Meet Roslyn Platt, a Customer Of Putnam. She's Not Amused.

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Meet Roslyn Platt, a Customer Of Putnam. She's Not Amused.

By Danny Hakim, The New York Times

November 4, 2003

Last week, Roslyn Platt read in her local paper that Putnam Investments, which manages some of her mutual funds, had become embroiled in an investigation by state and federal securities regulators.

Within days, Ms. Platt, an 80-year-old retiree who lives in Mission Viejo, Calif., said, she sold her Putnam shares.

"There's so much crookedness now; I always thought a fund would be reliable and honest because it's not an individual stock," Ms. Platt said.
"It's shaken my faith," she added

The whirlwind of financial scandal that has already rattled Enron and Tyco, Wall Street brokerage firms and the New York Stock Exchange is now engulfing the $7 trillion mutual fund industry, which has long portrayed itself as the model citizen of the investment world.

For the 90 million Americans invested in mutual funds - representing about half the nation's households - the most pressing question is whether funds are more risky than they thought.

People with money at firms under scrutiny are worried about the future of those investments. They are less angry about the small amounts of money they may have lost to favored investors granted special treatment than they are fearful about what else their fund firms are doing that they do not know about.

Financial advisers say owning a fund at a firm in the spotlight is considerably less of a risk than owning the stock of a company under scrutiny. But there are concerns, particularly if a fund were to see a tide of withdrawals in a short period.

Large withdrawals make it difficult for fund managers to invest, because they need more cash on hand to handle redemptions, and big withdrawals can lead to higher fees and lower returns for the investors who remain.
Three of the firms that have drawn regulators' attention - Janus, Strong and Putnam - have experienced some initial withdrawals, but its too soon to gauge the effect, and analysts do not view them as perilous. Several investors said they were losing confidence in the Securities and Exchange Commission for allowing improprieties to happen.

"If it wasn't for Eliot Spitzer, nothing would have happened," said Melvin Klahr, 60, who teaches math at a community college in Miami.
He was referring to the New York attorney general, whose office started the inquiry in early September.

Don Phillips of Morningstar, a leading tracker of mutual funds that has advised investors to consider selling funds managed by some firms under scrutiny, said, "We're reaching some sort of critical mass where a lot more investors are starting to talk about this."

Mr. Phillips said many investors did not take much notice until the scope of the inquiry widened in recent weeks.

"With this next round, and the escalation of the charges, it's 'Oh, wait, there were fund mangers involved and the C.E.O. of a fund company market timing their own funds to the detriment of shareholders,' " Mr. Phillips said. "Now, the magnitude of these issues has risen considerably."
Federal and state regulators are investigating preferential trading terms granted to insiders, including top fund executives and managers, as well as hedge funds. The transactions raise questions of fraud and whether fund companies were fulfilling obligations to put investors' interests ahead of their own.

In Congressional testimony yesterday, Mr. Spitzer went so far as to call the industry a "cesspool."

Some investors echo his disenchantment. "I have a real problem with their ethics," said Steve Rozich, 58, a consultant in San Juan Capistrano, Calif., who owns Putnam and Janus funds and plans to sell at least the Putnam fund. "Ethically it violates the principles of mutual funds that I understand, that everyone is supposed to be treated equally."

Among fund analysts, the most tangible concern is the potential for mass withdrawals.

"I think the biggest downside will be that other investors will sell out ahead of you," said Jeff Tjornehoj, an analyst at Lipper Inc., a fund-tracking firm.
That can drive up trading costs and leave a smaller pool of investors to pay a fund's tax bill, though rocky markets have left many funds with accumulated losses, not gains. And fund companies increase their fees if there is a smaller shareholder base over which to spread costs.

Further, fund managers have a hard time succeeding "when you're constantly selling" to raise cash for departing shareholders, said Russel Kinnel, Morningstar's director of fund analysis.

There have been extreme cases, including the departure in the mid-1990's of Garrett Van Wagoner, then a star manager, from the $500 million Govett Small Company fund. Investors fled, performance lagged and the fund shrank to a third of its size by 1997.

"Having to sell to meet redemptions is an impossible state to be in," the fund's new manager, Gareth Watts, told The New York Times then.
Financial advisers are preaching caution and paint such outcomes as worst cases, especially given the size of several of the firms under investigation. Some investors may have paid sales loads to buy a fund and might face another big fee at a different company. There are also tax implications; gains on fund investments sold within 12 months are taxed at a higher rate.

Some fund firms already appear to be feeling the effects of the investigation. About $4.1 billion was taken out of the Janus stock funds in September and October, while about $27 billion flowed into stock funds generally, according to AMG Data Services, a California firm that tracks fund flows. Janus was one of the four firms first cited by Mr. Spitzer in his investigation, along with Strong Funds and fund groups run by Bank of America and Bank One.

How much of this exodus was related to the inquiry is hard to tell. Janus, which practices an aggressive investing style, has had other problems since the bull market ended. Strong Funds had its biggest month of outflows in September, with $90.2 million leaving its equity funds.

In recent weeks, Putnam has been one of several additional firms under scrutiny. Investors pulled about $500 million from Putnam's stock and bond funds even as the fund industry took in $1.9 billion in the week ended last Wednesday, according to AMG. Over the last week, Putnam has been sued by regulators, its chief executive has resigned and state pension funds and university endowments have withdrawn $4 billion.

The questions about the fund industry come as Americans are increasingly being given control over their financial lives. Employers once held the nation's retirement purse strings through traditional pension plans; the rise of the 401(k) requires employees to play decision maker.

"I'm starting to get upset with the entire mutual fund industry," said Mr. Klahr, the Miami professor, who has a 403(b), a do-it-yourself plan for educators similar to a 401(k).

"They're supposed to help the shareholders instead of helping themselves," he said. But he added that he was not sure where else to put his money.
Harry Winn, 82, a retired engineer in Wilmington, Del., plans to sell his Janus fund when it makes tax sense.

"I've lost confidence in their ability to treat me like they're treating the big people," he said, adding that he was also disappointed by mutual fund boards, which are supposed to have some independent directors but only rarely challenge management.

"I don't think they're the watchdogs they ought to be," he said.
Despite the investigations, investors industrywide continue to pour cash into stock funds. Ultimately, performance reigns, and this year the markets are playing nice again, relatively speaking. And much of the new money comes on autopilot, dumped in weekly by millions of Americans who put a percentage of their paychecks into 401(k) plans.

Even Ms. Platt has not lost all her faith in the stock market.
"Where else would you put the money?" she said. "You can't put it under the mattress anymore."

Phil Cook, a certified financial planner in Torrance, Calif., and Ms. Platt's financial adviser, said the suspected activity at Putnam would have a small effect on her holdings.

"But you probably don't want to do business with someone who is less than straightforward when it comes to your money," he said.