On Sept. 3, 2003, then-New York Attorney General Eliot Spitzer announced he was investigating mutual fund companies for practices hurting small investors. The companies were allowing special clients to make rapid mutual fund trades, in violation of their prospectuses and at the expense of fund investors.
“[The mutual fund industry] was an industry that was largely scandal-free,” recalls Russ Kinnel, director of ratings for manager research, who was a Morningstar analyst at the time. “We knew enough to know that it wasn’t a pure industry that was without fault, but it was a surprise.”
It’s been 20 years since that story, which later became known simply as “the market-timing scandal,” broke.
The scandal sent shock waves through the industry, raising questions of how the SEC was regulating mutual funds, how the industry was exploiting fair value pricing, and if investors could really count on fund companies to be on their side.
Many of the Morningstar analysts who covered the scandal at the time are still with us today—including Kinnel, who wrote dozens of articles exploring the depth and breadth of the scandal. And Chief Executive Officer Kunal Kapoor, who was an analyst at the time, wrote Morningstar’s very first article on the Spitzer investigation. (Note that you’ll need access to Morningstar Research Portal to view Kapoor’s article.)
With the wisdom of two decades on our side, what do we now know about what this meant for the industry?
In this episode of Investing Insights, Kinnel discusses the long-term effects of the market-timing scandal, the progress the industry has made since then, and more.
From “Ripped Off” to a “Better Deal” – How Investors Fared Since the Market-Timing Scandal
Also, five expensive stocks to dump and how Birkenstock hopes to expand its shoe brand.
27m 5s
And for more perspective on the state of the industry 20 years later, dive into these insights from Kinnel, senior manager research analyst Gabriel Denis, director of parent research Bridget Hughes, and director of editorial for manager research Dan Culloton.
Market-Timing Scandal: From the Morningstar Archives
Our analysts sorted through the accusations, indictments, settlements, and regulatory remedies, withdrew recommendations from some implicated funds and firms, and offered advice to investors on the ones to avoid or consider selling.
For a closer look, check out this content from our archives.
You can also revisit managing director Don Phillips’ Congressional testimonies, which highlighted the strengths and shortcomings of the fund industry and the necessary steps to reforming it.
This article was compiled by Emelia Fredlick.
The author or authors do not own shares in any securities mentioned in this article.Find out about Morningstar’s editorial policies.
On Sept. 3, 2003, then-New York Attorney General Eliot Spitzer announced he was investigating mutual fund companies for practices hurting small investors. The companies were allowing special clients to make rapid mutual fund trades, in violation of their prospectuses and at the expense of fund investors.
Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
The majority of mutual fund schemes have a 3 PM buy transaction deadline. Liquid fund schemes, however, are not subject to this scheduling. This indicates that if you invest up to 3:00 PM, you will receive the day's NAV. If you submit your application after the deadline, the mutual fund firm will still accept it.
Market timing is difficult because many different investors are using their own strategies and trading on their own time, so to speak. This can cause delays in markets or confusion when an otherwise clear move might present itself and make timing difficult.
According to the market timing. theory, managers are able to time the market and issue equity when the stock of the firm is overvalued and repurchase equity when it is undervalued.
It requires a trader to consistently follow up on market movements and trends. It entails higher transaction costs and commissions and includes a substantial opportunity cost. Market timers exit the market during periods of high volatility.
Timing risk is the speculation that an investor enters into when trying to buy or sell a stock based on future price predictions. Timing risk explains the potential for missing out on beneficial movements in price due to an error in timing.
Market timing is not illegal, but making a false statement in a prospectus is clearly a violation of law – at a minimum Section 10(b) of the Securities Exchange Act of 1934.
Mutual funds tend to discourage timing because it increases their management costs, to the disadvantage of long-term investors. Most funds have rules to limit short-term trading, such as additional redemption fees and limitations on round-trip trading.
When investing in equity mutual funds, do it via systematic investment plans (SIPs). By investing a fixed amount at regular intervals, irrespective of prevalent market conditions, you reduce the risk factor further. When markets are down, you get more units, and when markets are up, you buy fewer units.
Unlike stocks and ETFs, mutual funds trade only once per day, after the markets close at 4 p.m. ET. If you enter a trade to buy or sell shares of a mutual fund, your trade will be executed at the next available net asset value, which is calculated after the market closes and typically posted by 6 p.m. ET.
With Drew's help, Fisk aided Gould in an attempt to corner the gold market by inflating the price, a venture that brought them vast sums but led to the panic of “Black Friday,” Sept. 24, 1869. Because Gould secretly sold much of his gold before prices fell, Fisk lost a considerable part of his investment.
Black Monday refers to the catastrophic worldwide stock market crash on October 19, 1987, when the DJIA fell 508 points, or 22.6%, in a single day. It remains the largest one-day decline ever. Other major stock markets saw similarly huge declines.
Lack of investor confidence in bank solvency and declines in credit availability led to plummeting stock and commodity prices in late 2008 and early 2009. The crisis rapidly spread into a global economic shock, resulting in several bank failures.
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