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Several States Fire Putnam As Fund Manager

Oct 31, 2003 | www.thestreet.com

Do you hear that giant sucking sound? Well, if you were in Boston, you might be able to it's the sound of money getting sucked out of Putnam funds.

Within the past 24 hours, three state pension plans fired Boston-based Putnam Investments as their plan manager in the wake of the fund-trading scandal that has engulfed the nation's fifth-largest fund company.

On Friday morning, the board that oversees the Rhode Island state employees' retirement plan voted to drop Putnam pulling its $651 million account. The Iowa Public Employee Retirement System also voted to oust Putnam from managing its $586 million plan. On Thursday, the Massachusetts state pension plan voted to withdraw its $1.7 billion out of Putnam's hands.

The latest developments mark the inevitable "other shoe" to drop on Putnam, the Marsh & McLennan unit that has been charged with separate civil securities fraud actions by state and federal regulators.

When asked Friday morning about Rhode Island's move, a spokesman for Putnam said, "We are disappointed about their decision, but hope that we will have the opportunity to manage investments for Rhode Island in the future."

Also Friday, the New York State Teachers' Retirement System said it fired Putnam as the manager of its pension portfolio, according to Reuters reports. Pennsylvania's teacher pension fund also fired Putnam from a $1 billion account, the reports said.

Earlier this week, the Securities and Exchange Commission and Massachusetts charged Putnam and two of its managers with civil fraud for engaging in improper trading in its international funds. The SEC says the investigation into Putnam is ongoing -- four other managers engaged in improper trading, according to Putnam. Massachusetts Secretary of the Commonwealth William Galvin also charged that Putnam committed securities fraud by allowing members of a New York boilermakers union to engage in trading in violation of the fund's policies.

The funds of Rhode Island, Iowa and Massachusetts constitute just over 1% of Putnam's $272 billion in assets, but this is likely to be the first trickle of a steady stream of outflows. Several other states, including California and Florida, have indicated that they may also dismiss Putnam from their pension plans.

Several fund-industry watchers had noted that state and corporate trustees for retirement plans might start dropping Putnam and other scandal-plagued fund firms from their plans because of the potential legal exposure they have as fiduciaries.

According to Mercer Bullard, University of Mississippi securities law professor and founder of fund-investor advocacy group Fund Democracy, pension plan fiduciaries are "once burned, twice liable" if they continue to invest in a fund that has been flagged for securities violations.

According to Putnam, four fund managers engaged in improper trading at the international funds they oversaw, and two other managers traded Putnam funds they didn't manage. According to published reports, Putnam said the four international fund managers generated profits of $500,000, while the other two managers generated $200,000 in profits. Putnam said it detected the trading activity in early 2000 and that the managers were identified and warned, but no disciplinary action was taken a point that has raised a chorus of angry voices asking why wasn't disciplinary action taken sooner.

The trading did not involve late trading of funds an illegal practice in which traders buy or sell a fund's shares after the 4 p.m. close but still get the earlier closing price. Apparently, the improper trading involved arbitrage of "stale prices" of international funds. This strategy involves "time-zone arbitrage," in which investors take advantage of the stale prices in the overseas stocks that a fund owns.

This strategy is not illegal on its face but clearly unethical for a fund firm or manager to engage in because it skims off the profits of long-term investors and raises their expenses because of the active trading. Meanwhile, many fund firms, including Putnam, say they work aggressively to curtail this type of market timing -- and do put obstacles in place for individual investors. Regulators say Putnam, and other implicated fund firms, have violated securities law by claiming to discourage market-timing in their prospectuses and then allowing it for a select few investors

Putnam is one of nearly a dozen mutual funds firms and the list is growing tainted by the stream of unseemly disclosures by regulators and fund firms themselves involving abusive trading practices that skimmed profits and raised expenses for long-term fund investors. It began Sept. 3, when New York Attorney General Eliot Spitzer announced a settlement with Canary Capital Partners, a New Jersey hedge fund, on Sept. 3.

In a 44-page complaint, Spitzer alleged Canary engaged in illegal and unethical trading in mutual funds. Canary paid $40 million in fines to settle the charges without admitting or denying guilt. The bombshell for the fund industry was that four fund firms allegedly entered into agreements with Canary, allowing the hedge fund to make illegal trades in exchange for Canary's parking millions of dollars into their funds which meant more fees for the fund firms. The four firms are Bank of America's Nations Funds, Bank One's One Group funds, Janus and Strong.

Since then, other firms have been implicated in market-timing or late-trading abuses, including Fred Alger Management, Alliance Capital, hedge fund Millennium Partners, Putnam and brokers Merrill Lynch and Citigroup's Salomon Smith Barney.


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