Da-Dum … Da-Dum … Da-Dum Da Dum Da Dum … Da Da Da Da Da Da Da Da … Da Da Daaaa …..
Sound familiar? While you could mistaken it for my toddler son Spencer calling me, it’s really the eerily memorable theme song from the classic water thriller Jaws. (Or at least that’s what it sounds like when I’m singing it).
Like many, after seeing this movie I was more than a bit afraid to go swimming even in my own backyard pool. Let’s not even talk about trips to the beach!
Just as investors thought it was safe to get back into investing waters as the market continues to sport positive numbers on several indexes like the Dow and S&P, news of another potential scandal comes out that may cause investors to pause once again.
After a decade that has included three stock market busts, a real estate bubble burst, a mutual fund industry timing scandal, the greatest Ponzi scheme ever and a whole lot of smaller ones coupled with a long and wearying Recession and near financial meltdown, we now have another cloud on the horizon.
Since a November 20 article in the Wall Street Journal, there has been an increasing amount of media scrutiny about a widening investigation by the FBI, Securities and Exchange Commission and the New York Attorney General’s Office into possible insider trading by several well-known mutual funds, hedge funds and investment managers.
How this plays out is anyone’s guess. But the last time there was a wide-spread scandal in mutual funds, the bedrock investment that allows many retail investors to get in on the action of Wall Street, it resulted in not only bad PR but in more than $3 billion paid out to investors to make up for the inequity of favorable market timing by a select few.
In fact more than six years after the scandal, I continue to receive checks in the amounts ranging from $2 to $30 from mutual fund companies that used to hold my investments.
Will this result in the same sort of long-tail remedy? Who knows but the more immediate concern will be if individuals decide that this is one more piece of evidence that the Wall Street game is rigged against them.
I hope that is not the case. Throwing the baby out with the bath water will ultimately do no good for an investor saving for long-term goals. Sure, you can take all your marbles and go home. In fact, more than $90 billion has been withdrawn from mutual funds since the beginning of 2009.
The general gist of this investigation is centered on so-called expert networks that offer research of various stocks to investment managers. Since investing is all about determining what is a fair value to pay for the stock of a company, it’s important to understand the company’s cash flows and things that can affect the top and bottom line. So certain research companies go about like investigative reporters developing contacts with companies, asking questions about new products or sales and then reporting this to stock analysts that work at other firms.
There is nothing inherently wrong or illegal about asset managers using third-party research. Since there’s no easy to see bright line about what is or isn’t insider information in some of these cases, nothing wrong may have been done.
The problem for many investors right now is one of perception. There is the cockroach theory in accounting and finance. When you turn on a light in a room and you see something scampering off, it’s almost safe to say that there were probably more bugs running about when the lights were off. So to avoid future surprises, you might want to relocate from the apartment and in investing you might be inclined to also get out of Dodge.
I think it’s too early to simply paint the whole industry with a broad brush and say that they’re all corrupt. Yes, there were some bad apples. But you should think about this sentiment best expressed by Frank Black in Investment News (11/29/2010, page 2): If they are getting inside information … why did the average fund decline almost 50% in 2008-2009?
Trying to get a leg up on the other guy is pretty normal in a competitive marketplace. Information is king after all.
But there are more honest fools in this business than corrupt ones.
Even a lump of coal is something useful even if it is dirty and messy right now.
So stay calm and avoid shooting first before asking questions of your financial adviser. This is just another type of risk to be aware of and there are ways to lessen the adverse impact on your long-term portfolio and goals.