The Markets October 20, 2007

Bear Stearns Probed for Conflicted Trading in Failed Hedge Funds

Massachusetts securities regulators have begun a probe into whether Bear Stearns Cos. improperly traded with two in-house hedge funds that collapsed this summer.
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The Wall Street Journal reports that regulators in the office of Secretary of State William F. Galvin are examining whether Bear Stearns traded mortgage-backed securities for its own account with the hedge funds without notifying the funds’ independent directors in advance, according to sources familiar with the investigation. Investigators are also attempting to determine whether the trades were priced fairly and whether troubled securities positions were offloaded onto investors in the two funds, the sources told the WSJ.

Investors lost $1.6 billion when the two mortgage-related funds, Bear Stearns High-Grade Structured Credit Strategies Fund and High-Grade Structured Credit Enhanced Leverage Fund, failed.

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Federal prosecutors and the SEC are also examining the circumstances surrounding the funds’ collapse, but the Massachusetts investigation appears to be the first suggestion that potential conflicted trading at Bear Stearns is being scrutinized, the news report said. Massachusetts regulators have found “a material number of principal transactions,” between Bear Stearns and the two funds, a person familiar with the investigation told the WSJ.

The Bear Stearns funds’ offering memorandums listed types of arrangements that could lead to conflicts, including handling brokerage business for the funds, allocating positions between the funds and other entities managed by Bear Stearns, valuing the assets of the partnerships, and lending to the funds. Also, when acting for the firm’s own account, Bear Stearns traders have a primary responsibility to make money for Bear Stearns, not for the mostly investor-owned hedge funds.

The memorandums note federal securities law mandates that any investment adviser whose affiliates engage in principal trading with clients must obtain their consent in writing in advance, and Bear Stearns Asset Management, the unit that sponsored the two funds, promised in the memorandums that it would do this by obtaining the consent of the funds’ independent directors, who act on behalf of investors. The two hedge funds each had the same five directors, three of whom were affiliated with Bear Stearns.

They had posted a string of quarters with positive returns, but when the market for subprime home loans went downhill, so did many of the funds’ holdings. Prominent in the funds were pools of securities made up of bonds backed by subprime mortgages, which are extended to borrowers with poor credit.

The Markets October 19, 2007

Study Says 401(k) Fees Can Take Huge Bite Out of Plan Balance

Hefty 401(k) plan fees can take a big bite out of a participant’s balance – a 26% chunk, according to a new study by the Congressional Research Service (CRS).
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The CRS report, “Retirement Savings Accounts: Fees, Expenses, and Account Balances,’ found that the difference in ending balances between scenarios where fees were 2% of plan assets and where they were 0.4% of assets was $92,771 – $356,434 with lower fees and $263,663 with heftier charges.

CRS researcher Patrick Purcell, Specialist in Income Security in the CRS Domestic Social Policy Division, explained in the report the scenarios studied involve a median-earning married couple saving 6% of family earnings yearly for 30 years with two-thirds of the account invested in equities and the rest in fixed income.

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Purcell cited Investment Company Institute (ICI) data showing the average asset-weighted 401(k) stock fund expense ratio was 0.76% in 2006.

The calculations also used the distribution of rates of return in U.S. stock and bond markets over the 80-year period from 1926 through 2005, the researcher explained.

Meanwhile, according to the CRS, a median-earning single person who contributes 6% of earnings each year for 30 years to a retirement account that is invested two-thirds in stocks and one-third in bonds could expect to accumulate $187,738 in constant 2004 dollars if investment rates of return are at the historical median over the investment period and annual expenses are equal to 0.4% of plan assets.

Purcell said that same person in a plan where annual expenses were 2% of plan assets, could expect to accumulate $138,344, or 26.3% less than under the low-cost program.

For this report, CRS estimated the effect of expenses ranging from 0.4% to 2% of assets on the amounts accumulated in retirement accounts over a thirty-year period by married couples and single persons with high, median, and low earnings who contribute 6%, 8%, or 10% of earnings each year to a retirement account invested in a mix of stocks and bonds.

The study compared annual expenses of 0.8%, 1.2%, 1.6%, and 2% of plan assets to a low-cost “base case” in which annual expenses were equal to 0.4% of assets in the account.

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