billion, or 0.14 percent, and custodian fees brought in $537 million, or 0.01 percent.

How Should Plan Fiduciaries Address Mutual Fund Investigations and Allegations?

Plan fiduciaries who have responsibility for investments have an ongoing obligation to monitor the funds offered as investment options under their plans and to decide whether these funds should be kept or removed. Although what constitutes a prudent review is determined by the specific facts and circumstances, here are some practical steps that may help to show that plan fiduciaries have acted prudently.

  1. Hold an Investment Review Meeting: Depending on how often regularly scheduled meetings are held regarding plan investments, a special meeting may be in order.
  2. Gather Information and Consider Alternatives: Determining whether to retain a fund involves many considerations. Plan fiduciaries should educate themselves on the issues and should not be afraid to ask questions. For example, fiduciaries may wish to contact their plan investment advisors for advice regarding the effect of the recent mutual fund allegations on the funds offered under their plans even if these funds have not been identified in the press. Fiduciaries should then evaluate available alternatives and decide what actions are needed, if any.
  3. Document Each Step: Fiduciaries should be sure to keep good records regarding information received, meetings held, and actions taken in response to the recent mutual fund allegations. This kind of documentation can help protect fiduciaries from liability.
  4. Inform Participants: Fiduciary litigation often involves claims that adequate information was not communicated to participants. Fiduciaries should carefully consider the extent to which their duty of loyalty and the disclosure provisions of ERISA Section 404(c) may require them to inform participants about the current issues of late trading and market timing and what the plan fiduciaries are doing to address the issues.
bullet The American Society of Pension Actuaries (ASPA) official position on the current Mutual Funds issues:  Amendments to Rules Governing Pricing of Mutual Fund Shares (Release No. IC-26288; File No. S7-27-03) For official details from ASPA please visit this pag

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DOL Clarifies Pension Fund Duties for Dealing with Mutual Funds Seeking to aid pension plan fiduciaries in dealing with the recently revealed illegal or otherwise questionable practices of various mutual funds, the Labor Department's Assistant Secretary for Employee Benefits Administration, Ann L. Combs, issued a guidance statement on Feb. 17. "In cases where specific funds have been identified as under investigation by government agencies, fiduciaries should consider the nature of the alleged abuses, the potential economic impact of those abuses on the plan's investments, the steps taken by the fund to limit the potential for such abuses in the future, and any remedial action taken or contemplated to make investors whole." In deciding whether to participate in settlements or lawsuits involving mutual fund misconduct, "weigh the costs to the plan against the likelihood and amount of potential recoveries," the guidance suggests. In general, it reminds plan fiduciaries that they must act prudently and that this means using a "deliberative process" and documenting the process and decisions made. Also, a plan may charge redemption fees or place limits on the frequency of trading by its own participants; this would not, in and of itself, negate protection enjoyed by plan fiduciaries from the use of participant-directed accounts under Section 404(c), the statement maintains. However, its warns that use of trading restrictions not contemplated under terms of the plan raises issues concerning the application of section 404(c) and imposition of a "blackout period" requiring advance notice to affected participants and beneficiaries.

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