Much as it had hoped to set a new course for the troubled Fundamental Funds, Cornerstone Equity Advisors will be paying the price for the funds' past problems.
Substantial debts that Fundamental has accumulated because of setbacks over the last few years persist and Cornerstone has agreed to cover the costs. The existence of the persisting debts and the fact the Cornerstone will be paying them was disclosed in a proxy statement now being sent to the 5,000 shareholders of Fundamentals' five funds. The proxy is to gain shareholder approval for the appointment of Cornerstone as the funds' permanent adviser. Cornerstone has been the funds' interim adviser since September 30.
According to the proxy, Cornerstone of New York, will enter into a $30,000 a month licensing agreement with Fundamental, the funds' original adviser. Under the arrangement, Fundamental will supply computer equipment and services to Cornerstone for the next 12 months. Products to be leased include a modeling software program that is used in conjunction with market timing activities. A significant portion of the Fundamental Funds' shareholders are market timers. Cornerstone, not the shareholders, will be paying for the equipment.
Despite the generous arrangement, Fundamental will not be profiting significantly. A newly assembled board of directors has mandated that Cornerstone place more than $300,000 of its total expected lease payments of $360,000 in an escrow account in order to satisfy several old, outstanding obligations.
The list of Fundamental's still outstanding liabilities includes $81,000, a legal bill apparently paid out of three of the Fundamental funds themselves. There is also a $102,000 obligation to pay investors a cash settlement as part of a class action suit filed against Fundamental Portfolio Advisors in 1994 and settled in 1996. That settlement called for at least $192,000 to be paid to plaintiffs. Fundamental has already paid $90,000 but $102,000 is apparently past due. The proxy suggests but does not say explicitly, that there are additional debts, including possible future payments to plaintiffs involved in the lawsuit settlement. The fund's lawyer and that of the plaintiffs did not return phone calls.
Details of the lawsuit were not disclosed in the proxy. But, one source recalled that the Fundamental U.S. Government Fund had suffered heavy losses in 1994 amid interest rate spikes. Investors who lost money sued, charging that the fund adviser had not invested according to the fund's stated policies.
Fundamental has been in turmoil for over a year. Both the SEC and National Association of Securities Dealers within the last 15 months, sanctioned the firm's two principals, on charges that they marketed one fixed-income fund as a "safe" investment although the portfolio was filled with highly volatile, complex derivatives.
Then, this past June, the funds' board of directors gave the fund manager a no confidence vote and terminated the management agreement between the funds and Fundamental Portfolio Advisors. The board then designated Tocqueville Asset Management as the fund managers. But that arrangement ended within three months because of differences between the board and Tocqueville over how to treat market timers.
Cornerstone had been hoping for a fresh start. After intially losing about $5 million because of shareholder concern over adviser turnover, total fund assets have now leveled off at $157 million, the adviser said.
Since taking over as interim adviser, Cornerstone has been removing derivatives from the portfolios and replacing them with better quality securities. And it has been trying to calm down disgruntled shareholders.
"We have begun the cleanup. We're in a solid turnaround position," said Stephen Leslie, chairman, ceo and fund portfolio manager at Cornerstone. "We want to maximize the market timers' activities while helping to satisfy old problems. We want to finally put that ghost behind us."