Market Timing Leads to "Late" Departure of Putnam Fund Managers

October 24, 2003 ( - Under the withering scrutiny of regulators, four Putnam money managers - including its head of international investing - are being forced to leave the firm for taking advantage of market timing in their personal accounts.

The money managers, along with two other Putnam employees, made profits of approximately $700,000 on the prohibited trades, according to Putnam officials.

However, while the mutual fund trading controversy has only grabbed headlines in recent weeks, the market timing activities in question reportedly date back to 2000 – and haven’t reoccurred since Putnam detected – and stopped the activities some three years ago.

Detected Activity

Published reports, citing government and Putnam officials, say that some of the trades were for more than $1 million.   However, the Putnam employees involved were told by Putnam senior managers in 2000 to stop such trading, after the activity was detected by monitoring systems the company established specifically to catch market timers.   However, the employees were not disciplined at the time, and they were allowed to keep their profits.

“We considered what the people were doing at the time to be inconsistent with what we felt to be appropriate for employees to be doing in terms of trading a mutual fund,” Putnam general counsel William H. Woolverton told the Boston Globe. “And you can call it market timing. You can call it excessive short term trading. Whatever you call it, it went through our screens and we detected it. We sat down with these people and said, `Look we don’t think this is the right thing for you to be doing, to be engaging in this type of activity.’ And they agreed, and they stopped doing it.”

“Fundamentally Dishonest”

Secretary of State William F. Galvin, who has led the investigation of Putnam, said he was “stunned” at the disclosure, calling the trading “fundamentally dishonest,” according to the Boston Globe.   “They took advantage of, in effect, insider trading to do market timing to pick the pockets of their own customers. The profits they made didn’t come out of thin air; they came from the funds they were supposed to be protecting,” he said, according to the report.

Galvin was already preparing to charge Putnam with civil securities fraud Tuesday for allegedly allowing groups of outside investors to market-time the Boston company’s funds (see  Union K Plan Trading Activity Leads to Putnam Fund Probe ).   Now they plan to charge the six Putnam executives with fraud as well, according to the Globe.

It’s not the first time mutual fund employees have been caught taking advantage of market timing to enhance their own portfolios.   Several years ago, a group of participants of the Prudential Employee Savings Plan had developed a trading strategy involving regular transfers of large amounts of money into and out of plan investment funds several times per month.   The strategy, once discovered by the firm, was blocked by new rules applied to the plan that barred rapid timing trades in excess of $75,000.   The participants subsequently sued to reclaim their “right” to unlimited trading as an ERISA right, but lost (see  Savings Plan Restrictions Are Within Plan Parameters ).

With regard to the Putnam transactions, while the transactions apparently occurred some time ago, Galvin said, "That the company protected them for three years, took no action and never sought to reimburse anybody for anything, until we caught them, suggests that the company's culpable.   "It isn't a few rogue managers who did this. The company's responsible," he said, according to the Globe.

For its part, Woolverton said Putnam decided to make the disclosure now because of the increased sensitivity toward market timing. "Times changed; the climate's changed; opinions changed," Woolverton said.   Woolverton also said Putnam has now decided to reimburse the funds in the amount the profits its employees made from their trading activity.

Frequent Trading "Not Illegal"

However, Woolverton insisted that the managers' frequent trading was not illegal, per se, and that market timing, which involves rapidly trading in and out of mutual funds to take advantage of inefficiencies in the market, is not against the law.   International funds are particularly susceptible to market timing because of the time differences involved in the closing of those markets and the establishment of net asset values (NAVs) for those funds.

On Wednesday Galvin subpoenaed trading records of Omid Kamshad, now chief investment officer for international equities, and Justin Scott, who now heads the firm's specialty growth investing team.  A February 18, 2000 , memorandum obtained by the Globe recounts a conversation between Kamshad and Richard B. Tibbetts, a Putnam human resources official "regarding large and frequent movement of deferred compensation."

Short-term Concerns?

"Omid's quick reaction was that he was not `market timing' as he held positions for 2-3 days," Tibbets wrote. "I confirmed our concerns about large amounts of money being moved within short timeframes . . . was inconsistent with out belief in investing over long-term as well and more importantly inconsistent with our tolerances of standard mutual fund clients."

Putnam officials disputed Galvin's assertions, but declined to comment on the memo and trading records because they involved confidential personnel matters, according to the Globe.

John Brown, head of Putnam's institutional business, told the WSJ that the trading occurred 3½ years ago, before the current uproar over market timing. "The world was a different place then," he said.   As for the trading Putnam discovered, Brown described it as "episodic, not a routine thing," according to the Journal.   But by putting a stop to the activity, Brown said, Putnam executives at the time "did the right thing, given the environment they were operating in."

Putnam, founded in 1937, is the fifth-largest fund company in the nation, managing $272 billion in assets for 12 million investors.