To Bail or Not to Bail

By Green, Paula L. | Global Finance, January 2004 | Go to article overview

To Bail or Not to Bail


Green, Paula L., Global Finance


Managers of corporate 401(k) plans invested in US mutual funds have been closely watching the emerging scandals. * By Paula L. Green

Corporate financial executives responsible for billions of dollars of assets in hundreds of thousands of 401(k) plans have been anxiously watching the latest wave of Wall Street financial scandals to hit the mutual fund business. While plan sponsors are not yet making any drastic changes, they are investigating whether the allegations of improper and illegal trading within the trillion-dollar mutual fund industry are affecting their own 401(k) plans, also known as defined contribution plans.

"What do you do when your fund manager is indicted?" says Judy Schub, managing director of pension and investment policy at the Association for Financial Professionals in Bethesda, Maryland. "There's a lot of concern out there, and companies are looking at what choices and options they have."

The mutual fund crisis erupted in September of 2003 when New York Attorney General Eliot Spitzer alleged that four mutual fund companies had engaged in improper relationships with Canary Capital Partners, a New Jersey hedge fund. Since then, some of the mutual funds under the scrutiny of federal and state regulators have included Bank of America's fund business as well as the Janus, Strong, Pilgrim and Invesco funds.

Many of the allegations have centered on activities such as late trading and 'market timing,' a practice in which an investor jumps in and out of a mutual fund in order to make a fast profit. While not illegal, fund companies can violate securities laws if they state in their fund prospectuses that they discourage market timing, but then make exceptions for favored investors.

Mutual funds captured $519 billion-about a third-of the $1.5 trillion that US employees invested in almost half a million 401(k) plans across the United States in 2002, according to statistics provided by Cerulli Associates, a market research firm based in Boston. At the end of 2002, 401(k) plans had about 43 million active plan participants.

Schub says the investment committees of many corporations are now scrutinizing their fund managers' activities. "Some are changing funds, others have adopted a wait-and-see attitude, and others are in the early stages and just asking questions," Schub says.

Jeff Robertson, an attorney with the Portland, Oregon, law firm of Bullivant Houser Bailey, agrees that plan sponsors should not automatically begin switching funds even if their fund is grabbing headlines.

"I tell my clients not to make any rash decisions even if they are in an affected fund," says Robertson, whose firm advises plan sponsors with anywhere from 50 to 1,000 employees. "Sponsors need to evaluate their funds, but there is no need to pull out as long as they make prudent decisions and evaluate the pros and cons." As fiduciaries of the 401(k) monies, plan sponsors need to show that they have acted in a responsible manner in order to avoid subjecting themselves to future lawsuits by plan participants.

Rick Meigs, president of the 401khelpcenter.com, agrees that dropping an implicated fund is not always the best option. "If you move from a fund that is in the headlines, you may not escape the issue," says Meigs, adding that a new selection may end up on the radar screen of regulatory officials. …

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