Putnam Investments has found itself an industry example again, only this time, regulators are praising the Boston-based fund firm, once synonymous with scandal and sanctions, as a model corporate citizen.
On Dec. 30, the Securities and Exchange Commission charged six former executives of Putnam Fiduciary Trust Co. (PFTC), but not the transfer agent itself, with civil fraud. Regulators claim that in January 2001, the team conspired to cover up a mistake at a cost of $4 million to investors in several mutual funds and one retirement plan. The scam went undetected until 2004, when Kevin Crain, one of the accused six who had "been terminated for other reasons," blew the whistle, according to the Federal complaint filed with the United States District Court in Massachusetts.
SEC Deputy Director of Enforcement Walter G. Ricciardi called the alleged fraud "egregious," but praised Putnam for taking "extraordinary" steps to correct the problem.
"PFTC's cooperation consisted of prompt self-reporting, an independent investigation, sharing the results with the government, terminating or otherwise disciplining wrongdoers, paying for the attorneys' and consultants' fees of its defrauded clients and implementing new controls," according to the SEC's litigation release.
Roy Weitz, of watchdog Web site FundAlarm.com, considers Putnam's response a good sign for the industry, and proof that enforcement works. "The company that was hit hard pays attention," Weitz said.
Just last year, Putnam settled a lawsuit brought by New York Attorney General Eliot Spitzer involving charges of securities fraud. Although Putnam's parent company Marsh & McLennan neither admitted nor denied any wrongdoing, the settlement slammed the company with the largest enforcement action in history, requiring Putnam to pay clients $850 million and requiring rigorous reforms to Putnam's practices to increase transparency and prevent any such future fraud. Putnam, then on the verge of implosion, revamped its image by completely replacing its executive team.
"We have worked hard at Putnam to create a culture in which all of our colleagues value the importance of taking care of other people's money and putting our clients first," said Ed Haldeman, often described as the "reform-minded" president and chief executive, who joined Putnam in 2004.
So, at the first hint of the problem with the squad of six named in the Dec. 30 lawsuit, Putnam took immediate action. After an internal investigation in 2004, Putnam fired three of the six defendants who still worked at the firm, and even converted the two-year-old resignation of another into a termination, according to the SEC complaint. Putnam also refunded the affected investors, and handed the case to the SEC.
As a reward, Putnam received impunity from the SEC.
"This represents the broader lessons of a case like this, whereby the company gets a pass from the SEC in exchange for immediately self-reporting a material problem and getting rid of everyone who might have had a fingerprint on the problem," said C. Evan Stewart, a partner in the New York office of Zuckerman Spaeder, who specializes in securities defense.
According to the SEC, those fingerprints belonged to six former Putnam executives, including Karnig Durgarian, who, at the time, held the top executive spot of chief of operations services; Donald McCracken, formerly a managing director and the head of global operations in charge of fund accounting; Ronald B. Hogan, vice president of the new businesses implementation unit; Virginia A. Papa, director of defined contribution plan servicing and a managing director; Sandra Childs, head of the compliance department and a managing director; and, Crain, a managing director in charge of plan administration.
The problem started on Jan. 2, 2001 when Cardinal Health of Dublin, Ohio, asked PFTC to invest money from its employees' 401(k) plan. But Putnam managers did not reinvest the assets until Jan. 3, missing out on a significant market upswing. That day, a Cardinal employee sent an e-mail to someone at Putnam exclaiming, "The market is up, and we look great being invested on the upswing," according to court filings.
In fact, Cardinal shareholders had lost $4 million. Rather than admit the mistake to Cardinal, the defendants conspired to conceal it, according to SEC allegations. In a series of closed-door meetings, the defendants devised a complicated accounting scheme to forge trade confirmation documents and dip into five other Putnam mutual funds to replace $3 million of the assets Cardinal would expect to see. Still about $1 million short, the SEC claims that Hogan and Durgarian contacted colleagues at Franklin Resources to ask that retroactively execute certain trades. Franklin executives refused. As a result, the Cardinal account absorbed the remaining $1 million loss.
In 2002 and again in 2003, Childs, Crain, Papa and Durgarian each signed sworn statements presented by auditors claiming no knowledge of unusual, illegal or fraudulent acts relating to these accounts, according to court papers.
Frank A. Libby, Jr., an attorney representing Durgarian, said in a statement that his client "looks forward to his opportunity to contest the SEC's claims." The SEC complaint claims that during the investigation leading to its lawsuit, Durgarian invoked his Fifth Amendment protection against self-incrimination.
Gary Matsko, who represents McCracken, said that his client, who retired two years ago after an "unblemished" career, is prepared to "defend against the charges."
Michael J. Connelly, who represents Papa, said his client "looks forward to full vindication in court." Attorneys representing other defendants did not return calls for comment last week, nor did representatives from Cardinal.
The SEC seeks unspecified civil fines through the lawsuit and to "restrain and enjoin" each from ever repeating the same types of transgressions.
Whether the defendants get the specific punishment the SEC seeks is less important than the trend this case represents, Stewart said. In addition to demonstrating how companies may be more eager to cooperate with regulators, the Putnam case also shows that individual employees cannot count on their companies to help them defend themselves against Federal charges, creating a guilty-until-proven-innocent approach to justice. "Companies are told by regulators that they will be deemed uncooperative if they advance fees to these individuals, as they are usually required to by the company by-laws," Stewart said.
Without the aegis of indemnity protection written into company by-laws, the six ex-Putnam executives must provide - and pay for - their own defenses. Between attorneys, experts and other fees, that can be a costly process, pitting individuals' pocketbooks against the treasury of the SEC.
"Whether the individuals have the financial ability to defend themselves is unclear," Stewart said.
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