Faces grave crisis in wake of formal charges of allowing illegal trades: Putnam between a rock and a hard place

Putnam Investments LLC faces a difficult future.

As the first mutual fund company formally charged with wrongdoing in the escalating market-timing scandal, Putnam has seen investors yank billions in assets from its funds in recent weeks, and billions more are likely to leave before things settle down. The Boston-based company must also contend with the prospect of huge fines and substantial legal bills.

Even worse, Putnam faces a grave crisis of confidence on the part of the 130,000 brokers, financial planners and other middlemen that sell its funds. The groundwork for that crisis was laid in 2000 when returns for many Putnam funds plunged because managers had placed huge bets on technology stocks.

dire consequences

If Putnam fails to regain the loyalty of advisers, the 66-year-old firm is destined to become forever known as the mutual fund powerhouse that never lived up to its potential, say industry observers.

“As far as I see it, the future of Putnam is really up in the air right now,” says Louis Harvey, president of Dalbar Inc., a Boston-based research company. “Worst-case scenario: Putnam becomes the poster child for evil in the mutual fund industry. If that happens, people are going to avoid Putnam like the plague.”

The company’s former director of compliance, Edward A.H. Siedle, declines to comment on Putnam’s problems. However, any company found guilty of illegal or unethical mutual fund trading could easily find itself out of the fund business, he says.

“When the public loses confidence with any money management firm, particularly a firm that doesn’t have good performance, what’s left?” asks Mr. Siedle, who is now president of Benchmark Advisory Services Inc., a consulting firm in Lighthouse Point, Fla., that investigates investment advisers for institutional investors.

Mr. Siedle, a former staff lawyer at the Securities and Exchange Commission, brought a suit against Putnam in 1997. In that suit, he accused the firm of allowing some of its fund managers to front-run, or engage in illegal trading for their own accounts ahead of trades for fund investors.

Even if Putnam manages to survive the scandal, its relationship with many advisers is clearly on the rocks. That’s because many feel duped by Putnam, one of many fund companies that have long held themselves out as beacons of integrity.

Craig Richart, a financial planner in Chicago, had 5% of his clients’ fund assets in Putnam International Equity, one of the funds where portfolio managers allegedly made short-term trades for personal gain. Today, he is slowly moving those assets out of that fund and into the EuroPacific Growth Fund, run by the American Funds Group of Los Angeles.

“They lost more from people like me because I won’t wait a certain period of time and go back to [that fund] again,” says Mr. Richart, a principal at Financial Strategy Network LLC, which does not disclose assets under management. “I might never look at it again if where I am putting the money now is doing really well; it will just stay there.”

That said, he may be willing to consider another Putnam fund down the road.

“I’m the kind of person that will say `OK, I believe you; I’ll give you the benefit of the doubt,”‘ Mr. Richart says. “But if you screw me again, forget it; I’ll walk away forever.”

Putnam, of course, realizes that it faces a monumental task in trying to win back advisers. Days after being charged with fraud, it unveiled the beginnings of a massive overhaul.

The first to get the boot was Lawrence J. Lasser, the CEO, a 33-year veteran of the company and the man credited with turning Putnam into a giant. Replacing him was Charles E. “Ed” Haldeman, a relative newcomer to the firm but one with a record of orchestrating turnarounds.

Putnam also retained Barry P. Barbash, a former head of the SEC’s investment management division and now a lawyer in Washington, to conduct an independent review of its controls and procedures.

“I am very confident we can get back to restoring trust and restoring the Putnam brand in the eyes of our clients,” says Gordon Forrester, director of marketing at Putnam. “But it’s going to take time.”

Even though it’s been only a little more than eight weeks, Mr. Forrester insists Putnam is a very different organization from what it was when the scandal broke. The new Putnam, he says, is much more focused on ethical standards and putting investors first.

“Integrity is obviously uppermost in everything we think and do,” Mr. Forrester says.

Try telling that to Marilyn S. Steinmetz, a financial adviser at Money Matters in West Hartford, Conn. Ms. Steinmetz, whose firm oversees about $70 million, doubts whether she will ever recommend a Putnam fund.

“I wasn’t crazy about them before, and now I don’t trust them,” she says.

Putnam is not alone in the Mutual Fund Hall of Shame.

Last week, regulators charged Denver-based INVESCO Funds Group Inc. and its chief executive, Raymond Cunningham, with civil fraud, saying they had defrauded shareholders by allowing certain clients to engage in market timing even though company policies prohibit the practice.

Later the same day, Richard S. Strong, founder of Strong Capital Management Inc., announced he was stepping down as chairman and chief executive of the Menomonee Falls, Wis.-based company.

His announcement followed months of pressure by regulators, who have accused Mr. Strong of making improper trades to his personal benefit. The 61-year-old executive also intends to divest himself of a controlling stake in the company he founded nearly 30 years ago.

eye of the storm

Still, Putnam remains firmly planted in the midst of the controversy.

The firm’s assets plunged by $32 billion, or nearly 12%, to $245 billion in November. Much of the outflow stemmed from institutional investors. Meanwhile, Putnam’s parent, New York-based insurer Marsh & McLennan Cos. Inc., has seen the value of its stock shrink 11% since the scandal broke.

It’s no wonder some industry observers are starting to suggest that Marsh & McLennan might be putting Putnam on the block.

For its part, Marsh & McLennan insists Putnam is going nowhere.

“Marsh & McLennan is absolutely not planning to sell Putnam or reduce its support,” says a company spokeswoman, Barbara Perlmutter.