Clients, for the most part, also appear uninterested. Jetton reports that she has received no phone calls regarding any of the fund scandals, while Sullivan says he has fielded queries from "a couple" of individuals. The fact that stock funds took in some $3 billion during the week ending September 17, less than two weeks after news of the investigation broke, validates the observation by advisors that individual investors generally do not believe that what they are hearing about in the news has any impact on their own portfolios.
Reasons For Concern
But some advisors see that viewpoint as wishful thinking, and believe recently reported incidents reflect a deeper industry malaise. Steve Kanaly, president of Kanaly Trust Co. in Houston, says that many professionals don't realize the magnitude of governance problems funds have, or how those problems might affect them in the future. "We need to get a handle on an industry that has clearly gotten out of hand," he says.
A lack of independent oversight tops Kanaly's list of concerns. "Mutual funds are pretty much a self-regulated group," he says. "All too often, the board of directors consists of people who rubber-stamp what the fund company wants, and fail to consider the best interest of shareholders. They (the fund companies) have forgotten who they are working for." Kanaly believes that because of its tight budget and limited resources, the SEC is not giving funds the kind of oversight they need. "The mutual fund industry has grown much more rapidly than the regulators who are supposed to be watching it," he says.
Some advisors fear that if stiff penalties are not imposed on the fund executives who violated laws, more such behavior is likely to follow. "It's a total betrayal of confidence," declares Bill Bengen of Bengen Financial in El Cajon, Calif. "These guys have to be brought to justice. Until recently the mutual industry has stood out as an exception to all the problems and scandals on Wall Street."
But Bengen himself never used Strong or Janus funds for clients. "I always thought they were a little too aggressive, taking big risks in the name of performance," he explains.
The blasé attitude of some advisors also worries Richard Wagner of WorthLiving LLC in Denver. "Financial advisors have to be careful about who they do business with," he says. "To a large degree, the financial services business is based on trust. The accountants blew Enron and look what happened to them. Where are we on Strong and Janus?" Two years ago, Wagner authored an article in Financial Advisor proposing that investment companies who do business with advisors appoint at least one advisor to their board of directors. Given the questionable oversight of many funds' boards, such an idea could potentially address that problem.
Others agree with the need for more shareholder-responsive governance. "Most mutual fund boards are made up of 'yes' men who do not properly oversee the funds they are paid to oversee," observes Scott Dauenhauer, a principal of Meridian Wealth Management in Laguna Hills, Calif. "Most mutual fund companies focus on short-term rather than long-term performance. They are more interested in pleasing advisors, who control distribution, than the end user." He believes that while mutual fund after-hours trading is probably an isolated incident, it exemplifies "a greater problem in the mutual fund industry-the fund company and the boards putting the fund company's interests above and beyond the interests of the investor."
The bottom line for advisors, says Kanaly, is their responsibility as client fiduciaries. "Advisors are such a fragmented, busy group that it is often difficult for them to think things through and react," he says. "But I think the courts will react if they feel advisors should be held more accountable as fiduciaries. That makes it critical to reconcile whether mutual funds are adhering to certain guidelines."
While the possibility that an advisor could face legal action because of a fund's governance practices may seem remote, it is not impossible. In a worst-case scenario, a financial advisor could face a lawsuit from a client who lost money in a mutual fund with a record of severe and repeated violations, says Mercer Bullard, a securities law professor at the University of Mississippi School of Law and a former SEC Assistant Chief Counsel. "If an advisor had reason to know that a fund has a demonstrated history of compliance problems, then legal action would not be inconceivable," he says. "I think the bigger question is why anyone should risk that kind of liability when there are so many fund alternatives out there."
Apparently, some corporate retirement plan administrators agree that enough liability risk exists to justify an exit from funds under the microscope. Scott Brewster of Brewster Financial Planning in Brooklyn, N.Y., reports that one of his clients who had the Janus Overseas Fund in a company retirement plan was forced by her company to sell the fund and put the proceeds into cash. Her only other international investment option is a fund with a 5.75% front-end load and high annual fees. "The whole situation stinks," he says. "It seems the mutual fund companies win no matter what they do, at the expense of our clients."