My friend Univ. of Illinois law professor Larry Ribstein (who also put together the BusFilm web site on business movies) has an op-ed in draft on the mutual fund scandal, in which he argues:
Investors care mainly about fund returns. Market timing and late trading by large investors are significant only to the extent that they might affect expected returns, as by indicating mismanagement. But then it seems enough that investors know about the fund’s policies so they can decide whether to, for example, hire their own professional portfolio managers, invest in exchange traded funds whose prices are constantly updated, or buy low-fee index funds whose managers lack incentives to make deals with big investors.
Although at first glance Larry seems to be making the same "much ado about nothing" argument recently advanced by Alex Tabarrok, Larry does acknowledge the need for limited regulatory intervention; indeed, he seems to agree with my points that (a) no new laws are needed but (b) we do need to enforce the laws on the books:
There does seem to be a problem here. Special favors to large investors allow them to make discount purchases or premium sales of fund shares, siphoning $5 billion a year for “market timing” and $400 million for late trading from small investors, in addition to “liquidity” costs of portfolio rebalancing. ...
In short, [however,] the problems with mutual funds do not require a federal solution. Congress and the SEC have had their chance for 60 years. It’s time to give markets and state law a chance.
i agree with the thrust of Larry's case against new regulation, but disagree insofar as Larry seems unwilling to apply the federal laws that are already on the books. As I understand it, the mutual funds in trouble all had policies against late trading and market timing. The prospectuses by which they sold those funds described those policies (I pulled some of my fund prospectuses and they all have fairly detailed statements of such policies, although none of the fund companies in which I'm invested have been implicated -- yet). Hence, as I suggested in my original post, we not only have a problem of self dealing, we also have fraud. So while I'm all in favor of markets and state fiduciary duty law being used as constraints on the fund industry, I also think that the fraudsters can and should be punished under Securities Exchange Act Rule 10b-5 and the relevant Investment Company Act provisions. UPDATE: Larry emailed me:
To clarify [that] I don't suggest not enforcing current disclosure laws. My article asks whether disclosure alone is enough ("Beyond disclosure, the potential solutions become murky . . . "). Also, I'm curious what you think about my suggestion in my followup post that all we have in most of these cases is bad business judgment.
I don't know that I would call fraud bad business judgment. Anyway, as I understand the facts, at some of these funds the managers have had a financial stake in the entities allowed to do market timing, which would be self dealing.
