Mutual fund scandal shakes up 401(k) plans


FOR MANY workers, the mutual fund scandal is hitting close to home: their 401(k) plans.

Employers have a duty to make sure the plans are run in the best interest of workers, so many have been monitoring the evolving scandal that has engulfed some of the best-known fund companies.

Some tarnished mutual fund companies that administer 401(k) plans have been fired. And some 401(k)s have jettisoned funds from companies that ran afoul of regulators.

The 401(k) for Carroll County government workers recently dropped three funds from Invesco Funds Group. The funds had been underperforming, but when regulators filed civil fraud charges in December against Invesco and its chief executive officer, "that was the straw that broke the camel's back," said Bill Bates, who coordinates the 401(k).

Carroll County pulled $11.75 million, one-third of the plan's assets, out of Invesco funds. Last month, it began offering workers three better-performing and scandal-free funds, Bates said.

"I'm glad we replaced Invesco," Bates said. "These companies need to understand there are consequences when they are doing improper things. They should not be rewarded for it. They should know that people can take their business elsewhere."

The parent company of Invesco recently acknowledged that its procedures to protect against improper trading in its funds were not "completely effective." A spokesman said the company hopes Carroll County would give Invesco funds another chance someday.

More changes than usual are expected this year in 401(k) plans as a fallout to the scandal.

Nearly half of the 307 chief financial officers polled recently said their 401(k)s contained tainted funds, according to a survey by Duke University's business school and Financial Executives International. Among those with scandal-beset funds, three-quarters said they had made changes to their plans or might do so.

Here are changes likely to occur:

New funds. While some employers may take the major step of firing the fund company administering the 401(k), workers are more likely to see the ouster of one or two disgraced funds.

In some cases, employers automatically will shift money out of an old fund into a new one with a similar investing style, said Christopher Jones, an executive vice president with Financial Engines, an online investment advice provider in California.

Not all funds with similar styles are alike, Jones warned, and investors need to drill down to see if the new fund still meets their investment objective.

Check out the new fund's fees, too, Jones said. If they're much higher, investors might want to consider putting less in that fund and more in lower-cost funds, provided this move fits with their goals, he said.

Sometimes money from a dumped stock or bond fund is transferred into a cash-like investment, said John Rekenthaler, president of Morningstar Associates in Chicago.

The problem is that many participants leave the money there when it should be back in bonds or stocks, Rekenthaler said.

"Inertia is an overwhelming way in which 401(k) plans are managed by participants," he said.

Ideally, workers would take this opportunity to take a long, hard review of their portfolio. The quick fix is to immediately switch the money into another stock or bond fund in the plan, Rekenthaler said. "It's better than having it sit in cash for the long term," he said.

Limits on trading. A big part of the fund scandal involved market timing, in which some investors were allowed to jump in and out of funds to take advantage of price changes.

Though not illegal, market timing is often prohibited by funds because it can cut into the profits of long-term shareholders and run up transaction costs.

Market timing isn't just for fund insiders. Some employers early last year became worried about a handful of their workers market-timing in their 401(k)'s international funds, said Judy Schub, a managing director for a committee of the Association for Financial Professionals in Bethesda.

In some cases, employers are responding by requiring participants to hold international fund shares for a week or longer before trading, she said.

Other proposals being floated to prevent market timing include limiting the number of trades 401(k) participants can make each year or charging a fee to workers who bail in and out of funds too often, experts said.

Early trades. The investigation into mutual funds also uncovered illegal late trading in which investors were able to trade in funds after the market closed to take advantage of late-breaking news.

To prevent late trading, the Securities and Exchange Commission has proposed a "hard close," which would mean no trading order could be accepted after the 4 p.m. market close.

For 401(k) participants, whose orders take longer to process, that could mean submitting an order much earlier in the day to get that day's price. An order that came in too late would get the next day's price.

Some experts say that puts 401(k) participants at a big disadvantage. Others say it should have little impact on what's supposed to be a long-term investment.

Lower fees. New York state Attorney General Eliot Spitzer, who has led the charge against fund abuses, said he intends to force fund companies to lower their fees in settlement cases.

Fund companies may also lower them on their own. Putnam Investments, whose reputation was damaged in the scandal, said last week that it was lowering fees in its effort to regain investor trust.

The outpouring of bad news about mutual funds has a silver lining, said Michael Scarborough, president of the Scarborough Group in Annapolis, which manages individuals' 401(k) accounts. Workers notorious for neglecting their accounts are taking time to review them and ask questions, he said.

The last time workers had a renewed interest in their 401(k)s was during the corporate scandals.

"I always said Enron was a pretty good thing to happen," Scarborough said, "as long as you didn't work at Enron."

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