S.E.C. Turns Its Eye To Hidden Fees In Mutual Funds: First Eagle Case

Ted

FYI: On Sept. 21, the Securities and Exchange Commission’s enforcement division filed proceedings against First Eagle Investment Management, an asset-management company overseeing $100 billion — mostly in eight stock, bond and multi-asset funds. The S.E.C. said that from January 2008 through March 2014, First Eagle improperly billed its investors $25 million for payments to brokers marketing the funds’ shares. The commission also accused First Eagle of misleading investors by maintaining in fund documents during that period that it was paying the marketing costs itself.
Regards,
Ted
http://www.nytimes.com/2015/09/27/business/sec-turns-its-eye-to-hidden-fees-in-mutual-funds.html?_r=0

Archaic

So..........First Eagle is a branch of Volkswagen? They sold their integrity and good name for 25 mil? I've had a bunch of money with these guys for 10 years -- and they stole from me? Time to move on.

msf

Given the relatively small amount of money involved (as was pointed out in the NYTimes article), this may have been a situation where First Eagle cut legal corners on something it could have done legally.

It could have gone to the board and said: The fund is bleeding cash. This is causing fire sales and hurting investors. We need to staunch the outflow, by increasing marketing. Raise our management fees to cover that marketing and we'll pay for the marketing services. That would have been legal, and the net effect would have been to have the investors pay for the extra marketing expenses.

Instead, First Eagle decided to short circuit the process and just use the fund assets directly without involving the board. It was aware this wasn't legal, because it hid the payments from the board and from shareholders by saying they were for shareholder services (which were allowed to come from investor assets).

I'm not saying this was their thinking, and what they did certainly wasn't legal. But since the same investor money could have been spent legally on marketing, it doesn't seem to me that investors were fleeced. Rather, what bothers me is the deliberate illegality.

A footnote - Morgenson's calculation of the amount of money First Eagle netted from management fees on the net inflows is wrong. She said that First Eagle took in $23.1B over six years. Multiplying it by the management fee of 0.75% per year, she gets additional management fees of $173M.

But this was over six years. The average extra AUM was half of the $23.1B (assuming linear growth). And this amount should be multiplied by 0.75 times six (for six years). That makes the $25M spent on marketing look even smaller, and thus less likely that this was done by First Eagle to make an illegal buck. Hardly excuses it.

Charles

Thanks for insight on this issue msf, as always. Wonder who blew whistle or if it was just routine examination by SEC.

Nice article Ted. 'Cept for the math error pointed out by msf, think Gretchen Morgenson does fine job.

Wonder how widespread the practice is...in any case, hopefully case sheds more light into actual use of 12b-1 fees...

“Of course, the problem is much bigger than this one case,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “The S.E.C. has allowed 12b-1 fees to morph into distribution fees when they were originally intended to serve a very different purpose. The agency had a reform proposal ready to go back in the early days of this administration, but the industry didn’t like it, so it never went anywhere.”

There are signs, however, that the First Eagle case may be just the initial S.E.C. salvo on improper mutual fund fee practices. Tricks involving 12b-1 fees are a rich vein for the S.E.C. to mine because these charges are exceedingly opaque. Bringing cases in this area is crucial for investors since these fees drag down fund returns.

These fees also pose real conflicts of interest. Investment advisers are paid based on a percentage of assets under management; as these assets grow, so does the adviser’s income. Marketing a fund helps increase assets under management, so the investment adviser is the primary beneficiary of any fees paid for that purpose.

And, gotta love (not) this...

First Eagle’s website contains a list of its guiding principles. This is one of them: “Always act with honesty, integrity and transparency. Never have anything to hide.”

VintageFreak

Why does this happen to me? I try and evaluate a fund company carefully before buying their funds. I own FEBAX. Now I have to look for replacement...

The managers do have significant ownership. I just can't figure this out.