The Wooden Anniversary

Evidently, the proper gift for a fifth anniversary is something made of wood. Given that we are celebrating the fifth anniversary of the mutual fund scandal of 2003, wood seems particularly apt: it’s sort of boring and a little stale. That said, now that we are in the midst of a bear market, I thought it might be interesting to revisit the mutual fund world five years after the scandals made headlines on September 3, 2003.

The first thing that strikes me as ironic is that the dragon-slayer who was at the center of the scandal was then-New York Attorney general Eliot Spitzer. (Yes, the Eliot Spitzer who is now the former-NY Governor after become ensnarled in a headline-grabbing sex scandal.) The mutual fund cases were Spitzer’s second act after blackmailing the nation’s top investment banks in the analyst settlement.

Initially, Spitzer announced the probe into four mutual funds that were thought to have engaged in “market timing,” which is somewhat of a misplaced name, since timing the market is obviously not illegal. The basic premise of the case was that certain large institutions and/or hedge funds were allowed privileges that regular old shareholders like us could not get. That was the catalyst that brought the mutual fund business under the microscope.

Five years hence, it is amazing to consider that a couple dozen funds or their executives were formally charged by the SEC or state regulators and millions of dollars of fines and penalties were paid. At the time, it was a slap on the wrist, but the exposure of mutual fund excesses helped small investors in significant ways.

The scandal exposed an industry filled with excess. For the first time in twenty years, investors started to pay more attention to the fees inside funds and forced the most egregious fund families (Putnam, Janus) to change their ways. It was as if the curtain was lifted and out came a little (albeit rich) man, not a wizard. Suddenly, the mutual fund business was naked, with its fat, hidden fee structure apparent for all to see. Only when investors dared to look, were they able to see the truth. The mutual fund industry lost its way during the bull market and until investors demanded a more transparent fee structure, they were doomed to be on the short end of the stick.

As the fund scandal celebrates its fifth anniversary, there have been some terrific changes that investors should celebrate. The 2003 mutual fund scandal ushered in an era of exchange-traded funds and savvier investors, forcing mutual fund families to lower their fees and become more transparent. To celebrate, investors may find that they finally are on the longer stick…a piece of wood, after all!