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Mutual Fund Firms Under Investigation by the NASD

Securities: The companies, which aren't identified, allegedly misled investors about risk.

October 17, 1996|From Bloomberg Business News

WASHINGTON — The National Assn. of Securities Dealers said Wednesday that it is investigating at least three large mutual fund companies on allegations that they misled customers about investment risks.

The companies, which the NASD would not identify, allegedly advertised funds as safe, conservative investments even though they contained risky derivatives securities, said Barry R. Goldsmith, the top enforcement official for the NASD's regulatory unit.

Goldsmith said the NASD, an industry body that polices all U.S. brokers and runs the Nasdaq Stock Market, expects to file at least two cases against fund companies in the next few months. He didn't say when additional cases might be filed.

"We're really focusing on information delivered at the point of sale, including prospectuses, advertising, sales literature, oral representations and sales scripts," Goldsmith said. "Several funds appear to be understating their risks."

The NASD is also examining these funds for possible violations of "suitability" regulations requiring them to evaluate whether investments fit customers' financial objectives, Goldsmith said.

Derivatives are contracts whose value is tied to the fluctuating value of another asset, such as a bond, commodity or currency. They're used to hedge against changes in the value of those assets, or to make leveraged bets.

Derivatives investments have led to huge losses in recent years for municipalities such as Orange County and companies such as Gibson Greetings Inc. and Procter & Gamble Co.

Goldsmith, who joined the NASD two months ago, wouldn't say exactly how many funds are under fraud investigation, but he said the NASD is investigating "at least three cases of large fund companies." Each company has one or more funds under scrutiny, he said.

Each fund under inquiry has thousands of customers who have invested a total of hundreds of millions of dollars, Goldsmith said. The allegations are similar to those made in the NASD case against Piper Jaffray Cos. in March, he said.

The NASD fined Piper Jaffray, a regional brokerage firm, $1.25 million in a case in which it was accused of failing to tell investors that one of its mutual funds that plunged in value contained derivatives. About 7,000 investors, many of them Midwest retirees, lost $120 million from investing in the firm's Institutional Government Income Portfolio between 1991 and 1994.

Goldsmith, former chief litigation counsel of the Securities and Exchange Commission, said the NASD investigations originated from routine annual examinations of fund procedures.

In addition to Piper Jaffray, at least three other funds--managed by Fundamental Portfolio Advisors Inc., PaineWebber Group Inc. and Value Line Asset Management--suffered losses by investing in derivatives in 1994 when interest rates rose.

Fundamental was sued by investors and agreed last summer to settle the suit for $500,000. The company said in March that it is under SEC investigation related to the adequacy of its marketing disclosures to investors. The New York-based company declined to comment Wednesday.

PaineWebber paid $90 million, including $33 million to investors, to shore up its $1-billion Short-Term U.S. Government Income Fund following 1994 losses in high-risk mortgage securities. The New York-based firm also declined to comment.

Value Line had two "government securities" funds with a total of $455 million in assets that lost money in 1994 after investing in so-called inverse floaters, or bonds whose coupon payment rises as a benchmark interest rate falls. The New York-based company also declined to comment.

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