Sucheta Dalal :Scandals galore on global fund management front (10 Nov 2003)
Sucheta Dalal

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Scandals galore on global fund management front (10 Nov 2003)  

Just as Indian retail investors are turning to mutual funds, hoping to catch at least a part of the stock market boom, the scandalous revelations about American Fund Management practices are threatening to eclipse the mega corporate scandals of a year ago.

Scandal has engulfed the biggest names in the global fund management business such as Prudential, Putnam, Strong Financial Corporation (whose founder chairman faces charges of personally making $6,00,000 through improper trades), Bank One, Alliance Capital and Bank of America. But a bigger casualty has been the exit of Juan M. Marceline, head of the Securities Exchange Commission’s (SEC) Boston office, over criticism that he failed to investigate a whistleblower’s allegation about wrong doings at Putnam Investments with alacrity.

Indian investors are now asking if such mischief is rampant in the Indian mutual fund industry as well. The answer is unequivocally yes. But one must remember that much of what US authorities are investigating was probably ‘accepted market practice’ until the numbers were added up. That is why New York Attorney General Eliot Spitzer, who opened the Mutual Funds’ can of worms says that ‘heads should roll’ at the SEC for failing to detect the fraud much earlier. US investigators are now focussed on what SEC’s chief of enforcement, Stephen M. Cutler has called ‘‘the ‘unholy trinity’ of illegal late trading—abusive market timing and related self-dealing practices’’.

Late trading allows favoured investors to illegally purchase units at old Net Asset Values (NAV) and abusive market timing allows big investors to indulge in rapid trading to take advantage of price fluctuations at the cost of other investors. Since many Indian Funds are of American parentage or have borrowed their structure and regulations, their gimmicks for attracting and favouring new, high net worth investors are also the same. In fact, one Indian fund manager has blown the whistle on such practices by writing to the Association of Mutual Funds of India (AMFI) to demand a clean up. He has also offered specific suggestions on how to end the mischief, which are now being examined by AMFI and the Sebi.

Astonishingly enough, despite the turmoil in the Fund management industry abroad, the most reputed Indian Funds continue to exploit convenient loopholes. For instance, on November 3, 2003, the day the Reserve Bank of India announced its half yearly credit policy, HDFC Mutual Fund issued an advertisement (dated November 1,2003) in a business newspaper saying that from 9.30 to 11 am on that day alone, it would accept valid investment applications at the previous day’s NAV. Strangely, this was applicable only to those investing over Rs 1 crore. The changes were made to the ‘Offer Documents of HDFC Short Term Plan and HDFC High Interest Fund-Short Term Plan schemes’. You begin to understand how big a bonanza this was when you notice that the BSE Sensitive index jumped an incredible 156 points on that day to close at 5,063.03. How could HDFC change the terms of the scheme for just one and a half hours on a particular day and that too for the big guys?

Simple. Some diabolical changes in Sebi’s Mutual Fund regulations that were made a few years ago allow Asset Management Companies (AMCs) to change the terms of the offer by merely issuing a statutory newspaper advertisement. Investors who dislike the changes, merely have be offered an exit at NAV. It is a take it or leave it situation. Many AMCs have changed the terms of their offer document through such statutory advertisements, but this is the first instance I know where the terms were changed for less than two hours.

Since few investors could possibly have read the newspaper notice and put together their cheques before 11 am that morning, one suspects that the AMC changed the rules to allow specific investors to get a favourable entry. Most fund managers are astonished at HDFC’s audacity and are waiting to see how the regulator reacts. If it does take immediate action, HDFC’s brand of ‘continuing a tradition of trust’ through 1.5-hour changes to offer documents will quickly be adopted by other funds too.

Retail investors are short-changed in several other ways. One of these, discussed earlier in these columns, is waiving entry and exit loads only for large investors. The cost is borne by small investors who remain with the scheme. Sebi has yet to plug this practice by mandating uniform loads for all investors in the same scheme.

A fund manager tells us that there isn’t even a uniform industry standard for deciding applicable NAV. Each scheme goes by the calculations put down in its Offer Document for individual schemes, but few investors understand whether this works to their disadvantage. Other forms of mischief include collecting high value cheques from large investors in the morning, allotting units at the previous day’s NAV and then ‘forgetting’ to deposit the cheque for a couple of days to give the investor an unfair advantage.

Our source says that an audit of liquid fund unit allotments, matched with the date of cheque realisation in respect of investments over Rs 5 crore, will reveal the extent of this malpractice. Another problem is the fact that Saturdays are treated as ‘non-business’ days by liquid and short-term plans, even though the debt market is open on that day. This allows an investor coming into an income or gilt fund on Monday morning to get Friday’s NAV and occasionally gives him room for arbitraging market movements.

Each time these tricks are employed, the losses to the fund are probably tiny, but as the US authorities have found, they add up to fairly substantial numbers and reveal a large scale betrayal of investor trust and fiduciary responsibility. Eliot Spitzer told a US Senate hearing that he had ‘opened up a window’ into ‘what has been foggy, murky and impossible to understand.’ Although the Indian fund management industry does not run into trillions of dollars, it is time that Indian regulators open that window too before the problem grows any bigger.

-- Sucheta Dalal