As Wall Street began to wind down for the Thanksgiving holiday, the ongoing investigation of the mutual fund industry trading scandal showed no signs of letting up. Citibank offered to refund $16 million to fund investors. Federated Investors fired a manager for deleting emails relevant the probe. A Morgan Stanley branch manager faces civil charges in Massachusetts. And New York Attorney General Eliot Spitzer said any fund company that wants to settle charges first has to explain how they’re going to cut their fees.
In an interview with CNBC, Spitzer said late Tuesday that has told the boards of directors of funds that they need to change the way they do business to guarantee that they are getting the best deal for investors by negotiating with fund managers for the lowest fees.
“The boards of directors, who are supposed to look out for your interests as an investor and fulfilling their fiduciary duty, could drive the fees down, and have been doing just the opposite,” he said on CNBC’s Capitol Report. “There will not be settlements with companies unless they assure me through structural reform that fees are going to be addressed. We’re talking about tens of billions of dollars that investors are losing because mutual fund boards aren’t living up to their fiduciary duty.”
Spitzer also said that criminal charges filed Tuesday against three former top executives at Security Trust Co. had effectively put the company out of business. The complaint said the three had allegedly acted as middlemen for hedge funds in an illegal late-trading scheme that cost investors $1 million.
“They were funneling illegal trades from a hedge fund through to the mutual funds, illegal trades that siphoned the money out of the pockets of long term, everyday investors,” he said. “It was illegal. The company is gone, it’s history … one more piece of evidence that the fund industry itself needs fundamental reform.”
And Spitzer said the investigation by his office, other state regulators and the SEC continues to find fresh evidence of trading abuses by the mutual fund industry.
“There are a vast number of companies, and the number continues to increase who are doing it improperly,” he said. “The SEC’s own inquiry — and they did this inquiry about a month ago when we were involved working in this effort — they said about 50 percent of companies are improperly involved in timing abuses. That’s a vast number.”
Fund refund
In other developments Wednesday, Citigroup Asset Management said it agreed to refund some $16 million, plus interest, to mutual funds that were overcharged for stock transaction.
The company said it had discovered problems in a revenue-guarantee agreement with a subcontractor when the nation’s largest bank broke into the transfer agent business. The issue involves an agreement with a subcontractor for Citigroup’s transfer agent business from 1997 to 1999 that required the unnamed company to guarantee $16 million revenue to Citigroup Management and its affiliates. The agreement was eventually changed to require the subcontractor to give Citigroup a one-time payment.
Transfer agents handle record keeping for stock sales and other transactions.
However, the agreement or the amendment was not disclosed to the board of Citigroup Asset Management Funds when the boards were considering whether to approve transfer agent arrangements.
“Regrettably, we can now see that it was not done the way it should have been,” Citigroup said in a statement.
The company said it has brought the issue to the attention of Spitzer, the SEC and other regulators. It also said federal prosecutors in New York are investigating.
Citigroup said it would correct the problem, including a $16 million payment, plus interest, to its mutual funds. The company also plans to implement new procedures and make personnel changes.
Federated fesses up
In Pittsburgh, Federated Investors detailed improper trading found at the mutual fund company, saying employees accepted after-hours orders from an investment firm on 15 occasions.
The company , also said in a report late Tuesday that one “mid-level” officer was fired after he told Federated he had deleted emails relevant to investigations into fund trading. Federated said all the emails were recovered, and that it gave regulators information on the employee’s actions.
Federated Investors, which oversees roughly $200 billion in assets, said that the employees “did not have sufficient understanding” of how buy and sell orders made after the market closes at 4 p.m. were supposed to be carried out.
The company said it had not discovered any evidence employees had agreements with investors to permit late trading, a practice that has drawn the scrutiny of regulators in recent months and tarnished the mutual fund industry’s reputation.
Regulators say the strategy is illegal.
Federated also said in its report that employees on 100 additional occasions incorrectly accepted orders after the 4 p.m. close. Those orders averaged about $28,000, the company said.
An investor placing a buy or sell order for fund shares after 4 p.m. is supposed to receive the next day’s price. But under late trading, orders made after the market closes still get the same day’s price, which can allow the investor to reap big profits by acting on news a day ahead of other investors.
Separately, the company said it arranged to let hedge fund Canary Capital Partners LLC engage in a limited amount of rapid trading in U.S. stock funds. The hedge fund as part of the deal invested about $10 million in one fund, Federated said.
Federated CEO J. Christopher Donahue said in a letter attached to the findings on Tuesday that the company is taking steps to prevent further improper trading.
“We fully understand that even a few deviations from our standards and procedures can have adverse consequences and are not acceptable.”
Federated Investors disclosed last month that it had uncovered improper trading and said it had been subpoenaed as part of a sweeping probe into the fund industry.
Federated said at the time that some investors in its funds might have been granted exceptions to the company’s internal procedures limiting frequent transactions, and that some may have made late trades.
Morgan manager named
Massachusetts regulators named a former Morgan Stanley branch manager Tuesday in a civil complaint alleging he violated state securities law by promoting in-house mutual funds and failing to disclose incentives to investors.
Secretary of State William Galvin had already brought a civil complaint against Morgan Stanley concerning activity at its former branch office in Boston’s Back Bay section. David Varela was the manager of that office and was mentioned in the complaint against Morgan Stanley but had not been named individually.
No phone number could immediately be found for Varela, whom Galvin’s office said is still employed by the firm, though not as a branch manager.
Last week, Morgan Stanley agreed to pay $50 million to settle allegations by the Securities and Exchange Commission and the National Association of Securities Dealers that it steered clients toward “preferred” mutual funds in exchange in exchange for millions of dollars in commission payments from those fund companies. Morgan Stanley did not tell investors about the practice or the higher fees.
The case brought by Massachusetts regulators, however, is still pending.
Tuesday’s complaint claims Varela “reaped the benefits that he so fondly coveted in the form of promotions, recognition, and financial reward. His fame and fortune was ultimately achieved at the expense of Massachusetts investors who were sold funds regardless of their best interests.”
The Associated Press contributed to this report.