Last week produced the first congressional mutual-fund hearings, and showed how the fund story hasn’t stirred emotions the way Enron did. When the Enron hearings started in early 2002, stocks were in the tank and a standing-room-only crowd watched pols try to outdo each other with sound bites. By contrast, the hearings run by Sen. Peter Fitzgerald, an Illinois Republican, attracted only three of the 13 senators on the Governmental Affairs subcommittee that he chairs. The amount of news coverage was a rounding error compared with the Enron hearings. That’s too bad because, despite its low heat level, Fitzgerald’s hearing produced a lot of light: regulators served up the shocking assertion that about half the fund companies they’ve looked at were breaking rules designed to protect investors. Even better, Fitzgerald–who comes from a business family and understands numbers–managed to explain this scandal in emotional rather than intellectual terms, calling it “the world’s biggest skimming operation.” That evokes wonderful images of bad guys at casinos, and is exactly right. Because, to cut through the technicalities, fund companies have let a handful of investors skim relatively small amounts of money from millions of other investors. (I’ll explain the workings some other time.) In at least one company, Putnam, fund managers are accused of skimming from the funds they ran. According to New York Attorney General Eliot Spitzer, who kicked off this scandal two months ago, Strong Funds founder Richard Strong will soon be accused of doing the same.
A major reason you don’t hear average investors screaming about these outrages involves nomenclature. When Spitzer got a big hedge fund, Canary Capital, to cop to feathering its own nest at the expense of investors in four mutual-fund families, his filings used the term “market timing,” which in most contexts (but not this one) is a legitimate and legal investment technique. The Canaries of the world call what they’re doing–taking unfair advantage of mutual-fund investors–“market timing” because it sounds so much nicer than “skimming” or “stealing” or “looting.” Wall Street, after all, is big on euphemisms. It calls market crashes “corrections,” and selling becomes “profit taking.”
Let’s think for a minute about many of the transactions that regulators have described. Well-connected investors get real-time information about what’s in mutual funds’ portfolios, information that’s not available to the public. Then these Connected Ones use that information to make profits. “If it’s material, nonpublic and they’re trading on it to their advantage, it’s insider trading,” says Stephen Cutler, director of enforcement at the Securities and Exchange Commission. Exactly so.
Why aren’t regulators and the media using terms like “insider trading”? Because we’re trained to be careful and–don’t snicker, now–we occasionally try to be fair. In this case, though, we’ve been way too nice.
That could change soon, I think, because we’ll learn that some fund-company malefactors were even worse than we thought. And that some of them, not content with their high pay and the profits they skimmed from their own companies’ funds, bought and sold securities in anticipation of what their funds would do. That would be “front running,” another nice, emotional term. Maybe we’ll have an individual villain or two to focus on, finally, rather than an entire diffuse industry.
And who knows? Someone may find a potent political connection between some fund bad guys and the political elite, the way Enron’s “Kenny Boy” Lay was linked to George W. Bush through ties of fund-raising and mutual back-scratching. Let that happen, and the fund story will leap the species barrier and become a political story. Then, finally, this story will attract the attention it deserves and we’ll fix the fund industry. And the villains will get what they deserve: infamy everlasting.
