Trouble At The Top Strong Funds founder Dick Strong is accused of making rapid market-timing trades in his own firm's mutual funds
(MONEY Magazine) – The rapidly spreading fund scandal has reached the top at one major firm. In late October, New York State attorney general Eliot Spitzer accused Strong Funds founder Richard Strong of making rapid-fire market-timing trades in his firm's funds on behalf of himself and others. Spitzer promised to file charges--perhaps a criminal indictment--against Strong personally. Within days, Strong resigned as chairman of the board of Strong Mutual Funds, although he retained his seat on the funds' board of directors and will continue to head Strong Capital Management, the Menomonee Falls, Wis. business that runs the funds. Strong's resignation was just one of several alarming developments in the fund fiasco during October and early November. (See the box above right.) But the news about Strong seemed to take the scandal to a new level. Spitzer alleged that between 1998 and 2001, Strong made several quick trades into and out of some of his firm's funds for himself and on behalf of friends and associates. A spokesman for Spitzer declined to identify the funds Strong traded "at this time." Generally speaking, funds that contain foreign stocks are the ripest target for market-timing plays, and Strong offers a number of such funds. What's wrong with such trades? For a start, Strong itself claims to have policies discouraging market timing. And fast trades can incur transaction costs that eat away at all shareholders' returns. If the charge that a fund company's CEO gamed his own funds for personal profit was shocking, the idea that a man worth $800 million (according to the Forbes 400 list) would risk his reputation for what is said to be $600,000 in trading profits was just puzzling. But Strong has always been a maverick figure in the fund world, an intensely driven entrepreneur who dominates every aspect of his business. Spitzer's allegation that "other senior people" at Strong were aware of the troublesome trades seems wrong in one regard: There are no other senior people at Strong, if "senior" means someone with the stature to challenge the boss. Strong personally owns almost all of the equity in the firm's parent company. Strong declined through a spokesman to be interviewed by MONEY. In a statement posted on the firm's website, Strong confirmed that he made the trades in question but also said that only a small number of them were quick "next day" transactions. Strong added that he was cooperating with Spitzer's investigation--as well as with those of the Securities and Exchange Commission and the Wisconsin Department of Financial Institutions. He promised to reimburse the funds for any shareholder losses his trades may have caused, but he also maintained that he did not believe they had been "disruptive." Strong has been caught up in the fund scandal since it first broke. In August, Spitzer named Strong Capital Management in his now settled civil lawsuit against hedge fund manager Edward Stern's Canary Capital. Spitzer did not accuse Strong of any wrongdoing at the time, but he did claim that Strong had allowed Canary to time some of its funds in exchange for a promised investment in a Strong-run hedge fund. Following those charges, Strong hired consultants Deloitte & Touche to review its operations. In response to the latest revelations, the firm has hired former SEC chairman David Ruder "to review policies and procedures at Strong relating to issues that have arisen from regulatory investigations and compliance systems applicable to those issues." So far there's little evidence that Strong's retail investors are running for the exits or that Strong is losing many major clients. Shareholders took $166 million out of the company's funds in October, according to a spokeswoman. That is not a huge number considering that Strong manages $42.7 billion. Early in November, however, there were some ominous rumblings. Oregon treasurer Randall Edwards said he would ask the board that runs the state's 529 college savings plan, for which Strong manages $134 million, to drop Strong. Directors of the Nevada and Wisconsin 529 plans, both managed or co-managed by Strong, have heard calls from some investors to fire Strong but so far have held off, apparently waiting to see if Spitzer makes good on his threat to file charges. Strong Capital Management runs $86 million of the Nevada plan's assets and $1 billion for Wisconsin's. This is not the first time Dick Strong has had problems with regulators. In 1994, without admitting wrongdoing, the firm settled charges brought by the SEC that it made improper junk bond trades between some of its funds and did not divulge to investors that Strong personally was an investor in a Bermuda investment company that traded with Strong funds. The junk trades came back to bite the firm again in 1996, when the Labor Department required it to reimburse about $5.9 million to some pension accounts it managed. When MONEY last interviewed Strong this past summer, all that seemed to be ancient history. He shrugged off a recent upheaval in his firm's bond division and predicted that the company, at the time managing about $40 billion, would eventually run a half-trillion dollars in assets. He added, "There's no way our firm is going to implode except through incompetence." --PETER CARBONARA |
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