When an inquiry by New York attorney-general Eliot Spitzer led to a US$1.4 billion settlement last year of claims that United States securities companies had misled investors, it did not take a strong imagination to wonder whether the US mutual funds industry had similar skeletons in the closet.
Sure enough, Mr Spitzer put the funds industry in the crosshairs in September this year when a hedge fund, Canary Capital, was charged with illegally trading in mutual funds. The illegal activities of the hedge fund set up by billionaire Edward Stern were exposed by whistleblower Noreen Harrington, a former executive of Stern Asset Management, and led to a US$40 million settlement by Stern.
Since then the lid has come off the industry, revealing growing allegations of nefarious practices that allow the privileged few to benefit at the expense of retail investors.
The investigations are still unfolding in the US, but the two main issues at this stage are market timing, in which some investors are allowed to buy and sell shares in the fund very rapidly, and late trading, in which they are allowed to trade shares after the price has been fixed for the day. While market timing is not illegal, most mutual funds do not allow it. Late trading is illegal, but difficult to detect.
So far some of the biggest and most respected names in the US mutual funds world have felt the heat of the latest Spitzer-led investigation, including Morgan Stanley, Putnam Investments, Citigroup, Merrill Lynch, Invesco and Janus Capital.
With almost daily reports of abuses coming out of the US, Hong Kong investment fund unit-holders cannot help but ask themselves whether or not the funds they hold could be engaging in similar practices.