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The Mutual-Fund Scandals


Even those jaded by the corporate and Wall Street scandals of the past few years may find it hard not to be shocked by this year's revelations of preferential treatment and self-dealing in the once-conservative mutual-fund industry. On Dec. 17, James P. Connelly Jr., the 40-year-old former vice-chair of Fred Alger & Co., became the first mutual-fund executive to be sentenced to jail (one to three years). That must have been particularly shocking to this roster of onetime luminaries now humbled.

Over a hard-driving 30-year career, Richard S. Strong, 61, built a small Milwaukee business into a national financial empire with $43 billion in assets at its peak. He also made himself very rich: He's worth $800 million. Now he has admitted to engaging in short-term trading of his own company's mutual funds, in violation of the funds' rules, for a paltry $600,000 in trading profits. New York Attorney General Eliot Spitzer's office says he is considering filing criminal and civil charges against Strong. And the Securities & Exchange Commission is weighing a civil case. Strong has resigned and promised to repay investors any losses. The company has hired Goldman, Sachs (GS) & Co. to explore a possible sale.

Edward "Eddie" Stern, 38, has become the poster boy for the exploding mutual-funds scandal. The scion of Hartz Mountain Industries Inc.'s founding family and son of real estate magnate Leonard N. Stern, he ran the $730 million Canary Capital Partners LLC hedge fund. He was the first to be implicated by Spitzer for late trading and market timing. In September, Stern settled and was forced to cough up $40 million in fines and restitution without admitting any wrongdoing.

Last month, incoming chief executive of Janus Capital Management LLC (JANSX), Mark Whitson, 42, faced two big problems: plunging assets due to the bear market in stocks and a host of top manager departures. Whitson made his first priority improving mutual-fund performance, but it seems he should have set his sights instead on eliminating special deals. The firm has admitted to Spitzer's allegation, part of the Canary case, that it gave one hedge fund the right to make frequent jumps in and out of its funds, a practice prohibited to ordinary investors. And it will refund $31.5 million to investors. Janus, the ninth-largest mutual fund, with $85.7 billion in assets, has not been charged with wrongdoing.

Gary L. Pilgrim built Pilgrim Baxter & Associates from scratch, sold it at the top of the market in 2000 for $400 million, and was paid handsomely to keep his job picking stocks, to boot. But that apparently wasn't enough for the 63-year-old mutual-fund manager. A big fan of tech stocks, he didn't trim his holdings fast enough during the market downturn, and soon Pilgrim, his wife, and two others had set up a hedge fund that traded in and out of his own company's funds 120 times in 2000 and 2001, in violation of its own rules, the SEC says. Spitzer wants Pilgrim and his longtime partner, Harold J. Baxter, to return $250 million to investors. And he has filed civil charges against both of them. Pilgrim's lawyer was unavailable to comment.

Best known for investing in fast-growing stocks, Alliance Capital Management Corp. made the most of the stock market's momentum in the late 1990s. But 59-year-old former chief John D. Carifa also made tens of millions during the bad times, even as his New York firm's investors lost millions. Now it turns out that under his watch the company allowed sophisticated traders to rapidly trade its funds in exchange for parking money with Alliance. The company, which manages about $453 billion, agreed on Dec. 18 to a $350 million cut in fees plus a $250 million fine as part of separate settlements with Spitzer and the SEC, but neither admitted nor denied their findings.

The "people's broker," Charles Schwab & Co. (SCH), was quick to capitalize on Wall Street's problems last year with a searing TV ad campaign: "Let's put some lipstick on this pig," quipped one broker to another about selling a loser stock to unsuspecting investors. Now, the San Francisco company has launched an internal investigation into market-timing at a fund unit after receiving queries from both the SEC and Spitzer. The company and its chief executive, David S. Pottruck, 56, have acknowledged they allowed a handful of institutional investors to trade in and out of its Excelsior Funds family. The firm's profits are down, its stock hammered.


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