Meet A Major-League Whistleblower

Woman Who Exposed Mutual Fund Scandal Talks To <B>60 Minutes II</B>

If you are one of the 100 million Americans who has a 401(k) through your company, or an IRA retirement account, or a private mutual fund, this story is about you.

Mutual funds are those bundles of stocks, which so many of us own without knowing exactly what we own. But they've always been thought of as just about the safest investment out there.

Therefore, it came as a shock when it was revealed that many of these funds were allowing illegal trades that took money right out of our pockets.

What's more, the schemes were so subtle, so insidious, that they went on right under the noses of regulators for years -- that is, until an anonymous whistleblower made a phone call to New York State Attorney General Eliot Spitzer, who's made a name for himself going after crooked brokers on Wall Street. Correspondent Bob Simon reports.
"We were all cheated in a way that was criminal. It was wrong. And it was outrageous," says Spitzer. "The brazenness of some of these schemes is absolutely remarkable."

It was so brazen that Spitzer and his staff were skeptical when they got a call from an anonymous Wall Street insider who said people she worked with were trading mutual fund shares in a way that was illegal -- which was skimming profits from everyone else.

"We said, 'That can't be true,'" recalls Spitzer. "But every single fact that she alleged has been proven out."

The whistleblower, it turns out, was a respected 20-year Wall Street veteran named Noreen Harrington, who'd recently left her job as a manager of a private investment fund.

"I knew I needed to tell somebody, just so I could sleep with what I knew," she says.

Harrington says she didn't tell anyone about her first call to Spitzer's office: "I told nobody. These are powerful people. And some people are gonna go to jail. It is scary."

It was scary because Harrington was about to expose a series of scams that were making a lot of people a lot of money.
The worst of the scandal comes down to the moment when the most famous bell at the New York Stock Exchange rings at 4 p.m. in the afternoon.

At this moment, the closing price of mutual funds is set for the day, and trading is closed. It's as simple as that. But Harrington claimed that some big traders were sending in orders hours later and getting the 4 p.m. price -- when they had good reason to believe the market would go up or down the next day.

The practice is called late trading. It is patently illegal and it causes regular investors to lose a lot of money.

Although Harrington unknowingly made money herself off the scheme, she did not participate in it. So how did find out? The water cooler. "When people make money, there's part of them that wants to brag about that and tell other people," says Harrington. "That's how I learned a lot about what was going on."

But it wasn't just her word. The Attorney General found the paper trail: trades time-stamped long after 4 p.m. And there was more.

Harrington had turned Spitzer's office on to an Internet chat room where a colleague of hers, James Nesfield, used to find funds willing to do something called "market timing" -- quickly buying and selling mutual fund shares, something Nesfield acknowledged in chat room exchanges "might seem out of the normal request."

Out of normal because, unlike stock which are bought and sold every day, mutual funds are meant to be held long term in company retirement accounts like 401(k)s. And the rules governing mutual funds are supposed to make sure they're not "day traded" for quick profits that dilute the value of everyone else's shares.

"That was his [Nesfield's] job. And he got paid if he found mutual funds that would do this," says Harrington.

And, according to Nesfield, people at some of the most respected mutual funds – funds that advertised themselves as beacons of integrity – went for his pitch.
Nesfield, the point-man in the market timing scheme, admits he was searching for individuals within mutual funds like Janus who were willing to take the bait and bend the rules.

"Janus -- they had made a change in management. And the new guy, I mean, I saw him a mile away. He was a fish. You know what I'm saying? I took, take him in a game of cards tomorrow," says Nesfield, who sent Janus an email asking for a point of contact to negotiate market timing capacity – and asking if these restrictions could be lifted.

Nesfield says he wasn't asking them to break the rules: "Not the rules – things they strongly discouraged. Now, we're talking grey. We're not talking black and white. We're talking grey."

Grey, he insists, because, unless the fund's paperwork outright bans this practice, it's not technically illegal. But Janus – like most mutual funds – put it in black and white in its prospectus: "The Funds do not permit frequent trading."

"And here is the most critical misrepresentation. The mutual funds specifically said, 'We will not permit this type of market timing,'" says Spitzer. "And they did not enforce it as long as you went to them with enough money and said, 'We will bring you big bucks if you permit us to break this rule.'"

So, the mutual funds were able to bring in more money from big-bucks investors. And, it turns out, it went well beyond Janus. People at top firms, including Invesco and Bank Of America, were willing to play along.

"If you got a no, you asked the wrong person," says Nesfield.

Simon asks, "What was your batting average? For every 10 calls you made, how many hits did you get?"

Nesfield responds: "I'd say about 70 percent. When I got good, it was 70 percent, which is pretty good, you know? It's like batting .700. I could make the Yankees, right?"

But soon, Nesfield struck out. After Harrington blew the whistle, the dreaded subpoena showed up, and Nesfield decided to cooperate with Spitzer's office to help build the state's case against his and Harrington's boss, Edward Stern. Stern, in turn, has agreed to settle.

Nesfield says this is something that's been going on for a long time. But how many people were in the know? "Who knows. They're still finding them," says Nesfield. "[If it hadn't been] for Noreen Harrington, nothing would have happened."
"The pervasiveness of the impropriety continues to startle me," says Spitzer, who admits that Nesfield and his boss, Edward Stern, were just the tip of the iceberg.

Other investment firms have been implicated. And a recent federal study found that half of the major mutual funds engaged in market timing, and a quarter – that's 1 in 4 – admitted to late trading.

"There was a conspiracy of silence," says Spitzer. And, if there hadn't been the whistleblower, he says, he doesn't know if "we ever would have seen it."

"Remember those who are perpetrating this crime are smart. And they're careful to calibrate and take away not so much that anybody really notices," says Spitzer. "They were smart enough to limit what they did."

This could explain how this went on for so long – for years – right under the nose of the Security and Exchange Commission, the federal agency that's supposed to catch these things.

So why did Harrington decide to call Spitzer's office instead? "I called because I thought I was a witness to a crime, OK," says Harrington. "And Eliot Spitzer and the Attorney General of New York can actually move pretty fast to address those issues."

In other words, she says, the SEC had moved slowly, if at all. Remember Enron? Worldcom? The SEC failed in those and so many other cases to expose the frauds until it was too late.

Congress is now holding hearings on how this mutual fund scandal went undetected by the SEC for so long, and is drafting strict new rules for Wall Street.

"Do I wish that we'd have brought the case two months ago instead of two weeks ago? Of course I do," says Steven Cutler, the SEC's head of enforcement. He acknowledges that the agency moved slowly, but is now putting into place a new office to catch future frauds before they get out of hand. "Individual investors have a right to expect fair treatment, and quite simply have not gotten it."

Still, some within the government point out that each investor probably only lost a few hundred dollars from late trading and market timing.

Did the SEC drop the ball?

"I think they [SEC] were not as aggressive as they might have been. Right now, we are colleagues, we have a common objective and even though we disagree about certain issues at various times, we are working together."
Until now, it's been up to whistleblowers to pick up the ball. Sherron Watkins blew the whistle on Enron. Cynthia Cooper exposed the Worldcom scandal. And, now, there's Noreen Harrington.

What is it about whistle blowers and women?

"By definition, women aren't part of the old boy's network. And somehow the old boy's network has generated this notion of, 'Don't tell anybody what we're doing,'" says Spitzer. "Women who have begun to succeed thankfully on Wall Street are rising through the ranks and are saying to themselves, 'Wait a minute, you're doing what?'"

And what they've been doing on Wall Street goes well beyond what Harrington revealed. Spitzer is now looking at something that costs average investors even more than late trading and market timing combined - excessive, and unfair, fees charged by mutual funds.

"Even professional investors read a mutual fund prospectus and say, 'I can't make head or tail of this,'" says Spitzer. "What we have proposed, and others as well, is that there be a disclosure that is somewhat akin to the label that you see outside of every food package that you buy."

The SEC has launched its own probe into the mutual fund industry – and just last month, discovered a kickback scheme that hit the front pages: brokers were being paid off to push certain funds.

But is it a fair assessment to say that the entire financial world was corrupt?

"No. Most of the people that I work with, I think, are incredibly honest. I think the predominant amount of people do try to do the right thing," says Harrington.

Does she think that mutual funds in which so many millions of Americans put their money and their trust, will be safer now?

"I do. I believe this was enough of the black eye to the industry that people are focused and they're going to change this," says Harrington. "So that this crime cannot continue."

The New York Attorney General has already brought several criminal charges against mutual funds -- and at least one mutual fund executive has gone to jail already. Janus and other mutual funds have agreed to re-pay the money investors have lost, and they're changing their internal rules. As for the SEC, it plans to adopt sweeping changes to the industry this spring.
  • Rebecca Leung

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