The industry’s black eye

Eliot Spitzer's "Canarygate" investigation will damage the reputation of, and employee morale within, the institutional units of many investment management firms, consultants and executive recruiters predict.

"The financial services industry depends on trust," said Christopher McNickle, a consultant at Greenwich Associates LLC, Greenwich, Conn. "If even a reasonable handful of money management companies are called into question, it pulls them all into question."

So far, the impact has been the loss of top executives at some investment management firms, even before the New York Attorney General's office and the U.S. Securities and Exchange Commission filed criminal and civil charges. And observers are expecting more departures, although they won't name names.

As a result, the job of finding suitable candidates for money management openings just got a lot harder, recruiters say.

"From an investment company's perspective, they don't want to hire someone else's problem. We are asking a lot more questions; ‘How close were you to these gray areas of activity?' There are a lot of concerns about people from the distribution side, in particular. Candidates have to be literally squeaky clean," said recruiter David Barrett, partner, Higdon Barrett LLC, New York.

Whether executives from tainted companies will find new jobs in money management is a loaded question, said recruiter Peter D. Crist, president of Crist Associates LLC, Hinsdale, Ill.

"It's going to be very difficult, given the environment, for these guys to ever work again (in money management), even if they were just named in these investigations, not indicted. All the antennae are up. What board will forgive and forget? Not in this environment, they won't," said Mr. Crist.

All this scrutiny is new territory for money management executives, said Greenwich's Mr. McNickle. The current round of investigations represents the first large-scale scrutiny of the investment side of the financial services industry since the 1920s, he said.

"This level of investigation is unprecedented," agreed Mr. Crist. "This is a tsunami moving through the industry that will catch people who might have slipped through the net before. Not many companies or people will receive a ‘Pass ' in this environment."

Senior investment executives at two of the companies named by Mr. Spitzer in his Sept. 3 complaint — Bank of America Corp., Charlotte, N.C., and Bank One Corp., Chicago — resigned or were fired. Neither firm nor any employee has been charged with criminal or civil wrongdoing.

Robert H. Gordon, chief executive officer of Banc of America Capital Management LLC, New York, resigned shortly after Mr. Spitzer alleged Mr. Gordon was involved in approving market timing and late trading in mutual fund shares by Canary Capital Partners LLC., Secaucus, N.J. The firm is without leadership at the top, sources noted, since its chief investment officer, Michael Kenneally, defected earlier this year.

List goes on

Mark Beeson, president of Bank One's mutual fund family, also resigned after an internal investigation found that Canary Partners had been permitted more frequent trades of mutual funds than other clients, according to an internal memo to employees from parent Bank One CEO Jamie Dimon. David Kundert, CEO of asset management, assumed Mr. Beeson's duties.

John Abunassar, head of Banc One Institutional Asset Management, Columbus, Ohio, also left. Press reports linking Mr. Abunassar's departure to Canary were wrong, according to several Banc One insiders who could not be identified. They said the internal investigation uncovered another matter regarding an irregular client account that Mr. Abunassar accepted into the firm's institutional unit, but that the matter was unrelated to Canary Partners or mutual fund trading. Mr. Abunassar was replaced by Norm Cook, institutional sales director of the same unit.

Julie Crothers, a Banc One spokeswoman, declined to comment. Mr. Kundert did not return a call and, through Ms. Crothers, declined to comment. Mr. Abunassar also said he was unable to comment on the matter.

"A lot of managers have lost senior people, and that's going to raise a lot of questions," said Jeff Nipp, the head of investment research with Watson Wyatt Worldwide, Atlanta. "Are other people going to get fed up and leave?"

Some executives might not be walking out voluntarily.

With the SEC requesting information from at least 295 mutual fund companies, industry observers expect more senior money management executives will join James P. Connelly, vice chairman of Fred Alger Management Inc., New York, in a rogues' gallery of money managers who have resigned, been indicted or pleaded guilty. Mr. Connelly pleaded guilty to Mr. Spitzer's criminal evidence tampering and obstruction of justice charges and SEC administrative charges in connection with mutual fund trading.

Plus, executives at two companies named in Mr. Spitzer's initial complaint — Strong Financial Corp, Menomonee Falls, Wis., and Janus Capital Group Inc., Denver — have not been charged with any crimes yet. There also have not been any resignations.

Other money management companies known to have received subpoenas related to mutual fund trading from Mr. Spitzer, the SEC or other authorities are Wilshire Associates Inc. and its affiliates; BlackRock Inc.; Merrill Lynch & Co.; Goldman Sachs & Co.; The Vanguard Group of Investment Cos.; Fidelity Management Co.; Morgan Stanley; INVESCO; and Legg Mason Inc.

Federated Investors Inc., Pittsburgh, was also served with a subpoena and announced in its third-quarter earnings report last week that internal investigations uncovered instances where investors had been permitted to violate mutual fund prospectus limits on frequent trading. Some also were permitted to engage in late trading, the company said.

And Putnam Investments, Boston, moved to center stage of the widening official probes last week. First, William Galvin, secretary of the Commonwealth of Massachusetts, said he would file a civil fraud complaint within days alleging Putnam permitted defined contribution plan participants to market time mutual fund options in their plans. Then, as the week ended, company officials said four portfolio managers would be leaving as a result of market-timing trades they had made of mutual funds they were overseeing. That trading had taken place over three years until the company had detected it and put a stop to it.

"Fairly or unfairly, Putnam people suddenly just got radioactive," Higdon Barrett's Mr. Barrett said.

Institutional consulting clients have been asking questions and "worrying how they will be impacted," said Susan McDermott, a consultant at Stratford Advisory Group Inc., Chicago. The answer, said Ms. McDermott and other consultants, is simply: We don't know.

Steve Cummings, president and CEO of Ennis Knupp + Associates Inc., Chicago, said: "We are waiting to see if this is a systemic problem. If it isn't, then we should be able to tell the good guys from the bad, but it will take a tremendous amount of effort and resources to perform this due diligence."

There could be some legal wild cards as well, particularly for public pension funds. Some states might prohibit public funds from using investment management firms under indictment, said Burton J. Greenwald, president of a eponymous consulting firm in Philadelphia.

Even without such prohibitions, the fiduciary bar will be raised for funds looking to employ those money managers, he said.