It's hard to say which employees of mutual fund giant Janus Capital Group should be cashiered first—the executives who allegedly screwed thousands of mutual fund customers by striking special trading deals with disbanded hedge fund Canary Capital Partners, or the public relations executives who most likely wrote and approved the pathetic letter to investors that appeared on the company's Web site yesterday. The letter is posted under the name of President and CEO Mark B. Whiston and is, quite possibly, the worst act of corporate spin this year.
On Wednesday, the nation's top securities regulator, New York State Attorney General Eliot Spitzer, announced an enforcement action against Canary hedge fund manager Edward Stern. Stern—who neither denied nor admitted guilt, but nevertheless agreed to forfeit tens of millions of dollars in profits—is obviously cooperating.
Stern was allegedly granted special trading privileges by mutual fund managers in exchange for agreeing to place cash in other funds run by the same companies. The complaint describes two trading tactics. In "after-market," or "late" trading, investors are permitted to buy shares in mutual funds at the 4 p.m. closing price, after the market had closed. As Spitzer put it: "Allowing late trading is like allowing betting on a horse race after the horses have crossed the finish line." This is explicitly illegal. The second tactic is market-timing, in which investors jump in and out of the mutual fund shares at times when the net asset value doesn't reflect the current market value of the stocks in the fund. While not specifically outlawed, market-timing is nonetheless frowned upon. And, as Spitzer notes, "mutual fund companies state in their prospectuses that they discourage or prohibit these practices." In both instances—and here's the rub—any profits that accrue to a trader come directly out of the pockets of existing mutual fund shareholders, large and small.
The conduct was damaging for all three of the companies named in the complaint—Bank One, Bank of America, and Janus. But it's particularly dangerous for Janus. Bank of America and Bank One are gigantic financial services conglomerates with huge retail bank, commercial lending, credit card, and investment banking operations. But managing other people's money is Janus' only significant line of business. Which is why its stock is down about 10 percent in the past few days while those of the others are down only about 2 percent.
Mutual fund companies that do poorly by their customers suffer, as Janus knows first-hand. Because the company stuck with concentrated portfolios in high-tech high-fliers for far too long, its assets under management have plunged from over $300 billion at the height of the boom to $149 billion as of June 30. Given all this, you would think that Janus, essentially accused of shafting thousands of its own customers, would respond to the charges aggressively.
But rather than confront the allegations head on, Janus has responded with a mixture of evasion, dissembling, and reality denial that would do Ari Fleischer proud. "At the outset, it's important to note that Janus was not mentioned in connection with the after-market trading allegations—and that we were not named as a defendant in any legal proceeding," Whiston notes. That's a little like getting rounded up with a bunch of accused thieves and stipulating that it's important to note you haven't yet been charged with armed robbery. What's more, if you listened to Spitzer's press appearances, it's clear that Janus and others are highly likely to be a target of legal proceedings.
Whiston concedes that Spitzer has alleged that "we—and at least three other fund firms—allowed Canary to market time," and he points out that Spitzer said it was "a near certainty" that other mutual fund companies could be named. The implication: Since others were doing it, and since others as yet unnamed may have also done it, the conduct alleged isn't so bad or reprehensible. That's hardly a comforting message. Asset managers like Janus are supposed to beat the market and established benchmarks, not simply run alongside the crowd. They're supposed to follow best practices, not just-as-bad practices.
Because the investigation is in its early stages, Whiston continues, "there's very little we can say about the allegations except that we're reviewing the complaint closely and intend to continue cooperating with Attorney General Spitzer and his staff." Legally, this may make sense. But from a business perspective, it beggars belief. Janus stands accused of violating its most basic commitment to customers. It's long past the time for Janus to be "reviewing" allegations. Spitzer appended to the complaint several remarkably damning e-mails that show Janus executives grappling with the problematic issue—and coming down on the side of greater profits over investor protection. Responding to an employee's concern that letting investors engage in market-timing would be bad for business, Janus International CEO Robert Garland allegedly responded, "I have no interest in building a business around market timers, but at the same time I do not want to turn away $10m-$20 m."
When your corporate reputation is under assault, actions speak far louder than words. But Whiston has taken none. He didn't show up on CNBC and apologize personally to investors. Janus has apparently not moved to sanction, suspend, or discipline any of the employees who allegedly engaged in this behavior. It hasn't even taken the lame step of commissioning an outside law firm—hello, David Boies—to conduct an investigation.
Here's the line coming from Janus: We're just as bad as everybody else, and a few others are even worse. We haven't been charged with a crime—yet. We're really, really concerned about these investor-harming practices (which, by the way, padded our profits big-time). But we're not so concerned that anybody is going to be held responsible for their actions. We're innocent until proven guilty in a court of law. Now give us your hard-earned money.