Lousy funds, and a scandal, too: This month's FundAlarm database tracks 40 Smith Barney mutual funds: 19 of these funds are on this month's 3-ALARM list, and not a single Smith Barney fund is on the FundAlarm Honor Roll.....Overall, FundAlarm evaluates the 40 Smith Barney funds over a total of 120 measurement periods (i.e., 12 months, three years, and five years), and Smith Barney funds have underperformed their respective benchmarks in 80% of those periods -- a dismal showing even for brokerage-firm funds, which are chronic laggards.....If you're a Smith Barney fund investor, and you're feeling a bit uncomfortable right now, we have more bad news: Smith Barney funds were recently implicated in a scandal that was every bit as corrupt and cynical as any market-timing scandal, yet it received almost no media attention.....The Smith Barney scandal revolved around the relatively obscure transfer agency function, and that's probably one of the reasons for the great, collective yawn.....But if you stay with us, the story is relatively easy to follow:
Every fund needs a transfer agent, or some entity to perform the functions of a transfer agent, such as processing buy and sell orders for the fund, calculating daily net asset value, operating a customer service call center, distributing fund literature, preparing year-end tax reports, etc. Transfer agency fees are a legitimate fund expense, which are paid out of fund (i.e., shareholder) assets. But, as with all fund expenses, it's the obligation of the fund Board (and, to a lesser extent, the fund manager) to obtain transfer agency services at the lowest possible fee and the highest possible quality.
Beginning in 1994, First Data served as transfer agent for the Smith Barney funds, which were managed by Citigroup Asset Management (CAM). In 1998, First Data's transfer agency contract came up for review, and First Data offered to rebate a huge percentage of its transfer agency revenue directly to CAM in order to keep the contract. CAM never informed the directors of the Smith Barney funds about First Data's rebate offer, which potentially could have saved millions of dollars for fund shareholders.
CAM was told by its accounting firm that it would be illegal to keep the First Data rebates, because those rebates would belong to the funds. To get around this annoying little technicality, CAM created a shell transfer agent, and the shell transfer agent officially replaced First Data. The shell continued to collect the old transfer agency fee in full; the shell transfer agent then subcontracted with First Data to actually do the work at the previously negotiated, significantly reduced rate. In other words, a fund might pay $1,000 to CAM's shell transfer agent, the shell would pay First Data $500 to do the actual transfer agent work, and CAM would pocket the difference ($500) as pure profit.
CAM not only continued to hide the First Data rebates from the fund Board, but CAM actively misled the fund Board in a memo proposing that the shell transfer agent be hired. On the other hand, it doesn't appear as if the independent directors were asking a lot of tough questions, either.
Have you guessed by now? The chairman of the Smith Barney fund board was an "inside" director -- an employee of the fund management company, CAM. By misleading the independent directors on the fund Board, and promoting the sham transfer agency structure, the chairman of the Smith Barney funds enriched CAM -- his employer -- at the expense of every shareholder.
The SEC has required CAM to pay back its staggering, illicit profits -- about $100 million -- and also pay an $80 million penalty. As usual, CAM has admitted no wrongdoing.
So, Smith Barney fund investors, there you have it: Dismal performance by your fund family, do-nothing independent directors, and blatant thievery by your fund management company, assisted by the chairman of your funds' board of directors.....Not a pretty picture.
