The crime was so inventive, so preposterous, so outrageous, that we didn’t even have a name for it. We called it “market timing” or “time-zone arbitrage,” or just “late trading.” We fiddled with analogies like betting on horse races after the winner’s been declared or playing with loaded dice. But neither explained the demonic subtlety or the diabolical nature of the chicanery.
Don’t be fooled, though. What Eliot Spitzer revealed when he recently exposed the transgressions of Canary Capital Partners and how the mutual funds let this hedge fund abuse their mom-and-pop shareholders was nothing short of fraud. Mutual-fund fraud. No different from bank fraud.
It’s a testament to the mutual-fund industry that it has been so scandal-free that we didn’t have a term handy for the allegations. After all, mutual funds invest your money and give you a return. There’s theoretically no room for fraud in that process. There’s supposed to be total transparency.
The return is supposed to be better than the market’s, but chasing a positive return is something that most of these funds gave up doing years ago. They are too big, too unwieldy, to beat the market in any sustained fashion.
So some have turned into giant 401(k) machines, kicking back dollars to companies in return for being able to administer the plans and stuff their coffers with big fees. Others have become huge marketers, bragging about the performance of whatever fund in the family happens to be hot even if the others all suck.
But it wasn’t until last week that we realized what you—if you’re really desperate—can sell if you can’t sell performance or track record: You can sell out the very investors who trusted you in the first place. That’s exactly what Bank of America and Janus did if you gave them enough money to pay them off.
The press accounts were all needlessly complicated. The actual deed was simple: Bank of America let Canary Capital set the clock back after good news. It gave Canary, in return for hefty fees, the right to be able to steal from the little guys in its fund families. The bank even gave Canary an up-to-date list of holdings—a menu to screw people from, so to speak. (Oh, and there goes another canard: Mutual funds always tell you they can’t give you up-to-date holdings of your money, yet they gave them in real time to people who wanted to bet against you!)
“Bank of America even gave Canary an up-to-date list of holdings—a menu to screw people from, so to speak.”
In practice, here is how it worked: If Intel announced a better-than-expected quarter after the close of the market, Bank of America let Canary buy into the net-asset value of its funds that were loaded with Intel and were sure to jump the next day. When the fund opened dramatically higher, Canary rang the register. Or if Intel preannounced a shortfall after the close, it let Canary sell short funds stocked with Intel. Next day, boom, a cover at a lower net-asset value and more money got coined. How sweet!
No wonder Canary shot the lights out for three years of the bear. And don’t believe for a minute that these firms didn’t know how crooked this game was. In October 1997, during a particularly strange day when our markets opened down and then roared into the close, I called Fidelity, eager to see if I could invest in one of its Japan funds, knowing that the fund would most likely roar off the back of the strength of the U.S. market. I told the customer-service rep that I was a good customer of Fidelity—true, I had millions with the firm—and I wanted to see if I could buy into the fund at the last closing price. The rep told me that Fidelity never allowed that kind of trading because it would be dishonest, that it would hurt everyone else in the fund. She made me feel like a total miscreant. Looks like I simply called the wrong fund family! (It’s too bad that anyone is using the term “after-hours trading” in regards to Canary—I’ve traded millions of shares after hours. But I never traded one share after hours with before-closing prices, unlike Canary. I never set the clock back.)
Canary was stealing profit from the great unwashed, those who didn’t know you could—and had specifically been told that you couldn’t—do what Canary was doing. The prices that Canary got when Bank of America set the clock back were the prices for those who assumed the risk of ownership. Letting Canary horn in caused everyone else to make less money. How much less? That’s actually an attainable amount, and it should now be refunded to the rightful owners, no doubt by the funds that played this game themselves. It’s no different from journaling money out of your account into Canary’s; now the shift will be made back.
What’s more important, though, is how easy this scam was to perpetrate. The funds, allegedly tightly regulated by the SEC, actually received scant scrutiny from the government on this issue. You could tell from their reactions that the Feds didn’t even know that this stuff went on. Clueless! The boards of directors overseeing the funds have been out to lunch for years; these are great-paying sinecures if you can get one. If it weren’t for someone with a conscience sending Spitzer the records and the e-mails (replete with quotes about selling out the little guy to the hedgies only if it brings in big fees), no one would have been the wiser.
Wall Street looked askance at Spitzer as a wild-eyed opportunist when he first championed the little guy by challenging corrupt Wall Street research. “Didn’t everyone know it was corrupt?”—that was the refrain I heard from big guys when they dissed Spitzer.
Now with these revelations, the Street’s reconsidering Spitzer. The crimes here were so unambiguous, the revulsion so gut-wrenching, that even the SEC, which had been silently critical of Spitzer’s actions, cheered when he brought this scummy practice to light.
One thing’s for certain, though: When someone goes to jail for this—and believe me, someone will—it won’t be for abetting market timing, or late trading or timing arbitrage. It will be for mutual-fund fraud. Which, from now on, will be synonymous with bank fraud, thanks to Spitzer’s doggedness and refusal to back down in the face of the bizarre machinations the Street seems to devise endlessly to separate moms and pops from their hard-earned savings.