Mutual Funds: Legal Probes Threaten Profits

Oct. 30 -- Many mutual fund firms are enjoying strongquarterly earnings, thanks to growing investor optimism and arebounding economy. But a widening regulators' probe into shadytrading practices threatens to cut into fund firms' profits.

Massachusetts and federal regulators filed civil complaintsTuesday against Putnam Investments for allegedly improper activity.It was the first formal accusation of wrongdoing against a mutualfund company.

That comes after New York Attorney General Eliot Spitzer accusedhedge fund Canary Capital Partners LLC in September of illegaltrading involving Bank of America Corp., Janus Capital Group Inc.,Bank One Corp. and Strong Financial Corp. funds.

And several other companies, including Merrill Lynch & Co.,Alliance Capital Management Holding LP, Prudential Securities andFred Alger Management, in recent weeks have suspended or firedemployees believed to have engaged in illegal trading.

But while some fund shares have taken a hit on the news, theoverall stock market recovery has driven up mutual fund assets,leading to higher revenues and profits. Analysts say the probe'sfindings so far might have come too late for third-quarter earningsand the impact could be felt later.

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"The probe could affect every single company in the industry,"said Rachel Barnard, a stock analyst at Morningstar Inc. whofollows asset managers. "There certainly could be more revelationswhich have to make investors cautious."

Still, analysts believe the probe shouldn't dramatically hurtfund firms' earnings so long as the price tag of the scandalremains in the millions. That figure would be just a fraction ofthe $7 trillion total in industry assets.

Spitzer's complaint alleges illegal late trading, which StanfordUniversity professor Eric Zitzewitz has estimated costs investorsabout $400 million a year. It also includes allegations of markettiming, a practice that is illegal only to the extent fundprospectuses prohibit it; that activity is estimated to costlong-term investors billions of dollars.