Fund Administrator Fraud

We know funds involve all sorts of expenses, but the general principle is that the fund assets should not be abused to pay for those expenses not for the benefit of investors.

Last week SEC instituted an enforcement action against BISYS Fund Services, a mutual fund administrator. BISYS aided and abetted 27 mutual fund advisers' improper use of fund assets for fund marketing and other expenses.

BISYS entered into "side agreements" (either verbal or written) with those fund advisers, which obliged BISYS to rebate a portion of its fund administration fee to the advisers so that they would continue to recommend BISYS as an administrator to the fund board of trustees. Fund advisers used the money to pay for marketing expenses and even non-marketing expenses such as:

• check fraud losses
• seed capital for new mutual funds
• settlement of disputes with third parties

From Jul 1999 to Jun 2004, BISYS provided over US$230m from its administration fees to the fund advisers!

This fraud case is quite shocking because of its massive scale in terms of the number of advisers, amount involved and the long duration. It is sometimes hard to correct some people's impression that fund investing is cheating. Even the fund manager has done a great job, the fund performance could be eroded by those unnecessary expenses.