Mutual Distrust and What You Can Do About It

When my Daddy's car was getting low on gas and he'd roll by a garage that didn't have its fuel prices posted on big signs, he would observe that the reason they weren't displayed was because the owners weren't very proud of their prices.

The same might be said of investment and financial service providers. I am endlessly dismayed by the information some brokers, mutual funds, and other industry providers exclude from client statements. It's often difficult or impossible to determine, for example, how much the broker's fees or commissions are or which class of mutual fund the investor actually owns. If this information is not readily provided, my Daddy might have said, maybe it's because they aren't very proud of their prices.

Even if not prominently posted, many investors are nevertheless aware of the exorbitant prices some mutual funds charge, particularly those that carry a sales charge, or load. Another cost that came to light only recently is the price some mutual fund investors are paying to privileged customers of mutual funds. This is the cost of investor fraud.

It's Hard to Keep Up
You may be forgiven if you have not paid all that much attention. Rest assured, it's business as usual: Somebody's pulling a fast one, and Main Street investors once again wind up on the short end of the stick. The list of abuses is long, so I will summarize the highlights.

In early September New York Attorney General Eliot Spitzer accused four mutual fund families (Bank of America's Nations Funds, Banc One, Janus Capital Group, and Strong Capital Management) of fraudulent practices that enriched fund managers at the expense of . . . guess who: shareholders. The essence of Spitzer's charges was that these mutual funds permitted a privileged customer to trade after the market closed. This not only gave this customer a huge advantage at the expense of other mutual fund shareholders, it was indisputably illegal.

Here's why. Say Mutual Fund A owns a large block of Company XYZ shares. After the market closes, Company XYZ announces that it just lost a big contract and, as a result, its earnings will be down significantly. The privileged customer executes a trade, dumping shares of Mutual Fund A at that day's earlier closing price - the price it was before the news was announced.

The next day Mutual Fund A closes down sharply, driven lower largely by Company XYZ's news. This downward move is exacerbated by the privileged customer's selling. Remaining shareholders are left holding Mutual Fund A at its lower price. This investigation provides just one example of how some mutual fund investors are getting taken by Wall Street shysters. If you are not yet overcome with cynicism, here's a few more.

Morgan Stanley recently agreed to pay a $2 million fine to settle allegations that it held prohibited sales contests between October 1999 and December 2002. Morgan Stanley brokers were reportedly under intense pressure to sell in-house mutual funds and certain lucrative annuities, potentially steering clients into unsuitable investments. Massachusetts authorities accused Morgan Stanley of "contempt" for its customers.

A former Bank of America broker was recently charged with larceny and securities fraud. He won the distinction of becoming the first person to face criminal (as well as civil) prosecution as a result of recent ongoing investigations into shoddy mutual fund trading. Spitzer said this particular investigation "is likely to result in numerous other charges." I could go on, but you get the picture. It's not clear how many funds are involved. Spitzer said that privileged customer mentioned earlier had formal agreements with 17 mutual fund families.

How to Protect Yourself
What are we to do? Is there no sanctuary from this plague of corruption that is spreading like an Oregon wildfire through every investable nook and cranny, sucking dollars from our investments? Here's a few ideas.

Come to terms with the unfortunate reality that fraud and deception have been part of the human landscape since Lucifer distracted Eve, and neither is about to disappear any time soon.

Then consider that investing with a prominent name is no guarantee that you won't get burned. Names like WorldCom, Morgan Stanley, Bank of America, and Martha Stewart are well-known. Yet all of these, as well as many other big names, have recently been charged with misbehavior. Many already have or will soon reach a pretrial settlement while invoking the most overused phrase of the decade: "without admitting or denying wrongdoing."

While safety can never be entirely guaranteed, a few relatively easy steps can reduce the likelihood that you will become a victim of securities fraud.

First, you must take some responsibility for your own well-being. You may not have the knowledge, ability, or time to manage your own investments, but you must nevertheless take a certain minimum amount of responsibility to protect your wealth. You must be thoughtful and observant, not get into anything you don't understand, and seek trusted and knowledgeable advice. A certain amount of skepticism and cynicism can work in your favor.

If you hire an advisor or broker to manage your assets, monitor her on a regular basis. Ask your advisor or broker how much you are paying to invest. How does your investment advisor get paid? How much does your broker charge in commissions? Does your advisor or broker tend to put you into her company's mutual funds and investments? If so, could this be a conflict of interest that enriches her at your expense? Does she sell you loaded funds that are expensive to get into, maintain, or get out of? Does she seem to do a lot of trading in your portfolio? If your advisor or broker does not readily answer your questions or is not forthcoming in laying out all the costs to you to invest, it may be that she is not very proud of her prices.

Stick with companies that have a long track record of treating customers well. In the mutual fund industry, for example, I would favor names like Vanguard, T. Rowe Price, TIAA-CREF, and others that offer an assortment of low-cost funds, that generate much more good publicity than bad, and that can reasonably be expected to continue treating investors fairly?and at a price they can be proud of.