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End mutual fund ripoffs.

Byline: The Register-Guard

Some mutual funds, it turns out, aren't as mutual as investors have a right to expect - that is, a select group of shareholders and insiders have greater opportunities and fewer risks than the rest. These violations of the basic compact among mutual fund investors are corrosive to the $7 trillion mutual fund industry and to the financial markets generally. The scamming and skimming must end.

The appeal of mutual funds, particularly to small investors, is easy to understand: They offer the means to spread risk and gain the benefit of professional management. Investors can choose a mutual fund that holds any conceivable mixture of stocks, bonds and other financial instruments. Funds are managed for growth, income or other objectives, using every strategy Wall Street can devise.

Central to the concept of mutual funds is the idea that all shares are equal. The office worker who directs that a portion of her 401(k) retirement fund be invested in a mutual fund has a right to believe that her shares will perform no better and no worse than anyone else's. This faith has helped fuel an explosion of participation in the stock market - half of American families own stocks, up from just over 30 percent in 1989, and mutual funds are the most common investment vehicle. But now faith in shareholder equality has been shaken.

The opportunity for gaining special advantages results from the fact that mutual fund shares are priced just after U.S. stock exchanges close at 4 p.m. eastern time. News events after the close, however, can affect stock prices, as can trading on foreign exchanges. Mutual fund prices become outdated, or "stale." Someone who can buy or sell to exploit the gap between stale prices and real prices - a "market timer" - can make a killing. That's what some mutual fund insiders and favored shareholders have been doing.

The profits that accrue to the market timers are raked from those that would otherwise be distributed among ordinary long-term investors. The Wall Street Journal estimates that the value of ordinary investors' shares in international funds, the type most vulnerable to such skimming, are reduced by 1 percent to 2 percent a year. The newspaper quotes a Stanford University economist who places the total cost to long-term shareholders at $5 billion a year.

Some of the trading that has occurred is illegal, and prosecutions have already resulted. More should follow. But much of the trading is legal, and may not easily be controlled by regulation. Trading, after all, is what the financial markets are all about. Imposing fees on trades or limiting their number might increase the cost of owning mutual funds without correcting the abuses.

The Wall Street Journal suggests adjusting mutual-fund prices to reflect market trends at closing time, but this seems speculative and could be vulnerable to the same type of exploitation suffered by the current system. A 24-hour trading system, one that would continuously reflect the realities of global markets, might be the only way to erase the gap between stale and actual prices.

The mutual fund industry itself should be looking hardest for a way to end the abuses - by reporting illegal acts to prosecutors, and instituting practices that would eliminate legal market-timing advantages for insiders or favored investors. If Americans get the idea that mutual funds are a rigged game, they'll redeem their shares and invest elsewhere. Dishonest or unfair behavior by the mutual fund industry endangers not only the industry itself, but an economy that relies on mutual fund investors for huge amounts of capital.
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Title Annotation:Editorials; Investors need confidence in fair treatment
Publication:The Register-Guard (Eugene, OR)
Article Type:Editorial
Date:Nov 21, 2003
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