Don't Forget the Fund Scandal

You forgot, didn't you? You thought the mutual fund scandal was sooooo 2004. Oh, how I wish you were right. Monday, the SEC said that it had settled with Inside Value pick Federated Investors (NYSE: FII  ) over charges of trading practices that hurt long-term investors. The deal will require Federated to shell out an estimated $72 million.

Federated has long been implicated in the fund scandal; it's already paid close to $8 million to reimburse investors and $25 million to complete an internal investigation. At issue were practices called market timing and late trading.

Market timing is pretty much what it sounds like -- the rapid buying and selling of fund shares for the purpose of locking in gains or avoiding losses. Small investors aren't given this privilege, because doing so would make it more difficult for managers to keep funds on hand to for redemptions and making new investments. Certain large institutions -- including hedge fund Canary Capital Partners -- were offered an exemption in exchange for large investments in other Federated funds, according to the SEC.

Late trading, on the other hand, is far more despicable and illegal. It involves trading at the current day's net asset value after market close, making it possible to capitalize on information made public late in the day. The SEC said that certain Federated employees and a Texas hedge fund repeatedly engaged in the practice.

Sad, isn't it? Yep. The good news, though, is that this deal should close the book on the scandal for Federated. But Fools should note, too, that SEC's director of enforcement, Linda Chatman Thomsen, served notice with a statement that the Commission will continue to "... pursue mutual find advisers, and other fiduciaries, who place their interests above those of fund investors." Which means, quite simply, that this is no time to get lazy if you're a fund investor.

A while back, Motley Fool Champion Funds chief analyst Shannon Zimmerman offered a list of questions designed to help Fools find the best funds. They were as follows:

  • Is it pricey? (The typical actively managed stock fund's expense ratio will ding you about 1.5%.)
  • Does the manager churn through stocks like your kid goes through Xbox games?
  • How long has that guy been at the controls, anyway?
  • Does he put his money where his mouth is by investing his own moola in the fund? If not, why should you?
  • What's the fund's performance been like over the long haul? Would you have done just as well (if not better) in a low-cost S&P tracker?

I know these aren't easy questions to answer. They shouldn't be. Champ funds just aren't that easy to find. But they are out there, and these questions will help you screen for them at useful sites like Yahoo! Finance and MSN Money. Don't let your portfolio settle for anything less.

Are you a fund jockey? Never fear, we've got related Foolishness right here:

  • Have you prepared your fund portfolio for the New Year?
  • It's the season for fund distributions. Here's what you need to know.
  • How do you know you've found a market-beating fund? Find out here.

Who needs stocks, anyway? If you want market-beating returns from your funds, make sure you spend the time to find and invest in the best. Or let Shannon Zimmerman do the work for you. Subscribers to his Motley Fool Champion Funds newsletter have enjoyed picks that have outperformed their respective indices by more than 6% as of this writing. Get access to all of Shannon's buy reports by taking a risk-free 30-day trial today. All you have to lose is the prospect of better returns.

Federated Investors is a Motley Fool Inside Value pick. Take a risk-free 30-day trial today.

Fool contributor Tim Beyers has precious few funds. He only invests in champs. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what else is in his portfolio by checking Tim's Fool profile. The Motley Fool has an ironclad disclosure policy.


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