Financial Markets and Institutions (2-downloads)

New York Times, November 16, 2003, p. A1.

since the market is closed and no additional stock can be purchased by the fund.

As a result, the value of the fund’s assets the next morning will be $435 ($400 in

stock and $35 in cash). The NAV will be $435/11 = $39.54 instead of $40. All of

the original investors in the fund will have lost $0.46 per share, while the privileged

investor will have gained $4.54 ($39.54 – $35.00).

The costs to investors of market timing and late trading are very hard to estimate

since no reliable statistics are available on how frequently these abuses were prac-

ticed. Recent academic studies have estimated the losses to long-term investors to

be as high as $4.9 billion.

4

See the Conflicts of Interest box for a discussion of how

widespread mutual fund abuses may be.

Government Response to Abuses

Arthur Levitt, former chairman of the SEC, admitted, “I believe this is the worst scan-

dal we have seen in 50 years, and I can’t say that I saw it coming.”

5

In fact the SEC,

which is supposed to watch the mutual fund industry, was not the agency that ini-

tially investigated the abuses. It was New York State Attorney General Eliot Spitzer

who caught the SEC unaware by filing indictments against many of the major play-

ers in the mutual fund industry. Now that the issues are commonly recognized, both

the SEC and Congress are attempting to assure the safety of these funds.

•

More independent directors.

By January 2006, funds were required to

have an independent board chairman and 75% of the board must be inde-

pendent. In addition, the independent board members must hold annual

executive sessions outside the presence of fund managers. The legislation

also requires that these independent board members have authority to hire

staff to support their oversight efforts.

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