When it hit the headlines back in 1998, the "Dreyfus Affair" was one of the most troubling episodes in the history of the squeaky-clean mutual-fund industry. Michael L. Schonberg, a portfolio manager at the Dreyfus Corp. fund group, purchased shares for Dreyfus in two thinly traded microcap stocks--even though he personally owned those stocks. Such trading raised a serious question: Were Dreyfus' ethics policies sufficient to protect investors from conflicts of interest? And Dreyfus' vigorous defense of Schonberg raised yet another issue: Was the firm's stellar reputation a chimera?
Reputation is a malleable concept--especially on Wall Street, where a firm's repute is built as much on press releases, and the spin of highly paid flacks, as it is on its actual conduct. Wrongdoing is rarely admitted--thereby making it all the more likely to be repeated.
BOMBSHELLS. And that is the problem with the settlements that were reached on May 10 between Dreyfus and the Securities & Exchange Commission and the New York State Attorney General. By failing to force Dreyfus to admit wrongdoing, regulators missed a golden opportunity to show the Street that such conduct will not be tolerated.
The text of the SEC settlement makes clear that Dreyfus' ethical lapses were far worse than were known in 1998--and went far beyond possible conflicts of interest. The SEC found that Dreyfus violated the rule requiring mutual funds to adequately police personal trading. But that was just the "tail on the dog," in the words of Richard Sauer, the SEC's assistant director of enforcement. Even worse, the SEC found that Schonberg improperly inflated the performance of his Dreyfus Aggressive Growth fund by overallocating to his fund shares in hot initial public offerings.
And there's a bombshell buried in a footnote. Back in 1998, Business Week reported that Schonberg bought shares for his funds in two stocks he owned--Chromatics Color Sciences International and Tidel Technologies. Boy, were we wrong. The SEC found he bought nine stocks he personally owned. And Schonberg told Dreyfus about every one.
Dreyfus' procedures for detecting such potential conflicts were not just inadequate. They were nonexistent. Sauer says there weren't even basic procedures to ensure that Dreyfus knew if portfolio managers were engaged in such trades. But if you think that Dreyfus and Schonberg are even the slightest bit remorseful about all this--well, you've got another thing coming. Sure, Dreyfus and Schonberg, neither admitting nor denying liability, consented to pay $1 million in penalties to the SEC, and $2 million to New York--lunch money for Dreyfus--and Schonberg agreed to a nine-month suspension. But far from showing even a twinge of regret, they portrayed the settlements almost as a vindication.
Dreyfus was first out of the starting gate, with a press release proclaiming that regulators "did not find intentional wrongdoing"--glossing over that the SEC found that Dreyfus and Schonberg both "willfully violated" the law by improperly allotting IPOs to the fund. Schonberg's lawyer chimed in with a statement saying that neither the SEC nor the New York attorney general found that Schonberg's trading "in any way" violated federal or state law.
True. But since it was clear Schonberg had always told Dreyfus about his trades, legality was never the central issue raised by the affair. The problem went far deeper:
Did Dreyfus ignore possible conflicts of interest by one of its most visible portfolio managers?
Because of the firm's regrettable effort to minimize its misconduct, Dreyfus' customers may have good reason to doubt that the firm is truly mending its ways. And the SEC should take note. Instead of another meaningless million-dollar slap on the wrist, the SEC should penalize the next Wall Street press-release factory with a far more serious penalty and a sanction that would hurt even more: a press release containing three simple words: "We were wrong."