Could Your Fund Go Bankrupt? Why you don't have to worry
By Penelope Wang

(MONEY Magazine) – As regulators and class-action lawyers line up to demand fines and restitution from Strong, Putnam and the other fund groups accused of wrongdoing, fund shareholders may worry about the future of these companies and the safety of their portfolios. What happens if your mutual fund company goes under?

Not to worry. As a fund shareholder, you are protected from such fund-company disasters by the Investment Company Act of 1940. Under the act, each fund is set up as an individual company, separate from the fund sponsor and owned only by its shareholders. In essence, your fund hires the fund company to manage its assets. So in the (probably remote) event that the Strong fund company were to file for bankruptcy, its creditors would not be able to touch the money in, say, Strong Opportunity or any of the other funds.

Each fund also has its own board of directors that has a fiduciary responsibility to protect shareholder interests. Clearly, a lot of boards haven't been taking that duty as seriously as they should have. But if a fund company fails--or even just doesn't make shareholders happy--the directors can ask someone else to manage the money, notes fund consultant Geoff Bobroff, a former SEC lawyer. "If I were on the board of a Strong fund, I would be talking to a subadviser like Wellington right now," he says. Boards fire management companies infrequently, but it has happened. Last year, following Deutsche Bank's acquisition of Scudder, the board of the Scudder Japan fund voted to hire Fidelity to take over investment management. Shareholders must agree to any permanent adviser change.

Still, there is one risk investors should consider: Fellow shareholders fleeing your fund could hurt your returns. Fund prices don't go down just because investors sell shares, but if the fund manager is forced to keep more cash on hand to meet redemptions, performance may lag. Steep redemptions might also force the manager to sell large chunks of stock, which can generate taxable capital gains and even push down the price of those stocks, further damaging returns. Moreover, as assets shrink, expenses are likely to shoot up, warns former SEC lawyer Mercer Bullard, head of Fund Democracy, a shareholder advocacy group. That's what happened to the Yacktman fund in the late '90s, when the board tried to fire manager Don Yacktman. As assets dwindled from over $1 billion to less than $100 million, the fund's expense ratio climbed more than 40%, from 0.86% to a high of 1.23%. --PENELOPE WANG