Getting a Refund After the Scandal: Gauging the Odds

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Getting a Refund After the Scandal: Gauging the Odds

Riva D. Atlas, The New York Times

December 7, 2003

If the New York attorney general, Eliot Spitzer, has his way, investors will receive tens of millions of dollars in refunds from mutual fund managers who allowed improper trading in their funds.

But it's too early to say what that will mean for individual shareholders. How much money an investor held in a fund and for how long will be factors in determining the size of eventual payouts, experts said.

There is still a big difference between what Mr. Spitzer says is a fair way of reimbursing shareholders and what some of the fund companies have proposed. Mr. Spitzer says that all of the management fees earned by fund companies during periods of improper trading should be returned to investors. "The money should go back to the original shareholders for whom the fiduciary duty was breached,'' Mr. Spitzer said recently.

At the moment, though, companies like Janus Capital and Bank of America have promised to return only the management fees on the fund shares that were improperly traded, a much smaller sum that could wind up representing just pennies to the average investor.

Mr. Spitzer made his intentions clear on Nov. 20 in a suit against Gary L. Pilgrim and Harold J. Baxter, founders of the PBHG funds. He demanded that the men and their company return more than $250 million - all the management fees they earned in the several years in which they allowed improper trading in the PBHG funds. And last week, in a suit against Invesco Funds Group, the attorney general sought the return of $161 million in management fees earned over two years.

The fees that the attorney general wants to extract are subject to litigation, but some managers may yield to his demands to avoid a battle.

Mr. Spitzer's approach has raised eyebrows. "We're really starting to talk about big bucks, and that will hurt" the fund executives, said Kathryn McGrath, a lawyer with Crowell & Moring and a former director of mutual fund regulation at the Securities and Exchange Commission.

Of course, for individual shareholders, these sums could end up as small amounts after they are divided among hundreds of investors, particularly those who may have owned a fund for just part of the period of wrongdoing or who have since sold their investments in the fund.

Take the Invesco Dynamics fund, which, according to Mr. Spitzer and the S.E.C., was heavily used by frequent traders, in violation of limits in its prospectus. Russel Kinnel, the director of fund research at Morningstar Inc., suggested a way of calculating possible payouts for investors under Mr. Spitzer's principles. The fund charges investors 0.46 percent a year in management fees. An investor with $10,000 in the fund for a year may get $46 in restitution from the fund company, assuming the fund was held for the entire year.

Many lawyers say that it will be time-consuming and expensive for funds to track down all shareholders and to determine the extent of their losses. Bank of America, for example, has said it will return money to the fund itself, which would mean that only current shareholders would benefit.

But Mr. Spitzer said he was determined to refund the money directly to the people who were harmed. "The nice thing about a mutual fund is you actually know who owns it,'' Mr. Spitzer said, although he acknowledged that he had not sorted out exactly how the reimbursement process would work.

Fund companies, for the most part, have not indicated how they would accomplish this, either, and several declined to comment.

"Everyone is trying to figure this out, but ultimately they will clear whatever they do with Mr. Spitzer and the Securities and Exchange Commission,'' said Joel Goldberg, a partner with Shearman & Sterling, who has been in charge of funds regulation at the commission and said he was advising several investment firms that are dealing with this issue.

Fund companies that have said they will refund fees on money traded improperly in their funds may have trouble calculating reimbursements, given the frenetic pace of the traders' activity.

"It's a big fat load of work, but maybe that's part of the punishment,'' Ms. McGrath said. She added that she assumed regulators would make sure that the cost of sorting all this out "would not be charged to shareholders of the fund.''

One hedge fund, Canary Capital Partners, traded in and out of Invesco's Dynamics Fund 141 times in two years, according to the complaint filed by the attorney general last week.

A number of class-action suits have been filed against fund companies in connection with trading abuses. It is usually not considered cost-effective in class-action cases to pay claims of less than $5 a person, said Christopher Lovell, a lawyer whose firm has sued Janus Capital.

Still, he said, "record-keeping for funds is much better than it is for corporations.'' That means it may be less expensive for the fund managers to calculate the money owed to their customers, he said, and "the break point for what is efficient to send out might be lower.''

Mutual funds and other financial institutions have a poor record of collecting the proceeds owed to shareholders or other lawsuit beneficiaries, according to a 2002 study by James D. Cox, a law professor at Duke University, and Randall S. Thomas, a professor at Vanderbilt University Law School. They found that less than a third of the institutions that were parties to class-action suits even filed claims for the money owed.

One possible explanation is that "institutions are rational economic beings,'' the professors said. “They may expect to receive small recoveries in these cases,” and decide that it is not worth the trouble.

The difference in this case, Mr. Cox said, is that there is a very determined regulator who will pressure the fund managers to make good.