A year has passed since New York Attorney General Eliot Spitzer launched his investigation of improper trading by mutual-fund companies. Since then, regulators have reached settlements of nearly $2.5 billion with 11 fund companies. A number of high-profile executives, including Richard Strong of Strong Financial Corp. and Harold Baxter and Gary Pilgrim of Pilgrim Baxter & Associates, have resigned from their firms amid charges of improper trading in their funds.
The scandal has also forced a sleepy industry to enact more changes than at any time in its history. Spitzer has led the charge to lower fund fees as part of the settlements, while the Securities & Exchange Commission has proposed new rules, such as cutting off trading in fund shares at 4 p.m. Eastern time. To help prevent conflicts of interest, the SEC voted to require funds to put new compliance policies in place and designate a chief compliance officer by Oct. 5.
The SEC enacted another rule requiring fund companies to hire independent chairmen and that their boards be at least 75% independent, and that has sparked controversy. As a result, a number of fund-company chairmen will be forced to step down, and costs will most likely rise. "The regulations are anti-shareholder in that they add bureaucratic red tape, whose costs ultimately are borne by shareholders," wrote Robert Olstein, president of Purchase (N.Y.) money-management firm Olstein & Associates, in an Aug. 31 letter to his shareholders.
BusinessWeek Online's Karyn McCormack recently caught up with Olstein, who runs the Olstein Financial Alert Fund (OFALX ) and has been digging deep into company financials for the last 27 years. Here are edited excerpts from their conversation:
Q: What's your basic beef with the new rules?
A:The SEC and the critics of the industry who are trying to stamp out criminality and poor ethics, which some people in our industry engaged in, put out new rules and regulations that are anti-shareholder. They have no concept of what created the problem -- in fact they were all regulatory issues -- and the SEC and NASD fell down on their job.
They're asking me to resign as chairman [of my fund company]. Not that the chairman is anything other than a figurehead role, but it's sending out the wrong message to shareholders and investors. There has been a very profitable relationship between mutual funds and individual shareholders, and it has been a successful format.
The fact that they're giving independent directors more power than they had in the past is going to lead to some issues that need to be changed -- and that is giving independent directors policymaking roles. Once you give somebody a policymaking role, are they really independent?
Q: What do you think could happen as a result of the new rule?
A:Somewhere along the line, a bunch of independent directors are going to fire a manager without allowing shareholders the right to decide whether they should. The shareholders are the ones who should be able to fire a manager, and they can do that every day. To put a gun in independent directors' hands, someone is going to use it. This is an anti-shareholder regulation.
Q: Do you have to add staff as well?
A:Our costs have gone up over a million dollars as a result of these regulations. If anything, they're entrenching some of these bigger firms that engaged in the illegal activities. They're adding insignificant costs to these giant firms, and adding significant costs to the intermediate funds, like mine, and smaller funds, and they're going to keep entrepreneurs out of the business. In fact, one great manager has already left the business.
I spend half my day now dealing with regulatory issues. This industry works really well. I don't know what Mr. [SEC Chairman William] Donaldson, Mr. [Warren] Buffett, and all these people who think there are big problems in this industry are saying. There are conflicts in their industries as well. When does conflict equal criminality?
Q: In early September, the U.S. Chamber of Commerce said it would sue the SEC over the new independent-director rule.
A:They should. The SEC overstepped its bounds. This is a legislative matter, and I don't think they should be telling people who should be the chairman. Our shareholders are concerned now that we're going to be disinterested, and we've gotten letters saying, "are these people morons?"
Q: Aren't regulators just trying to prevent conflicts of interest and trading violations?
A:You cannot legislate honesty and integrity. There already were independent boards. The independent directors are the only ones who can vote on matters in which there are conflicts. It just shows me a lack of understanding of how this industry works by our leaders. That's what shocks me.
We have four independent directors and three affiliated directors. But on any matters of whether to rehire me, or any conflicts including audit committees, etc., only the independent directors have votes. So my now having to add an additional four independent directors accomplishes nothing. They're already independent.
Q: So funds already had measures in place to deal with conflicts?
A:Measures were in place, but the [regulators are] assuming the independent directors should have been policemen. They don't have a regulatory role. They're overseers for shareholders -- they should be in a role where they're reporting to shareholders whether their manager is abiding by the prospectus. But any issues of a regulatory nature that come up should come through the audit by the SEC and NASD. And the [auditors] blew it. They didn't find these issues.
Q: What else can regulators do to find abuses?
A:There's no way to stamp out criminality through the legislative process. You punish, disgorge fees, you fine, and they did a good job on that -- the SEC. Spitzer did a good job on uncovering the issues, but then he went too far and started telling people what they should charge. That to me is illegal in itself.
I'm one of the biggest critics out there, and I'm always an anti-Establishment guy, as you know. I was a big critic of all the analysts and the brokerage firms and the problems three or four years ago. Now the big problem is with the people who are trying to regulate. They're going to stamp out the entire industry and the free-enterprise system. There were some cockroaches in the sink -- you don't blow up the whole building.
Q: Do you agree with any of the new SEC rules?
A:Of course there should be an SEC rule for independent directors. But I think they don't understand the problem. They don't understand what the issues were, and the issues were regulatory in nature. Basically, they're sending out the wrong message to shareholders. They want us to lower fees, yet they're increasing our costs!
Q: Is the SEC going too far?
A:The SEC doesn't understand the problem. I'm not for anyone behaving criminally or unethically. But there are a thousand funds that have returned 10% or more to shareholders between 1998 and 2003 despite a bear market. Does that sound like an industry that doesn't work? I don't think so.