'Socially responsible' firm says fund hit by market timing in 2003


The Pax World funds, a pioneer in socially responsible investing that says it offers shareholders the chance "to do good while doing well," has acknowledged that one of its mutual funds has been hit by market timing.

In a recent letter to shareholders, Chairman Laurence Shadek and President Thomas Grant said an internal investigation in response to Securities and Exchange Commission inquiries determined that Pax World failed to prevent investors from engaging in market timing of its High Yield Fund during 2003.

Market timing, which is rapid in-and-out trading in funds, has been at the heart of the scandals that have engulfed the $7.9 trillion mutual fund industry in recent months.

Fund firms have been socked with hundreds of millions of dollars in penalties for allowing market timing and late trading, in which investors conducted transactions after the market closed at that day's ending price.

But unlike many of those cases, Grant said in an interview, the Pax World funds did not solicit the market-timing business in exchange for substantial, long-term investments from the market timers.

"There was none of that," he said, adding that there is no indication of any late trading at the fund or market timing by any Pax World employees.

Although critics say the market-timing transactions raise expenses for long-term investors, the letter from Shadek and Grant said the activity in the Pax World fund did not incur significant costs.

"While we regret this situation, we believe that our shareholders did not suffer any material losses due to this activity," the letter said.

But the admission is a black eye for an organization built on offering customers what it deems to be ethical choices in investing. Its funds screen companies by various criteria, and do not invest in firms involved in defense or weapons-related products or those that manufacture tobacco, liquor or gambling products.

Socially responsible funds "have kind of held themselves out not only as ethical funds but ones that were safe havens because they were focused on their companies' ethics as well," said Russel Kinnel, director of fund research at Morningstar Inc.

Although some funds linked to market timing and late trading have had large shareholder pullouts, Grant said the Pax High Yield Fund has seen no significant redemptions recently.

But Kinnel said socially responsible investors "are very focused on ethics and trying to do the right thing. Those kind of problems can have serious repercussions."

Kinnel said he was not aware of any other socially responsible funds implicated in market-timing or late-trading activities.

In Maryland, the Calvert Group Ltd., a Bethesda firm that offers more than a dozen socially responsible mutual funds, started to crack down on the practice after discovering market timing in its World Values International Equity Fund several years ago. Calvert monitors trades and imposes a fee for buying and selling within the same 30-day time frame in most of its funds, spokeswoman Elizabeth Laurienzo said yesterday.

"When all this came to light in the industry back a few months ago, the first thing we did was reinforce our communications with brokers, clients and shareholders that we don't allow and have never allowed market timers," Laurienzo said.

Socially responsible investing has grown sharply in recent years. The Pax World Balanced Fund, introduced in 1971, is widely credited with being the first diversified, publicly available fund to adopt broad socially responsible investing standards.

Since then, according to SocialFunds.com, the sector has grown to nearly 200 funds that use one or more social criteria in their investing, with all investments using at least one social investment strategy totaling hundreds of billions of dollars in assets.

The Pax World letter said the market timers took advantage of policies designed to allow long-term shareholders to switch investments among its funds, which helped the timers escape redemption fees that would have made the market timing "prohibitively expensive."

"The difficulty in discovering and stopping this form of activity resulted, we believe, from a combination of our outside vendors' systems limitations and a failure on our part to promptly recognize the significance of what was occurring," the letter read.

The letter said Pax World has undertaken several steps to prevent a recurrence, including close monitoring of unusual trading activity.

An SEC review brought the issue to Pax World's attention, the letter said, and the funds received a so-called deficiency letter in regard to the market timing. Deficiency letters are sent after about 90 percent of reviews, the SEC said, and not all are referred to enforcement officials for further investigation.

SEC spokesman John Heine declined to comment on the Pax World situation.

Sun staff writer Laura Smitherman contributed to this article. The Chicago Tribune is a Tribune Publishing newspaper.

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