With investors finally returning to the stock market, the last thing financial advisers and fund managers need right now is an industry scandal. But according to reports, that may be exactly what they're facing.
News of a federal investigation reportedly probing mutual fund companies, broker-dealers and consultants — as well as investment banks and hedge funds — could cause investors to dump equities, industry observers and financial advisers say.
The Wall Street Journal reported Saturday that the Securities and Exchange Commission, the FBI and the New York Attorney General's Office are conducting criminal and civil probes into possible insider trading at a number of companies. Specifically, investigators are looking at whether traders at various financial services firms received non-public information from expert networks and third-party research firms.
One of the research firms being investigated, Broadband Research LLC, works with Janus Capital Group, MFS Investment Management and Wellington Management Co.
The fact that mutual fund companies could be involved in a probe sets it apart from previous insider-trading scandals at hedge funds because it would involve average retail investors — the biggest users of mutual funds, experts said.
“This could have much bigger implications for investors if mutual funds are involved,” said Don Phillips, director of research at Morningstar Inc. “The expectations are much higher for mutual funds than for hedge funds.”
“The industry has shocked investors with two bear markets, the flash crash and now this,” said Geoff Bobroff, a mutual fund consultant. “From an investor standpoint, they are going to ask, ‘Is this a fair game?' and the answer is probably not.”
In reality, it is neither wrong nor illegal for asset managers to use third-party research firms. But advisers and industry observers worry that investors will get skittish if they learn which fund companies are involved in the probe.
“The industry is still trying to gain trust back from investors,” Mr. Phillips said. “This is a time when the fund industry, and financial services in general, need to be telling the public that they will put them first and will behave in ethical fashion.”
Shelley Peterson, a spokeswoman for Janus, John Reilly, a spokesman for MFS, and Sara Sherman, a spokeswoman for Wellington, declined to comment.
Calls to the FBI and the New York Attorney General's Office were not returned by press time. John Heine, an SEC spokesman, declined to comment.
One possible positive from the probe: Compliance executives will likely see their budgets increase, said Rick Nummi, a consultant with Nummi & Associates PA, a compliance consulting firm.
Many firms saw their compliance budgets cut after the financial crisis of 2008 and this could serve as a wake-up call alerting them that it's time to spend more money in those areas, he said.
“The minute you start pulling budgets away from compliance departments, you end up with this is as result,” he said.
One compliance executive at an investment management firm said that his department still is trying to get back to pre-2008 staffing levels. “We are still 20% down,” he said.
The news of the probe may also prompt the SEC to be more aggressive with its stance on the fiduciary standard of care, said Harold Evensky, president and principal of Evensky & Katz LLC.
“I am worried that this is just another nail in the coffin, in terms of undermining investor confidence,” Mr. Evensky said. “The only fringe benefit potentially could be that it causes Congress and the SEC to deal with the fiduciary standard of care.”
As mandated by the Dodd-Frank financial overhaul law, the SEC is conducting a six-month study for Congress about the differences in oversight of investment advisers and broker-dealers, and whether regulatory gaps exist. The study is due to be presented to Congress in January.
Not every adviser, however, believes that the investigation will affect investor sentiment. “I think if you had surveyed investors before this, and asked how many thought that some funds and hedge funds were taking advantage of insider trading, you would probably have found the percentage to be pretty high,” said Corey Vertich, a principal at Uhler & Vertich Financial Planners LLC. “There will always be a few who break the rules for their own interest."
