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Advisor Concern and Heated Exchanges at Morningstar Conference

The ability to sell mutual funds effectively was on the minds of advisors at the 16th annual investment conference.

CHICAGO – Financial advisors are a resilient bunch. In today’s world, they have to be, because it takes nerves to face clients on a daily basis when there’s so much bad news out there. While most advisors interviewed at the 16th annual Morningstar Investment Conference were hopeful that they could weather the recent spate of mutual fund-related scandals, it doesn’t mean that they—or their clients—are particularly happy about recent events.

“It’s self-defeating, says Michael Falk, CIO of ProManage, a Chicago-based managed account portfolio provider for participants in retirement plans. “The potential risk is dramatic if the average investor loses trust” in professional advice.

This conference, attended by 1,100 people, was the first since the announcement of major fines and sanctions brought against large fund companies for illegal late-trading and certain types of market-timing deals that seemed to violate the spirit and letter of many fund prospectuses.

The result has bloomed into fines, sanctions and penalties against many large fund companies, as well as further investigations into some related issues such as the appropriateness of directed brokerage, the need to state more information about soft-dollar arrangements and exactly what effective disclosure is when it comes to account statements. Some firms have banned directed brokerage and soft-dollar arrangements, which are seen as introducing conflicts of interest into the sale and marketing of funds by advisors, who should, ostensibly, be neutral in their approach to funds.

The ability for advisors to effectively sell mutual funds has become increasingly important. Russel Kinnel, Morningstar’s director of fund research, pointed out that 87 percent of mutual funds are now sold through financial intermediaries, making it paramount that investors can trust what they’re getting, and that advisors can sell funds that don’t have the taint of illegal late-trading and sketchy market-timing arrangements on them. Falk agreed, saying: “There’s no way to quantitatively discover an ethical lapse.”

Investors probably lost very little in individual funds as a result of illegal (and legal but sketchy) activities. Still, it would be a mistake, advisors say, to assume that because of this, it’s not something to be overly concerned about. Besides, the evidence suggests otherwise: According to Kinnel, of the top 20 mutual fund companies, those not tainted by scandal showed net inflows of $112 billion in the first four months of 2004, while those involved in the scandals showed net outflows of $14 billion. (Kinnel used data from the Financial Research Corp. of Boston to compile his stats.)

“It does affect most brokers out there,” says Robert Anderson of McSherry Associates, an investment advisory firm in Lake Geneva, Wis. “People are going to avoid the funds that got into trouble.”

Conference panelists were similarly concerned with extra regulations that will affect advisors in coming years, among them new corporate governance rulings and laws stipulating that fund managers offer more disclosure about fund expenses. Don Phillips, Morningstar managing director, was particularly critical of the Investment Company Institute, the industry’s trade group, in opposing what he termed “most suggestions for change” in the industry, particularly as it related to a recent SEC ruling stating that fund companies need to appoint independent chairmen. “The industry expended a lot of political capital fighting something that they were going to lose,” he said Wednesday night.

The topic reasserted itself Thursday night during a heated panel, when Phillips questioned Robert Pozen, late of Fidelity and now chairman of MFS, about some of the industry’s opposition to change. Pozen didn’t agree, saying that the ICI had come up with a number of substantive changes over the last decade to reform the industry.

Phillips countered by saying that the industry was getting dragged through the mud because of its resistance to change. But Pozen said, “The reason why this spread was because a lot of people lost money in 2001 and 2002.”

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