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Wilshire Associates Used Rapid Mutual Fund Trades

The investment giant denies it got special preference or hurt other holders of the funds.

September 23, 2003|Josh Friedman | Times Staff Writer

Santa Monica-based Wilshire Associates confirmed Monday that it engaged in rapid trading of stock mutual funds -- one of the tactics being probed in the fund industry -- but said it wasn't given special privileges to do so by the fund companies.

Wilshire founder and Chief Executive Dennis Tito also denied that his firm, best known as the keeper of the broad Wilshire 5,000 index but also an investment consultant and money manager, may have had a conflict of interest because the trading strategy could have hurt long-term investors, including Wilshire clients, who may have held shares in the mutual funds in which Wilshire made rapid trades.

"From the day we were founded 31 years ago, Wilshire has held itself to a higher standard by setting internal restrictions regarding conflicts of interest that were even more onerous and burdensome than those set by regulators," Tito said. "We are extremely offended that anyone would imply that we would ever put our interests before that of our clients. "

As for being granted special market timing privileges by fund companies, Tito said, "We never asked for nor, to our knowledge, did we ever receive any preferential treatment from any mutual fund while executing this investment strategy."

Mutual fund trading practices have come under scrutiny since Sept. 3, when New York Atty. Gen. Eliot Spitzer announced that he was investigating whether mutual funds allowed favored investors to engage in market timing and illegal after-the-bell trading. The Securities and Exchange Commission soon launched a probe of its own.

Money magazine, in a story to be published in its October issue, says several fund companies allowed Wilshire to engage in rapid-fire trading tactics, likening its strategy to a more complex version of the market timing practices Spitzer alleged were allowed by fund operators Bank of America Corp., Bank One Corp., Janus Capital Group Inc. and Strong Capital Management.

Market timing isn't illegal -- although many mutual funds discourage their investors from the practice, often by imposing extra fees on rapid trading. Spitzer contends that mutual funds unfairly allowed some big investors to conduct market timing at the expense of other shareholders, who absorbed most of the additional trading costs.

Tito implemented a complex "arbitrage" strategy more than a decade ago, using index futures based on benchmarks such as the Standard & Poor's 500 or the Russell 2,000 index of smaller stocks, Money said. When using arbitrage, investors try to profit by exploiting inefficiencies in the pricing of securities in various markets.

Wilshire would sell the index futures "short" -- betting on a decline that was virtually certain because ultimately the prices of futures and the underlying index should converge. At the same time, Wilshire would buy mutual funds tracking the underlying index.

Through this hedge, Wilshire would lock in a small gain with little risk as the prices converged at the 4 p.m. Eastern time market close.

Wilshire, which typically put at least $100 million to work across about 10 funds, ended the practice in early 2002, the magazine said. Money did not name any of the fund companies involved.

Tito acknowledged that Wilshire used the strategy, but said it took steps to minimize the effect on other investors.

"We took special care to ensure we were investing in large funds with significant cash positions where our investment represented a small fraction of the cash," he said.

"We purposely avoided investments which may have caused portfolio managers to buy or sell stocks solely because of our transaction."

An SEC spokesman said he was unsure whether the agency was looking into Wilshire's activities, and calls to Spitzer's office were not returned.

Tito said Wilshire has not heard from either regulator.

Richard Phillips, partner in the San Francisco office of Kirkpatrick & Lockhart, which represents investment companies, said even if the allegations were true, Wilshire may not have broken any law.

However, he said that if Wilshire had relevant information unavailable to the public, or if it violated a fiduciary duty to clients, "that potentially could be a problem."

Roy Weitz, editor of the L.A.-based Web site FundAlarm.com, said the Wilshire allegations highlighted the fact that the fund scandal continues to unfold.

"It's the nature of Wall Street: If you can make a tiny percentage [of profit] on a huge base, somebody's going to do it," he said. "There are probably 10 or 20 ways to arbitrage mutual funds, and so far we've heard about three or four."

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