Fighting The Fund Cheats

Are you disgusted enough with mutual funds to raise a stink? So far, savers don't seem nearly as outraged as they were about Enron--yet deceptive funds and sneaky "financial advisers" have swiped more money, from more people, than all the corporate scandals combined. The House of Representatives just passed a reform bill, but in the Senate, the going looks tough. Your legislators are scooping up money from the mutual-fund lobby, which hopes to head off any major change. To counter the lobby, Congress needs angry protest calls from voters like you.

At least the regulators are now tailing the fund frauds that flourished right under their noses. This week, the Securities and Exchange Commission is adopting new rules to push funds toward obeying the current laws (they don't now), as well as making it harder for them to let big investors skim off profits. In a few weeks, the NASD (formerly the National Association of Securities Dealers) will bring enforcement actions against brokerage firms that grossly overcharged investors. New York Attorney General Eliot Spitzer, who turned over the rock that exposed these worms, says he's likely to bring a lawsuit a week, through January, against devious mutual funds--and promises "a lot of criminal cases across the nation."

Here's how funds cheat:

They may pay brokerage firms to get on a 'preferred list'': The brokers sell from that list, whether the funds are good or not.

They may pay 'soft dollars': That means paying the brokerage firms more than necessary to buy and sell securities. In return, the funds get stock research, which could be useful. They might also get "free" computers or services that, by law, should be disclosed as part of the expense ratio. You pay soft-dollar costs without ever knowing it.

They don't disclose all your costs: The prospectus shows you the upfront sales charge, if any, and the "expense ratio," which covers operating costs. But it doesn't reveal brokerage costs or soft dollars. Vanguard founder John Bogle estimates that expenses on taxable funds run 2 to 3 percent. Add 0.4 percent more for brokerage costs. All together, that's about 25 percent of the stock market's long-term, 10.4 percent return.