Decoding the Fund Scandal

Two months ago, green-clad and stealthy, Eliot Spitzer's merry men descended on the offices of Canary Capital and stole another one away from the rich.

Sort of.

Removing his hood, New York's Attorney General announced that the big bad boys of the Canary Capital hedge fund had agreed to pay $40 million in exchange for that classic financial-services plea (what they must all regard as "Plan A") -- "No admission of wrongdoing."

Of course not.

(And oh, by the way, here's forty million dollars....)

We now know this initial Canary Capital settlement to be the tip of the iceberg, as accusations of "late trading" and "market timing" have rolled up into a burgeoning mutual fund scandal that now looks likely to hit the list of the top 10 news stories of 2003. And yet it has come to my attention that many members of the public general may not exactly get what was going on here. Well, that's what The Motley Fool is for. So here's basically how it started -- y'all ready?

It's 4:00 p.m. The market closes. Or... it was supposed to.

Cut to a narrow-angle shot of a distinguished hedge-fund manager's face pressed up against a computer monitor, watching corporate earnings and other material announcements stream out over the news wires. A diminutive old man, not much bigger than the telephone in his hand, sits by his side.

"Whoa, would you look at that?!" this hedge fund manager -- we'll call him Edward Stern -- says to the trader by his elbow. "Lo-Blo Bubble Gum just announced blowout earnings at 4:08 p.m.!"

"Is that right?" the trader wheezes. "That is wery, wery interestin', me good Ned. Let's see if we gots a FOOND, a FOOND on our listee, here, what owns some o' this Lo-Blo chattel, Neddee boy. I'm'a justa lookin'."

Turns out the Janus Bubble Gum Sector Fund owns a ton of that stock -- which the trader, whom we've imported for no clear reason from Charles Dickens, conveys in his own Dickensian way.

"Well what are you waiting for? BUY the Janus Bubble Gum Sector Fund, you ninny!" the hedge fund manager shouts at the man.

"But Ned -- dear Ned --" the old trader hesitates, because it hurts to disappoint the boss, "the market.... Why, the market. 'Tis closed, Ned. 'Tis after four pee-em, laddee."

"That's what you think."

The watery-eyed, overworked trader, uncomprehending, merely smirks toothlessly in bemusement. Edward Stern is losing his patience with this old dog, and it's time for a new trick.

"Listen, here's the number, OK? Now you call my friend over at Janus, you see? Because he's going to let us buy shares of his bleepin' Bubble Gum fund today, you got that? Today."

The trader's jaw drops. The distinguished hedge-fund manager continues.

"We're a hedge fund, right? This is Canary Capital, not some 17-year-old with a 56K modem, trading Daddy's E*Trade account."

"But why would they, the wights over at Yanus, why would they let us do that, now I ask ye? Buy the wery shares o' these funds what owns the stocks, I mean, before anyone else can?"

"Listen, you just open your big bopper and offer to pay them a million bucks, you got it? With the profits we scalp on this trade, heh-heh, let's just say we can afford it. And so WE make money, and THEY make money, and everyone's happy, right? Right. And while you're at it, call my guy over at Strong Financial, and also see if the boys at Bank One wanna play our game, and I'm betting Bank of America wants in on this action too."

(Anything misconstrued in the fictionalized story above is my fault, and I earnestly ask the partners of Canary Capital to drop me an e-mail at DavidG@Fool.com and let me know exactly how it was done.... Without admitting wrongdoing, of course.)

And, sure enough, they all wanted to play and they all did. And so, nota bene dear reader, the hedge fund took no risks, buying shares at YESTERDAY'S prices after a leisurely review of TODAY'S newspaper. And all seemed right with the world: Edward Stern and his trader made money, and therefore their customers made money, and of course their banking partners made money. In a way, even Eliot Spitzer made money, but for a different reason.

And it was all confessed to, apparently, without ever admitting any wrongdoing.

When even Morningstar, which always throw lots of stars -- morning, noon, and night -- this industry's way, comes out and says, "Don't buy these fund families anymore," you know something's up. I mean, that's like the adoring kid in The Natural -- who hands Robert Redford his magic bat -- handing him a dead fish, instead.

But this is not Canary Capital's story or Spitzer's or Morningstar's either. No sirree. This story, the way I'm telling it, isn't even those poor fundholders' story. Sure, they were played for suckers by their mutual fund companies, which were taking money on the sly to privilege someone else's hedge fund with the best prices available -- prices that never should have been available -- while Joe Fundholder got ripped off.

Nope, it's not their story either. It is not they for whom we sing.

You see, this is your story. It's for you. And the moral of it is the same moral that The Motley Fool has been espousing in print, over radio, on your computer monitor, in speeches, on TV, and yes, even occasionally in front of Congress, for more than 10 years now:

If you're going to buy a mutual fund, recognize that you're giving control of your money over to people who will think of it as their money... and whose goal is to take away as much of your money as they can, in fees and other expenses. It's not illegal -- in fact, it's just the business. Heck, some banks have people hired specifically to research how they can increase their fees, or find new ones to add on. If you were a bank, wouldn't you do that too? In a way, it's a war out there.

Thus, if you're insisting on buying mutual funds, buy index funds because at least they have low fees and are managed by computers, not egotistical, cheating, greedy, wimpy, downright evil, or otherwise, human fund managers.... who won't have to admit any wrongdoing.

But if you're like many of us here in Fooldom, you look to buy stock directly instead. YOU are buying the shares, NOT some overpaid middleman who is better known as the fund manager. If I'm going to get ripped off, I'd far rather be ripped off by a cheating CEO at a single one of the 15 companies I'm diversified into, rather than the mutual fund company that oversees all 15 of my mutual funds!

Here at The Motley Fool, we have several books that teach do-it-yourself investing in stocks, we have a free Fool's School you can read all the way through, and we have newsletters helping you find growth stocks, hidden gems, and dividend-paying stocks, depending on your needs.

No one is going to care more about your money than you do, and it makes as much sense in 2003 as it did in 1993 -- when we started The Fool -- for you to be the knowledgeable commander of it.

For then you won't have to look to Spitzer and his merry men to bail you out.

David Gardner co-founded The Motley Fool and writes for Motley Fool Stock Advisor. The Fool is investors writing for investors.


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