PREMIUM SEARCH Search by job title, geography and build a list of executive contacts
For New York Attorney General Eliot Spitzer, the lightning strike against illegal after-hours trading of mutual-fund shares was a no-brainer. In contrast to the "subjective" issues involving conflict of interest on Wall Street, the law is "clearcut" on after-hours trading, says Spitzer. His charges against four mutual-fund groups –- which exposed the unsavory practice of market-timing as well as the illegal one of late-day trading -- sent a shock wave across Wall Street (see BW Online, 9/17/03, "Spitzer's Moves Make a Virtue of Speed").
Spitzer, however, advises the 95 million investors who entrust large portions of their savings to mutual funds not to "run from the industry." BusinessWeek Markets & Investments Editor Mara Der Hovanesian spoke with him on Sept. 17 about his latest cause, the relationship between his office and the Securities & Exchange Commission, and what's next. Here are edited excerpts from their conversation:
Q: First, investors are told they can't trust the sell-side research analysts because of conflicts with investment bankers. Now, it looks like the buy-side, mutual-fund managers, are just as rotten. What's an investor to do?
A: While we're still looking at these issues with respect to some of the mutual-fund families and practices that are clearly questionable, the impact on the individual investor is still quite small.
The sums involved are big when you aggregate the losses -- which I believe to be in the billions because of market-timing and late-day trading -- but if you spread that across the millions and millions of investors in the mutual-fund sector, it still adds up to a rather small loss. Investors shouldn't run from the mutual-fund industry because of this. What they should do is demand that their mutual-fund families change their practices with respect to late-day trading and market-timers.
Q: It was one thing to say, "Oh sure, conflict of interest between research and investment banking has existed forever." Are we now to believe that all along, there have been conflicts or issues in the fund industry, too?
A: I don't know. I may have an opinion later when I've spoken to more people. [It's true that] everybody's reaction to the tension between research and investment banking was that it has been this way for a long time. The response I've gotten from most people on the mutual funds is that this is shocking: "How could they ever have done this?" Still, I don't think the fund industry's issues have the same historical roots that the Wall Street research did.
Q: How is it that this fund case is being prosecuted so swiftly, with individuals already taking the fall just two weeks after the complaint?
A: Every case has a different texture to it. Partly because of the quality of the information in this case, we have been able to generate [the complaint] rapidly. There's a certain clarity to the law on these issues. [It's very] clearcut on late-day trading: You simply cannot put in orders after 4 p.m. and be given the 4 p.m. price.
The issues relating to Tyco (TYC
) or WorldCom (MCWEQ
) are murkier. When or why a research analyst makes a buy recommendation is more subjective. It's easier to prove that it was sunny yesterday, rather than someone on a particular street corner was in a bad mood.
Q: Do you think there are certain types of mutual funds -- such as international, small-cap, or high-yield funds -- that may have unique risks that aren't obvious or transparent to fund investors, or that provide fertile ground for these illegal practices?
A: Certainly, when it comes to timing, international funds are more likely to be involved because they're more susceptible to stale pricing -- and that's what's at the heart of how an arbitrageur takes advantage. An Asian fund is much more susceptible than a large-cap fund, which has all its shares listed on an exchange.
Q: What sorts of operational controls need to be in place to prevent future conflicts of interest in the fund industry?
A: I'm sure we'll give some thought to that, as will the Securities & Exchange Commission in due course. The first step with respect to late-day trading is to make sure they know they can't break the law.... I don't think they misunderstood that, I just think they thought they could get away with it.
Q: Your announcement of criminal charges against a former Bank of America (BAC
) employee was done jointly with the SEC. Are you in a new cooperative mode now?
A: We like to work with the SEC, but that doesn't mean they're going to be interested in every case we're looking at and that we're not going to handle some things on our own. But any notion that there's tension between our offices or an inability to cooperate isn't accurate. We want folks to understand not only do we get along but we also intend to fully cooperate on our mission to protect investors.
Q: What's the next frontier? Have you looked at in-house hedge-fund managers who also run mutual funds internally? What about the prime brokerage business, where Wall Street offers research and office space in exchange for trading and other business?
A: These are definitely interesting topics that should be examined. The SEC will probably take a look at these things. We have very real resources constraints -- we have 15 lawyers.
At least these businesses are beginning to apply some self-criticism. They can't continue practices that they might have deemed acceptable two years ago. And investors need to continue to ask hard questions. They owe that to themselves.
Copyright 2003, by The McGraw-Hill Companies Inc. All rights reserved.
Printer-Friendly Version
