Max Rottersman has been pointing out problems in the mutual fund industry, shedding light on inconsistencies in data, and trying to drum up business for, a mutual fund data analysis firm based in New York, for which he serves as president.

By analyzing data, Rottersman has unearthed some disturbing trends and corporate mistakes in the fund arena. However, there is a unique connection between the data and the actual problems facing fund shops individually and the industry overall.

Rottersman spoke with Money Management Executive Associate Editor Chris Frankie about the industry's woes, the disconnect between fund firm upper management and the mid- and lower-tier workers, as well as bureaucratic inefficiencies at the country's lawmakers and regulators.

MME:You have written about problems with Fidelity's performance fee model on your Web site and noted in a letter to the SEC an incorrect filing by Putnam Investments. You have raised questions of insider trading at Alliance Capital. These claims should raise red flags. Why do you think corrective action for some of the things you have shed light on has been slow going?

Rottersman: The problem is that the SEC is the only entity that any of the companies really fear. Lawyers that have strong relationships with the SEC really call all the shots. Funds think that the problems result from a bad relationship with the SEC and are not derived from the data and the analysis that I do.

MME: In a recent letter to the SEC, you write about how difficult the SEC makes it for firms such as yours to provide board trustees with information. Do you think if some of those barriers were not in place, the scandal might not have gotten this out of hand?

Rottersman: Absolutely. Like any organism, when you have a lot of inbreeding, it gets corrupted. There's really no fresh blood in the fund industry. You have the same people talking about the same things, and their knowledge gets old. They don't understand new technologies.

MME: What barriers need to come down to make the information flow better for trustees?

Rottersman: I think there needs to be more of a connection between disclosed problems in the press and action by the SEC or by the prosecutors. There just isn't enough responsiveness to criticisms. Why should the boards do anything about a bad report unless they have to?

MME: You have said that mid- and lower-tier management are the real losers in the whole scandal. Why?

Rottersman: Those in middle- and lower-tier management are losers because they're the ones who will ultimately lose their jobs because of the fund management abuses. In general, CEOs can go from one job to another and are independently wealthy. But the middle managers suffer most from the loss of investor trust. Once people stop trusting in companies, they cease moving their money around. Of course, the top executives just fire the middle managers until things change.

You are seeing some corporate officers stepping down across the board, but the middle managers look like they're the culprits. The people who would like to have pride in their work just can't have it because the whole company is tarnished. One of the reasons that many of these middle managers are running into problems is because there is no clear direction from the top as to which rules need to be followed.

MME: You have claimed that a small number of people, about 1,000, wield the most power in the fund industry and this is harmful to the industry. However, most industries have a core of decision-makers and leaders. Why is this particularly bad in the fund industry?

Rottersman: You're right in pointing out that most other industries have even higher concentrations of power within just a few different companies. However, in other industries, the consumer understands their products a little bit more. When you buy a TV, you understand whether it works or it doesn't. The same goes for a car.

Financial products are so complicated that the consumer doesn't have the knowledge that they have in other industries, even though there is tons of disclosure. The problem with the 1,000 people in power in the fund business is that there is a concentration of that power in a group that doesn't change. The end consumer has the least amount of knowledge about these products than any other product that they buy in their lives.

MME: SEC Chairman William Donaldson came into his job preaching the "tone at the top" mentality, asking financial service firms to own up to their fiduciary responsibilities. However, you recently criticized Fidelity's Ned Johnson, and have noted that upper management is sending its misguided thinking downwards. Do you think the fund industry has taken to Donaldson's message, or is it business as usual?

Rottersman: It is business as usual. I brought up a criticism, and others have brought up criticisms of Ned Johnson, but he's not interested in the criticisms about how Fidelity deals with its shareholders. What he cares about is whether he is going to be chairman of the board of directors.

That's the problem with the industry, when people like Ned Johnson don't come out and be a leader in a way that is positive. Instead, he is just complaining about something that is just selfish. It's not that I disagree with his arguments, he's just exhibiting poor leadership.

One of my favorite stories that could relate to the fund industry today is about airbags in the automobile industry. In the beginning, the auto industry didn't want to pay the $300 or the $600 per car to put them in, and fought airbags tooth and nail.

Nobody showed stronger opposition to them than Lee Iacocca. But once it became clear that people wanted the airbags and the industry had to do it, then all of a sudden Lee Iacocca took a leadership position, saying, "Airbags are great, and every car should have them."

Reform is a foregone conclusion in the fund industry. But for the most part, Ned Johnson and others on his level are not taking the true leadership role. They need to say they are going to fix problems and listen to complaints. However, they're just protecting their own selfish needs. That's the ultimate problem.

MME: You offer a defense of James Connelly, Jr. in a recent article you wrote. You painted Connelly, vice chairman at Alger, as an outsider at a shop that is likely majority-owned by the Alger family and was paid good money for "a young man without rich parents." Can you explain your thinking behind the article?

Rottersman: What I really wanted to show is that the scandal is not a problem about a few people. The scandal is a problem about a shifted attitude away from fiduciary responsibility towards profits at any costs.

To just blame it on him, or on any of them, saying they are evil, is incorrect. The people aren't broken. It's the system and the attitude that are broken. I wanted to show in this article how Alger has had a very aggressive marketing machine that makes it understandable how somebody like James Connelly could get tripped up in it.

MME: So you are saying Connelly was just a cog in the machine and if it wasn't him, it would have been somebody else in his place?

Rottersman: Exactly. It would have been somebody else. And, there are others out there. They just didn't panic and delete their emails.

MME: Do you think the SEC needs to go higher up the food chain in prosecuting people criminally?

Rottersman: I don't think they should prosecute criminally. I don't think that if they throw 20 mutual fund executives in jail it is going to change anything.

MME: So then what needs to be done?

Rottersman: The problem right now is that there's no clear consensus on how mutual funds should be structured. So, really I blame the SEC and Congress for this. Congress and the SEC need to step in and say mutual funds are trying to do too many things for too many different people. They need to say they're going to separate some of the functions, so that each group of people can operate in a way that suits them. For example, if you really want to bet on high-growth stocks and want to do heavy marketing, fine, then you can go and do that.

If you are a 401(k) plan participant and you just want to park your money, then there is going to be another set of funds with another set of requirements, that are going to answer that retirement need.

The industry needs leadership from two places. The first is Congress and the SEC and the second is from the fund CEOs themselves.

MME: You have been labeled an investor advocate in the press. However, you don't like that label. Why not?

Rottersman: Many people look at what I have to say as being anti-mutual funds, but that's not true at all. It's the exact opposite. I just happen to have a certain sort of conservative bent towards the idea of investments.

I get upset that I am called a watchdog or investor advocate because we all should be watchdogs or investor advocates, shouldn't we? We want mutual funds that are good for the management companies and the shareholders. I want the management companies to make money. Nowhere on my site do I say that I don't think people should invest in mutual funds.

So, I think it's been difficult for me to do the stuff we do at, in a sense, because people are just having a knee-jerk reaction to it. The industry has the problem. It has to allow democratic comment and to own up to its shortcomings. There is no need to stonewall and not answer criticisms. It's not that big of a deal.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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