Spitzer fallout set to hit UK

Mutual funds are collective investment schemes specifically designed to give US private investors access to a wide range of other stocks and shares. Over 95 million Americans have approximately $7trn (£3.7trn) invested in mutual funds.

The US mutual-funds investigation has been led by New York State Attorney General, Eliot Spitzer. The allegations are that mutual funds and brokers have engaged in 'market timing' and 'late trading'. Trading in mutual funds should finish at 4pm Eastern Standard Time each day and the mutual-fund share will have a nominal closing price at that time. Market timing is essentially using price-sensitive information acquired after trading has ceased, which affects the value of the mutual-fund shares before their actual value is calculated when the market opens the following day. Market timing is not illegal but most mutual funds have a public policy prohibiting such practices.

Late trading involves allowing orders made after 4pm to be processed and treated as if they had been made before the 4pm deadline. Traders can, again, take advantage of information known to them, which affects the value of the mutual fund's assets and, consequently, the actual closing value of the mutual fund itself. Late trading is a criminal offence. Sophisticated professional investors have used these practices to make huge profits at the expense of less sophisticated private investors.

The mutual-funds scandal has resulted in class-action lawsuits in the US involving many of the largest names in investment, including Canary Capital, Janus Capital, Invesco and Putnam. The class actions have already resulted in large settlements of up to $250m in fines to the US authorities and in compensation to private investors. More settlements are expected.

The impact of these settlements will be felt in the UK in the context of both directors' and officers' and and errors and omissions policies.

The US class actions frequently involve allegations of criminal and fraudulent practices by the mutual funds, their directors and officers, as well as the brokers. Therefore, much importance will be attached to policy wordings and exclusions in ascertaining cover for liabilities when they hit the London reinsurance market. This is a situation many brokers may want to monitor closely.