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Your Funds / Charles Jaffe
Improper trading: restitution for some

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Ever since the mutual-fund industry first got nailed for allowing improper trades, investors have been left with the suspicion someone really got hurt.

Managers and regulators said the harm was insignificant, a few pennies per thousands of dollars. Settlements have included big fines but minimal restitution. But everyone suspected there had to be cases where rapid-fire trading led to much bigger performance woes. Simple math suggested the impact had the potential to devastate a tiny fund.

The proof came two weeks ago, when Citigroup Asset Management, or CAM, filed an amendment to a prospectus to liquidate the Salomon Brothers International Equity fund, effective Dec. 3.

Salomon Brothers International Equity has about $5 million in assets and never got much bigger than about $10 million. With miserable performance, it would have died unnoticed if not for an unusual item at the end of the closing notice.

"Citigroup Asset Management has decided that, following liquidation of the Fund, it will make certain voluntary payments to Fund shareholders to address CAM's dissatisfaction with the performance and operation of the Fund due, in part, to large cash flows that caused periods during which large cash positions were maintained in the Fund as a result of which the Fund's assets were underinvested in international securities."

In English, that means: "We allowed market-timing trades like crazy in this fund, which made performance so bad that we need to give investors their money back."

Citigroup — which has been in hot water with regulators over other issues — currently is not facing charges or regulatory actions involving Salomon Brothers International Equity, so it's hard to see what compelled this action. CAM issued only a terse statement saying it will "make certain additional voluntary payments to shareholders" without saying why.

Up to now, the company has stayed out of the biggest trading scandals. Citigroup Global Investment Management did return $16 million to CAM mutual funds in a case stemming from alleged issues over back-room operations, but the International Equity payment is not part of that money.
 
It appears CAM is prepared to make close to complete restitution, repaying much of the difference between the fund and its benchmark index. According to Morningstar, Salomon Brothers International Equity has the worst performance in the foreign large-cap blend category and has lagged the MSCI EAFE Index by 14 percent over the past three years, so payback would be a big deal.

The performance lag appears to be the cost of allowing bad trades in a small fund.

"This seems to be proof that investors endured significant harm from what fund companies were doing," says Mercer Bullard, founder of Fund Democracy, a shareholder advocates organization.

"It was clear that there had to be a fund — most likely a very small one — where investors lost 5 to 10 percent per year over a three-year period. ... And it looks like this is the kind of small international fund that was mispriced to where it caused those losses for long-term shareholders."

CAM has not revealed the formula or rules involved in its voluntary repayments.

Chuck Jaffe is senior columnist at CBS Marketwatch. He can be reached at jaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.