Federal regulators are sending a new message to some of the industry's best performing funds: double-check your math.

At issue, according to an April 8 report from the Wall Street Journal, are the higher portfolio management fees some funds charge investors when they beat their benchmark.

The variable charges are common at hedge funds, but mutual fund managers typically receive a set fee regardless of returns. And as the Wall Street Journal report notes, just 3% of U.S. stock and bond mutual funds, or 7.8% of the $7.5 trillion industry, use performance fees. But a number of those that do, including Boston powerhouse Putnam Investments, have recently been alerted by the Securities and Exchange Commission, as well as by outside auditors, that their calculations might be off and investors may have been overcharged.

One fund complex, Houston-based Bridgeway Capital Management, repaid investors in three funds $4.4 million worth of improper performance fees as part of deal it reached with the SEC last fall.

News of the heightened scrutiny has given funds that use the fees, or are considering them, reason for pause, experts told the WSJ. Seattle-based Accessor Capital Management, for example, removed performance fees from its 15-fund lineup. According to a regulatory filing, the firm said the SEC would recommend an enforcement action because of the oversight. Other funds that might be in hot water, SEC filings reveal, are n/I numeric Small Cap Value Fund, Gartmore U.S. Growth Leaders Fund, closed-end Taiwan Fund and WWW Internet Fund, which has since folded.

Industry leaders Fidelity Investments of Boston and Valley Forge, Penn.-based Vanguard Group, however, still use performance fees on a combined 73 funds with $493 billion assets. Vanguard chief Joseph Brennan said his firm likes them because that way management is "sharing in the gains and feeling the pain of losses along with the shareholder." Both firms told the WSJ that they haven't run into problems with the SEC over their performance fee calculations.

The bottom line is that the SEC requires funds to figure the fees based on the average assets during the time period used to measure performance, the WSJ observes. In the case of Bridgeway, the firm based its faulty performance fees on its latest asset levels. As a result, its performance fee figures were higher than they should have been.

While some industry experts contend that the method for determining performance fees has quirks, Elizabeth Osterman of the SEC's Division of Investment Management said the rules are "pretty specific about what can be done and how the performance fees have to be structured."

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.

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