The mutual-fund industry contends that the fast-spreading allegations of improper trading at fund companies should not worry the approximately 400,000 corporate sponsors of 401(k) plans. But worry they do.

That, at least, is the conclusion of a new survey by CFO magazine, in which a full 86 percent of respondents express concern about mutual-fund mismanagement. More than half, in fact, say they are quite or extremely concerned, especially about conflicts of interest among fund traders and high management fees.

Overall, the worrying doesn’t seem to have translated into drastic action, at least not yet. Rather, as the investigations of fund abuses proceed, many sponsors are waiting to see how funds in their 401(k) portfolios may be affected before they do anything. The CFO survey indicates, for example, that less than one-third of finance executives would support dropping an affected fund immediately from the 401(k) portfolio, while 57 percent would institute a review first.

“Companies are asking how high up the problems went, how serious they were, and what actions have been taken to remedy the situations,” says Patrick Reinkemeyer, president of Morningstar Inc.’s consulting group. Before they make a decision to drop a mutual fund, plan sponsors want to know “to what degree the fund’s ability to manage money has been compromised.” From the sponsor’s perspective, deciding on a particular fund’s future in the plan “is not easy,” says Reinkemeyer. “The standards can’t be the same for Calpers [the California Public Employees’ Retirement System] as they are for a neighborhood car wash.”

Even as the number of accused mutual-fund companies proliferates, most finance executives still believe that funds in general can deliver adequate retirement options to employees. Less than a third of our respondents say they are less confident about that ability now than they were two years ago, while 59 percent say there has been no change and 10 percent say they are actually more confident.

Many of the CFOs who are concerned about individual funds in their portfolios hesitate to take precipitous action until the full dimension of the problem is understood. “This is a very tricky period,” says David Wray, president of the Chicago-based Profit Sharing/401(k) Council of America. “A lot of people are being very cautious until they’re convinced that all the fallout has fallen.”

The Alternatives

So what’s a sponsor to do? Instead of simply eliminating a tainted fund from a portfolio, some are choosing to add alternative funds in the same category. The idea is to give participants a choice, rather than to direct them from one fund into another. Paradoxically, some of the funds identified in the first wave of the scandal are engaged in aggressive cleanups—and fee reviews—that may make them among the safest and best-priced options.

“Where in the world would you move if you wanted to be sure you were safe?” asks Textron Inc. CFO Ted French. “You could find yourself jumping out of the frying pan into the fire.” That would certainly be the case, he says, if the Textron investment committee he chairs were to ax one of its funds and then learn that the replacement fund was also a target of investigators.

It’s hardly an academic question for the Providence-based diversified manufacturer, which has Boston-based Putnam Investments as its plan administrator—and offered 7 of Putnam’s funds among the Textron plan’s 11 choices. “We had plenty of feedback from Putnam’s bad press,” according to French. “One of our offered funds was the International Fund, where the bad guys were,” he says, and “employees called us or E-mailed us asking, ‘Why are they still around? Why don’t you just shoot them today?'”

Textron’s investment committee—which includes French as well as the treasurer, assistant treasurer for investment management, vice president of human relations and benefits, controller, and an attorney for the investment-management group—decided to hear Putnam out before taking any action. Eventually, the committee decided to keep the Putnam funds, including the International Fund. Textron then launched an informational newsletter campaign to explain its actions to the 25,000 employees who together have about $1.6 billion invested in the 401(k) plan.

“There’s no grumbling now,” says French. “Our communications were effective.”

Plan Review

A deliberate plan review—in which the offenses and corrective actions at individual funds are only two of the elements studied—is recommended by benefits specialist Jeff Robertson of Portland, Oregon, law firm Bullivant Houser Bailey PC. “Saying ‘There’s a Janus fund in my portfolio, so I have to switch,’ is not the way to go about this,” he says. “Investment committees should start with a prudent overall policy, and then make a prudent review of all the funds.” That means looking at multiple plan elements that could affect participants. “If there’s an investigation, that’s a minus, while performance could be a plus,” Robertson says, and factors like fee structure, managerial changes, and the availability of alternative funds would enter in as well.

Of course, says Paul Bracaglia, Philadelphia-based partner in the human-resources services group of PricewaterhouseCoopers LLP, plan providers must also “weigh the market dynamics of the accusations, and especially the impact on the fund of other investors taking money out.” Mutual funds are harder to manage when significant outflows occur. “And if I have to create x amount of liquidity in order to meet the redemptions that day,” he says, “I might be forced to make a sell decision earlier.”

Another question is, What happens if the fund was chosen because of a particular manager, and that manager is fired? “In some organizations, the manager is the superstar. He’s the Allen Iverson of the team,” says Bracaglia. If that manager no longer works at a fund, the plan may decide to replace it. Some of Bracaglia’s clients have puzzled over whether to eliminate an entire fund family based on accusations against a few funds, or to replace only the specific funds identified. Plan sponsors have gone both ways, he adds, making decisions based on the specific facts and disclosures.

Noting that giant Calpers dropped a number of funds last fall after they were charged with abuses, attorney Robertson suggests that corporate 401(k) trustees tend to be less motivated by political issues, and gear decisions more to such factors as the corporate risk of lawsuits stemming from scandal-tarred funds in the company portfolio. “CFOs’ concerns are going to be issues of fiduciary responsibility rather than bad press,” says Robertson.

For his part, Morningstar’s Reinkemeyer doesn’t consider bad press alone to be a legitimate reason to act, even if it reflects pressure from plan members. “If a fund is dropped for political reasons, participants’ interests are not being kept in the forefront,” he says.

Bad Apples

The welfare of the participants—not politics—guides fund decisions made by the five-member investment committee at Houston-based Continental Airlines, says Jacques Lapointe, vice president of finance. He remembers when the biggest 401(k) issue was how to teach the company’s 49,000 qualified employees that a company-matched retirement-plan contribution “is the single best investment they can make every year.” Until last year, Continental considered its plan quite ordinary, with “nothing exotic or obscure,” just the usual funds from brand names like Fidelity and T. Rowe Price. Still, the fact that one was a Janus product came up for discussion last September, when Janus was the target of an investigation by the New York State Attorney’s office.

The investment committee—on which Lapointe serves along with the airline’s senior vice president of finance and treasurer, its controller, the HR vice president, and the cash-management director—”went over everything, all the allegations made against specific funds,” says Lapointe, and set up a call with Janus. The Janus presentation was persuasive, he says, and as a result, Continental decided to retain the Janus offering. Continental’s conclusion: “They had a couple of guys [guilty of] some market timing, but those guys are no longer with the firm. It was not a systemic problem; it was just those bad apples.”

Lapointe’s view is that “every mutual fund in the country must have had one or two guys who just got too cute.” Continental’s investment committee was impressed that Janus seemed to be dealing with its situation quickly. “I feel we did our due diligence very well,” says Lapointe, and that members kept in mind the high stakes involved. “As a member of the investment committee,” he notes, “I have liability.”

There have been few employee concerns at Continental. In fact, Lapointe says he received only two phone calls asking about the market-timing scandals and Continental’s inclusion of a Janus product. “If I were not on the committee and were just an employee, I would hope and expect that the company would be doing just what we’re doing,” he says.

Lapointe believes subsequent headlines—or, rather, Janus’s absence from those headlines—have borne out the committee’s decision. “If I were still reading stories about Janus in the Wall Street Journal or in CFO magazine, that fund would probably be long gone by now,” he says. (At press time, Janus had not reached a settlement, and said it was still “cooperating with the ongoing investigation” in New York and by the Securities and Exchange Commission.)

Of course, discussions about the mutual-fund scandal are occurring at plenty of companies unaffected by any revelations to date. As the scandal expands, says Jean Blackwell, CFO of Cummins Inc. and chairperson of its benefits-policy committee, “people are taking their fiduciary responsibilities much more seriously.” Blackwell—who in the past has served as the Columbus, Indiana, engine maker’s general counsel and as its vice president of HR—has observed that committee members these days “will push back and disagree,” where in the past they were more inclined to go along with the recommendations of the benefits staff.

Cummins currently has all Vanguard funds in its plan, which covers 14,000 U.S. employees, and Blackwell notes that Vanguard has yet to be mentioned by any investigator. Cummins is now engaged in its regular review of fund offerings, administrators, and recordkeepers. The company doesn’t rule out adding some funds that have been mentioned in investigations if they can show that their problems have been resolved. “We’re doing our best to pick funds that balance fees, risk, information flow, and potential returns, as well as a number of other factors,” says Blackwell. She knows that some funds mentioned in the earliest wave of charges seem to have taken strong corrective measures, and to have lowered their fees.

Blackwell believes that investment committees at other companies are also asking funds for more information these days, whether or not those funds have been targeted by investigators. She is sure there will be more surprises as the investigations proceed. “It will get uglier,” she predicts.

Repairing the Damage

“Putnam is fixing its system,” says Textron CFO French, who observes that “the interesting point is all the administrative issues that come up when you add choices” to a 401(k) portfolio.

For Putnam and other mutual-fund companies, of course, restoring confidence among customers like Textron is of primary importance.

Putnam CEO Charles “Ed” Haldeman says he “went to see a large number of our clients in the November and December period. We felt we had an obligation to have a face-to-face meeting…and to say to them that what had gone on at Putnam in the year 2000 was wrong.” He says that the trading records of all 12,700 traders working at Putnam since 1998 have now been reviewed, and 15 employees have been dismissed.

“With regard to market-timing issues,” states Haldeman, “Putnam fully understands the scope of that problem, and has dealt with it entirely.” Putnam notes that it quickly settled with the SEC, made “100 percent restitution,” and changed commission policies. It also reduced its fees.

John Brown, head of Putnam’s institution business, concedes that the firm has lost clients in the wake of the scandal. He says that “on balance, the private-sector clients have kept more assets with us than the public-sector funds.”

“Back in November, we were at the tip of the spear,” says Brown, because Putnam was one of the first companies to have the market-timing activities of some traders exposed. But most corporate clients “are going through a long process,” he says. “Nobody’s shooting from the hip.”

Worry about the Mutual-Fund Scandal…

How concerned are you about the alleged mismanagement of mutual funds?
Extremely concerned		18.1%
Quite concerned		33.3%
Somewhat concerned		34.5%
Not concerned		14.1%
In particular: Trader’s conflicts of interest
Extremely concerned		37.3%
Quite concerned		35.6%
Somewhat concerned		18.6%
Not concerned		8.5%
Market timing by traders
Extremely concerned		16.9%
Quite concerned		35.6%
Somewhat concerned		33.3%
Not concerned		14.2%
Secrecy surrounding mutual-fund operations
Extremely concerned		26.6%
Quite concerned		37.9%
Somewhat concerned		24.9%
Not concerned		9.6%
Government’s failure to detect mutual-fund abuses
Extremely concerned		28.2%
Quite concerned		37.9%
Somewhat concerned		21%
Not concerned		12.5%
High management fees
Extremely concerned		30.7%
Quite concerned		40.3%
Somewhat concerned		19.9%
Not concerned		9.1%

If one of your fund providers were implicated in the mutual-fund scandal, what would you do?
Drop it from our plan immediately		30.1%
Consider dropping it from our plan		56.8%
No course of action decided on		11.9%
Other		1.1%
Compared with two years ago, how confident are you about your company’s ability to provide adequate retirement option for employees?
Much less confident		5.7%
Somewhat less confident		25.6%
No change		58.5%
Somewhat more confident		8.0%
Much more confident		2.3%