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Stately fund managers tainted

The mutual funds scandal has taken on a new, perhaps much more damaging dimension with accusations that fund managers and top executives engaged in their own improper trading at the expense of other customers.

The allegation that even someone as highly placed as Richard Strong, founder of the Strong mutual fund family, was involved has infuriated investors and is a serious black mark against the $7-trillion industry, which long has enjoyed a squeaky-clean reputation.

At issue is not the money actually lost by investors, which at most may amount to a couple of billion dollars spread among some 90-million U.S. mutual fund shareholders. The real price is in a loss of trust that already is scaring some investors away.

"This is the biggest stink that's ever happened to the mutual fund industry," said Roy Smith, professor of finance at the Stern School at New York University. "You could say the first couple of cases of this were because of competition, but when the managers start to do it themselves, it's nothing more than putting your thumb on the scale."

Until this week, allegations in the spreading scandal focused on preferential treatment by fund managers of big-money customers, who were allowed to book after-hours trades at prices already closed to most fund shareholders and to engage in quick in-and-out investing known as market timing. Although market-timing is not illegal, most funds prohibit it because it racks up expenses that hurt long-term shareholders.

Now, the charges include trading by executives and fund managers themselves. Their profits came at the expense of fund shareholders whose interests they are supposed to protect.

Filings Tuesday by the Securities and Exchange Commission and Massachusetts suggested how widespread the trouble is.

Those documents allege that two international fund managers for Putnam Investments, Justin Scott and Omid Kamshad, reaped hundreds of thousands of dollars each with excessive short-term trades in Putnam funds they managed.

Putnam, which denies any wrongdoing, was aware of the activity and warned them to stop in early 2000. But Scott and Kamshad were allowed to keep their profits and continued to trade after the warnings, according to the filings. They were not fired until the end of October.

"As a result of his short-term trading, Scott realized hundreds of thousands of dollars in gains," the SEC complaint said. "Scott often traded millions of dollars worth of mutual fund shares."

Richard Strong has not been indicted or otherwise charged in the fund scandal, but he acknowledged conducting short-term trading in some of his and his family's personal accounts that were invested in Strong funds, despite the funds' policy against such trades.

In a statement, Strong did not say how much money the transactions involved but said he would personally compensate the funds for any financial losses, although he does not believe the transactions were harmful.

His offer came a day after New York Attorney General Eliot Spitzer indicated charges against Strong and his company were forthcoming. The Associated Press said an unnamed source familiar with the probe has estimated Strong's market-timing yielded as much as $600,000 _ pocket change to a man Forbes magazine estimates is worth $800-million.

Strong also said he would step down if it became appropriate _ but that may not be enough to reassure shareholders angered that the man supposed to protect them failed to do so. Strong is chairman of Strong Financial Corp., which manages nearly $43-billion in assets.

Pension funds in New York, Pennsylvania, Rhode Island and Iowa fired Putnam on Friday. They joined Massachusetts and Vermont pension officials, as well as some universities, in announcing plans to pull at least $4.4-billion out of the company, which lists $272-billion in assets under management. New England Pension Consultants, a firm that advises 190 pension plans with $150-billion in assets, has recommended that clients get out of Putnam international stock funds.

It's been a devastating year at Putnam Investments: underperforming funds, then scandal, and now a struggle to retain customers with the company's future on the line.

To reassure investors, the fund industry's trade association, the Investment Company Institute, is proposing tightening up on the 4 p.m. closing time for buy and sell orders for funds. It also wants the government to impose a 2 percent redemption fee on short-term transactions to discourage market-timing, and is asking fund firms to rewrite their ethics codes to prevent trading abuses by employees.

The SEC is expected to consider new rules for funds by the end of November. The first item on the agency's agenda would bar mutual fund companies from accepting orders from brokers after 4 p.m., a rule SEC officials say would reduce illegal late trading. The commission also will look at mutual funds' governance, management and board makeup

And Senate Banking Committee chairman Richard Shelby ordered his panel to begin an inquiry into the trading abuses, saying, "this is an issue that's not going to be swept under the rug, can't be swept under the rug, shouldn't be swept under the rug." The Alabama Republican called for hearings to begin in about two weeks.

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