Putnam, Oberweis, RS Funds Get Misleading Results From Last-Minute Trades
2003-12-30 01:38 (New York)
"Among the top six performers in the third quarter, the
Bjurman, Barry Small Cap Growth Fund, managed by Bjurman, Barry &
Associates, had three of its top 12 stocks increase by at least 1
percent in the final 30 minutes of trading.
The same was true for three of the top six stocks held by
Nicholas-Applegate Capital Management's Growth Discovery Fund; for
three of the eight biggest stocks in the RS Smaller Company Growth
Fund, managed by RS Investments; for six of the 18 biggest stock
holdings of Oberweis Securities Inc.'s Emerging Growth Portfolio;
and for six of the top 12 holdings of the Oberweis Micro-Cap
Portfolio.
The Bjurman Barry fund doesn't buy stocks at the end of the
quarter, says fund manager Thomas Barry. ``We've never done it,''
he says. ``We never tried to do it.''
`We Don't Play'
Oberweis President James W. Oberweis, says, ``We don't play
those games.''
_______________________________________________________
Dec. 30 (Bloomberg) -- With seconds left in U.S. stock
trading on June 30, the final day of 2003's second quarter, shares
of Advance Auto Parts Inc. vaulted 73 cents in a single trade to
close at the day's high of $60.90. Among the beneficiaries of that
last-instant leap was the retailer's biggest mutual fund
shareholder, Putnam Investments.
When it came time to calculate the second-quarter
performance, Putnam's Small Cap Growth Fund looked better because
five of its six biggest stock holdings gained at least 1 percent
in the last three minutes of trading on the last day of the
quarter, according to Bloomberg data.
State and federal regulators are probing the $7.2 trillion
mutual fund industry for giving favored treatment to big
investors. At the same time, unknown to millions of investors,
mutual fund buyers may be basing their decisions on misleading
information about mutual fund performance, according to Bloomberg
data on more than 200 funds.
Advertised fund performance often gets inflated when stock
prices jump in the last moments before the end of a quarter, data
show. These quarter-ending boosts can result in bonuses for fund
managers, says Randall Powley, chief economist of the Ontario
Securities Commission, Canada's primary market regulator.
``This suggests the pattern of conflicts of interest is
deeper and far more embedded than investors thought,'' says
William Patterson, director of investments at the AFL-CIO, whose
union pension funds manage $400 billion. ``The fact that it
appears to be systematic makes it all the more outrageous.''
Big Holdings Surge
On Sept. 30, when third-quarter performance figures were set,
Putnam's Small Cap Growth Fund got more than one boost, when five
of its 10 biggest holdings surged at least 1 percent in the final
15 minutes of trading, data show.
Gains by the Putnam Small Cap Growth Fund's top holdings in
the last seconds of a quarter aren't consistent with the way Marsh
& McLennan Cos.' Putnam purchases stocks, says Tino Sellitto,
senior manager of the fund.
``We adhere to a disciplined approach to managing money to
deliver consistent, dependable, superior performance over time,''
he says. He declines to comment on what caused stocks to jump.
``There can be many factors,'' he says.
Without access to individual stock orders, it's impossible to
tell who pushed up a stock with last-moment trades. If one person
manipulates a stock's closing price, all funds owning shares would
benefit.
When Advanced Auto shares jumped 1.2 percent late on June 30,
Federated Investors Inc., Fidelity Investments, Janus and Putnam
were among dozens of institutional shareholders that benefited,
SEC filings show.
Investors Misled
``It's hard to be sure who's doing it,'' says University of
Pennsylvania finance professor David Musto. The phenomenon is so
widespread that, regardless of who makes the trades, investors in
many funds are misled by fund results, Musto says.
The late quarter trades have their largest effect on funds
invested in smaller companies, Musto says.
There's a good chance that last-moment bounces are caused by
investment managers at several mutual fund companies who
deliberately manipulate share prices at the end of a quarter to
make their performance look better than it really is, says Douglas
Scheidt, chief counsel of the U.S. Securities and Exchange
Commission's investment management division, which regulates
mutual funds.
Such manipulation is called portfolio pumping and is illegal,
Scheidt says. ``There's a high degree of risk this stuff is out
there,'' Scheidt says. ``It's hard to find. It's hard to prove.
When we find it, we're going to prosecute it.''
Fund Manager's Bonuses
An increase of as little as 5 cents in a small-capitalization
company's stock can have consequences for managers who are close
to beating a benchmark index or moving into the top 25 percent of
funds in their category, says Powley, of the Ontario Securities
Commission.
``Their bonuses go up,'' he says. ``Based on one transaction,
someone can go from being a middling money manager to being a top-
quartile manager.''
Fund companies, too, can profit from closing-minute increases
in fund values, says Rob Solt, who manages the Pearl Aggressive
Growth Fund, ranked second during the third quarter among funds
that invest in other mutual funds, according to Bloomberg data.
Many funds collect fees based on the value of assets held, which
rises when stocks go up, he says.
The gains for shareholders, however, are temporary, because
the stock prices that got pumped up during the final minutes of
the quarter often drop to their previous levels days later,
Bloomberg data show.
Prices Fall
Steven Madden Ltd., a trendy footwear designer and retailer
that represented more than 1 percent of the assets of the Brazos
Micro Cap Portfolio and the Safeco Growth Opportunities Fund, rose
2.3 percent in the last trade of June 30 to $22.09, its highest
closing price since April 2000. It fell 2.4 percent on July 1.
Netflix Inc., an online movie rental service owned by Oberweis
Emerging Growth Portfolio and RS Diversified Growth Fund, among
others, jumped 2.6 percent to a record close of $25.55 on June 30.
It fell 3.1 percent on July 1.
Long-term shareholders lose because the costs of last-minute
trades come from their money, Powley says.
All of the fund managers interviewed whose funds had
benefited from last-day trades say their funds don't engage in
portfolio pumping. Some say, however, that they've seen stock
prices surge in the final minutes of a quarter and were aware that
their funds could benefit.
`Sit Back'
``We sort of sit back and say, `It'd be nice to get another
percent,''' says Bruce Vogenitz of Landis Associates Inc. in
Kennett Square, Pennsylvania. The $145 million Henlopen Fund,
managed by Landis, was the top-performing growth fund in the third
quarter of 2003, with a 23.8 percent return, Bloomberg data show.
Four of its top 11 holdings rose more than 1 percent during
the last 15 minutes of trading on Sept. 30. Vogenitz says the
Henlopen Fund hasn't bought any shares on the last day of at least
the past eight quarters.
A study by Musto and three colleagues that covered trading
from the end of 1993 to the end of 1997 found that the best-
performing small-cap stock funds gained an average of about 1
percentage point during the last hour of the fourth quarter.
``There is this surge of trading,'' Musto says.
Investors suffer because they've been given false impressions
about how funds actually performed, and they could be making an
investment in a fund at a time when its stock values have been
artificially pumped up by fund managers, the SEC's Scheidt says.
``They've manipulated the price of the security, so that anyone
who buys it next is paying more than they should,'' he says.
Two Day's Difference
Fund returns can be significantly different depending on
whether they include the results of end-of-quarter trading,
Bloomberg data show. An investor who doesn't know about late-
quarter trading can lose money by trading on the wrong days, data
show.
A $10,000 investment in the Kopp Emerging Growth Fund grew to
$13,510 from Dec. 30, 2002, to July 1, 2003. That's $241, or 2.4
percent, more than the $13,269 for an investment made from Dec.
31, 2002, to June 27, 2003 -- almost the exact same period minus
the last days of two quarters.
Five of the Kopp fund's 10 largest holdings vaulted more than
1 percent in the last 10 minutes of June 30. Steve Crowley, a
senior fund manager at Edina, Minnesota-based Kopp Investment
Advisors Inc., says his fund didn't make the trades that day.
He says such surges in stock prices may be caused by fund
managers concerned with something slightly different from
portfolio pumping. ``There's a thing called window dressing, where
portfolio managers who didn't own the right stocks during a period
are buying so it looks like they did,'' Crowley says.
`You Can Lose'
University of Mississippi law professor Mercer Bullard,
formerly a lawyer in the SEC division that regulates funds, says
portfolio pumping can snare millions of unwitting investors. ``If
you don't know this is going on, you can lose a lot of money,'' he
says.
``You get performance numbers that are misleading to
investors,'' he says. ``That's the whole purpose of it.''
When fund companies own blocks of a stock, an increase of a
few pennies can affect the holdings of many mutual funds.
American Tower Corp., which owns wireless communications
towers, was among the Putnam Small Cap Growth Fund's top 10
holdings on Sept. 30. Its shares jumped to $10.15 from $10.01
during the last minute of trading in the third quarter, according
to Bloomberg data.
Putnam, with 10.4 million American Tower shares, got an extra
$1.5 million from that one-minute rise, according to SEC filings.
The 14-cent jump added $3.8 million to the value of American Tower
shares held by Fidelity as well as $2.5 million to the value of
shares owned by Wellington Management Co.
The Gainers
Late-breaking stock jumps were more the rule than the
exception on Sept. 30 among top-ranked small-cap growth funds,
Bloomberg data show.
Among the top six performers in the third quarter, the
Bjurman, Barry Small Cap Growth Fund, managed by Bjurman, Barry &
Associates, had three of its top 12 stocks increase by at least 1
percent in the final 30 minutes of trading.
The same was true for three of the top six stocks held by
Nicholas-Applegate Capital Management's Growth Discovery Fund; for
three of the eight biggest stocks in the RS Smaller Company Growth
Fund, managed by RS Investments; for six of the 18 biggest stock
holdings of Oberweis Securities Inc.'s Emerging Growth Portfolio;
and for six of the top 12 holdings of the Oberweis Micro-Cap
Portfolio.
The Bjurman Barry fund doesn't buy stocks at the end of the
quarter, says fund manager Thomas Barry. ``We've never done it,''
he says. ``We never tried to do it.''
`We Don't Play'
Oberweis President James W. Oberweis, says, ``We don't play
those games.'' Officials at RS declined to comment, and officials
at Nicholas-Applegate didn't return calls.
SEC officials have spoken out against portfolio pumping,
warning fund managers to avoid the practice. ``Nothing ever came
of it,'' says former SEC lawyer Bullard, referring to the agency's
2000 announcement that its inspectors would review mutual fund
records to check for illegal end-of-quarter manipulation.
The SEC's review started within weeks of a June 2000 case in
which the Ontario Securities Commission negotiated a settlement of
claims that an investment management unit of Royal Bank of Canada
had manipulated the closing prices of Toronto Stock Exchange
securities on 53 occasions from October 1998 to March 1999.
Settlement Paid
The Royal Bank unit, RT Capital Management Inc., benefited
because its management fees were based on the value of fund assets
at the beginning and end of a quarter, the commission alleged.
Under settlement terms, RT Capital admitted it didn't have
adequate written procedures for market-closing trades and paid 3
million Canadian dollars (US$2.28 million) to settle the case.
The SEC brought its first case in May 2001, alleging
manipulative end-of-month stock purchases by Connecticut hedge
fund manager Burton G. Friedlander.
In a related case, federal prosecutors in New York said on
Oct. 24 that Friedlander had been indicted on criminal fraud
charges, including the manipulative stock purchases cited by the
SEC. Friedlander disputes the SEC allegations and has pleaded not
guilty in the criminal case, says his lawyer, William Pinzler.
In August 2001, the SEC accepted a total of $550,000 in
settlements of cases alleging that employees at Boston money
manager Oechsle International Advisors and the U.S. brokerage unit
of ABN Amro Holding NV had either planned or carried out five
schemes in 1998 to manipulate the closing prices of Volkswagen AG,
Renault SA and other stocks on exchanges in the U.S. and Europe.
Few Cases
The firms neither admitted nor denied wrongdoing. Last July,
the SEC alleged that hedge fund manager Lancer Management Group
LLC had manipulated the closing prices of the stocks of virtually
worthless companies so as to pump up the apparent value of its
holdings.
The case is pending in a Florida federal court, and lawyers
for managing partner Michael Lauer didn't return calls seeking
comment.
Because investors may have many different reasons for buying
stocks, the SEC is reluctant to bring cases unless it has tapes or
other hard evidence that fund managers bought stock with the
intent of manipulating shares, Bullard says.
``They want a case where they have some evidence other than
statistical evidence to show that purchases were made to drive up
the stock,'' he says.
In its 2001 settlement, SEC investigators cited taped
telephone conversations during which an Oechsle money manager and
an ABN Amro trader talked about buying enough stock to achieve a
targeted closing price.
Proof of Intent
The SEC's Scheidt says proof of intent to manipulate is
important to effective prosecution. ``You could spend a heck of a
lot of time tracking down all this stuff, and then there may be 10
different explanations for why they would buy more of this
stock,'' he says.
Still, SEC Associate Enforcement Director Lawrence West says
the agency is on the lookout and will act when it's able.
``Misvaluation, market manipulation, portfolio pumping and window
dressing are things we're perennially concerned about,'' West
says. ``We bring cases when we can.''
Meanwhile, funds continue to get last-second help from rising
stock prices.
Three of the top five stocks owned by the $179 million Fifth
Third Micro Cap Value Fund on Sept. 30, for example, jumped at
least 1 percent during the last 30 minutes of trading, Bloomberg
data show.
At the end of the second quarter, when it gained 23.3
percent, the $230 million Brazos Micro Cap Portfolio had four of
its five biggest holdings vault at least 1.2 percent during the
last 15 minutes of trading.
`Kind of Silly'
Denis Amato, manager of the Fifth Third fund, says his fund
doesn't trade on the last day of the quarter. ``It's kind of silly
to do that,'' he says. The manager of the Brazos fund's American
International Group Inc. unit John McStay Investment Counsel, said
in a statement, ``We do not engage in that sort of trading.''
In December 2002, the SEC gave initial approval to a proposal
to hamper portfolio pumping and other possible mutual fund
manipulations by increasing to four times a year from twice a year
the frequency that fund managers must disclose their holdings.
The reports don't list trading dates. The proposal was still
pending in December 2003.
Extremely short-term trading for the benefit of fund managers
runs counter to the buy-and-hold strategies of the best mutual
funds, says Diane Jaffee, manager of Los Angeles-based TCW Group
Inc.'s Galileo Opportunity Fund.
``It's just foolhardy, because it can come back to haunt
you,'' she says. ``It's stupid business to do that.''
Given the spotlight that's been aimed at the fund industry
during the investigations of improper trading, the University of
Pennsylvania's Musto says he's surprised there was so much trading
in the final hour of the third quarter on Sept. 30.
``You'd think people would feel more watched these days,'' he
says.
--Bob Drummond in Washington at (1) 202 624-1939 or
bdrummond@bloomberg.net., through the Princeton newsroom. |
