Trades In Janus Funds example essay topic

Janus Capital Group: History of the company, What are the ethical dilemmas that the management has faced? Janus Capital Group is a mutual fund company that specializes in the active management of investor assets. They are responsible for the investment advisory, distribution, and marketing of their various funds throughout the world. The company's asset management disciplines include growth, core, international and value. As of February 29, 2004 total assets under management at Janus was $147.5 billion (Janus. com).

Tom Bailey established Janus Mutual Funds in 1970 with only 30 investors and less than $500,000 in initial capital. By 1980, Janus had accumulated $33.5 million in assets and was easily beating the S&P 500 returns by investing in value-oriented stocks. In 1984, Kansas City Southern Railroad executive Landon Rowland decided that the railroad industry was stagnant. Rowland was looking for a way for his company to diversify and approached Tom Bailey with an offer to purchase his fund company. Tom decided he would sell 90% of his company to Kansas City Southern but managed to retain control of the firm through a clause in his contract. By 1990, the Janus family of funds had accumulated over $4 billion in assets and launched one of the first international funds in America, the Janus Worldwide fund.

In 1996, Janus begins their first foray into national advertising and a year later become one of the first fund companies to offer a website for investors to research their funds. In 1997, international fund manager Helen Young Hayes is named by Morningstar as fund manager of the year. In 1998, fund manager Scott Schoelzel is named Manager of the Year by Mutual Fund Magazine. Also in 1998, Janus is named "Family of the Year" by Mutual Funds Magazine and Fortune ranks Janus as one of the top 100 companies to work for.

By 2000, Janus was managing $250 billion and was the most revered fund company in America easily beating its peers in almost every investment category. In 2002 Janus shareholders were shocked to learn that Tom Bailey, the company's founder, decided to sell his remaining ownership to Kansas City Southern, effectively relinquishing control of the company he founded. 2003 ushered in change for Janus as the company merged with Berger Funds and began trading on the New York Stock Exchange under the tick JS (Janus. com). Janus' mission statement has always been to "get investors where they want to go". Tom Bailey began the company with this one simple idea and was able to impart oversized returns for his shareholders over the long run. But investors may not be willing to believe that Janus has their best interests in mind because of some recent scandals that have rocked the mutual fund industry.

This once respected fund company has come under fire for unethical and even illegal activities at a time when the company was struggling financially. For example, during the tech boom of the 1990's the Janus Mercury Fund had nearly $16 billion dollars in total assets and was creating over $100 million in revenue in the year 2000 (Strategic Insight). But as the tech bubble burst, the Mercury fund's total assets dropped nearly 70% to less than $5 billion and revenues fell to $30 million (See Graph 1). With revenues drying up, Janus apparently tried to increase revenue by allowing Canary Capital to market-time certain funds and trade after-hours. The actions of Janus seem quite clear; when things get tough financially, cut corners to increase revenue. In late 2003, Eliot Spitzer filed a complaint against Janus and Canary Capital Partners for allegedly engaging in late trading and market timing activities.

These trading allowances let Canary Capital to make low-risk profits at the expense of individual shareholders. Janus internal memos suggest that Canary's business could generate up to $50 million in additional profits for the fund company (SNL Financial). The complaint filed by Spitzer alleges that in the spring of 2002, Janus allowed Canary partners to engage in after hours trading of their funds. Because a number of companies report their earnings just after market close, Canary was able to make trades in Janus funds based on new information but at the old prices. When Janus allowed these trades to take place, they were diluting the returns of existing mutual fund shareholders. For example, if an earnings report about a major holding in a Janus fund announced spectacular earnings after market close, we would expect that stock to do well the following day.

But investors typically cannot trade on this information because the new information is already integrated into the stock price. However, the news will not be reflected in the Janus fund share price until the close of business the next day. So when Janus allowed Canary the opportunity to trade their shares at the old prices which were not based on the new information, they allowed the company to make a very low-risk profit. And the shareholders are the ones who get hurt. First, since Canary invests additional money in the fund, the number of shares that benefit from the news is increased, diluting each individual's share of the fund returns. Second, when Canary would buy after market close, they would often sell the following day, increasing transaction costs for existing shareholders.

Rule 22 c-1 of the Investment Company Act of 1940 states that all purchase and redemption orders received before a fund's close of business, usually 4: 00 p.m. Eastern Time, are processed at a price based on the fund's net asset value as of the close of business on the day received (Securities Lawyer's Deskbook). This means that all trades in a fund based on that day's NAV must be received by close of business. Because Janus allowed Canary to trade in and out of their funds as late as 9: 00 p. m., they clearly and intentionally violated the 1940 act, which was implemented to protect individual investors.

Not only were Janus' actions morally questionable, but they were also illegal according to the 1940 act. Eliot Spitzer also alleged that Janus allowed Canary Partners to market time their funds. Market timers looked to profit by purchasing shares of a fund before market close at 4: 00 p.m. Eastern Time.

But assets in the fund that are traded on exchanges outside the US often close much earlier in the day. The mutual fund company then bases the value of those securities as of the market close of the domestic market in which they trade (e.g. the Nikkei). So information that comes out after the market close about foreign markets or stocks may affect the underlying assets but will not be reflected in the share price of the mutual fund at 4 p.m. Eastern. For example, suppose there is a strong rally in US stocks on Monday, and we know there is a strong correlation between how US stocks perform and the Nikkei, an arbitrager could buy a Janus international fund before the close of business, 4 p. m., and receive a basket of Japanese stocks which do not yet reflect the rally in the US. When Japanese stocks rally the following day, the market timer would then sell the international fund and make a quick one day profit with very low risk.

The problem with this activity is that mutual funds tend to discourage quick buying and selling because they consider their funds to be long-term investments. But these market-timers tend to make dozens of trades in any given year even though fund companies discourage this rapid trading for their individual investors. In allowing this activity, Janus violated their own internal regulation of not allowing excessive trading. In fact, Janus Prospectuses state "The funds are intended for long-term investment purposes only. Excessive short-term trading into and out of a fund can disrupt portfolio investment strategies and may increase expenses, and negatively impact investment returns for all shareholders, including long-term investors who do not generate these costs (Mercury Fund Prospectus)". Janus clearly states what the dangers are to existing shareholders if this kind of activity is allowed.

Therefore, in allowing Canary to trade excessively in their fund, Janus knowingly and intentionally ignored the best interests of long-term shareholders in favor of generating extra revenue. There currently are no regulations in the Investment Advisors Act of 1940 or the Investment Company Act of 1940, which prohibit market timing. However, In 2001 the SEC staff wrote a number of letters to major fund companies asking them to protect their shareholders from this practice by employing "fair pricing" techniques for closing prices when there are significant developments that suggest that fair pricing may be more accurate (Hale and Door). This means that fund companies should use updated or after hours prices when calculating the NAV of the fund when foreign markets are expected to move significantly.

Since Janus received one of these letters, they were clearly aware of the concerns the SEC had for long-term shareholders if this kind of activity was allowed. Therefore, Janus' actions were also in violation of the SEC's request to protect their long-term shareholders from market timing. While the legality of market-timing may not be clear cut, it is absolutely certain that the SEC frowns on this kind of activity and that market-timing harms long-term investors. Therefore, even if Janus did not break the law, they still violated the ethical and fiduciary duty owed to existing shareholders. Once news of these activities and Spitzer's complaint hit the press, Janus Capital shares tumbled. Wall Street had big concerns about the fund companies named in Spitzer's report, and for good reason.

The mutual fund industry is built on trust, and in light of the current corporate governance concerns, any misstep by one of these companies could lead to disaster. In fact, Janus is expected to lose $7 billion in assets because of wary investors pulling money from the funds (Hayashi). Since Janus earns. 65% on assets invested, this comes to close to $50 million in lost revenue each year. Therefore, this net outflow will probably cost Janus Capital shareholders 5% of net profit going forward each year. Investor's in Janus Capital stock were further harmed by the stock's reaction to the scandals.

Prior to the announcement of the Spitzer report on September 4, Janus Capital was trading close to $18 per share. Shares eventually bottomed out in October closer to $13 per share (See Graph 2). Janus Capital lost over 25% of its value based largely on the news that the fund company had violated their fiduciary duty to investors. In addition, the actions of Janus executives and Canary Capital are estimated to have cost fund shareholders $31.5 million in lost returns and transaction fees (Washington Times). However, it should be noted that Janus plans to repay these lost returns and transaction fees to fund shareholders. But who will repay owners of Janus Capital stock who saw the company lose nearly $1 billion in market capitalization?

There are two ways to handle a crisis: proactively and re actively. Prior to their mutual fund scandals Janus has always taken more of a reactive approach. In 1997, fund manager Ron Speaker was accused by the SEC with usurping an investment opportunity from shareholders. In that action, Speaker settled the matter with the SEC and was place on 90-day suspension from managing his bond fund by Janus executives. Perhaps Janus could have sent a clearer message to employees that unethical behavior would not be tolerated in the future. This was a clear case where Janus reacted to a situation without taking measures to ensure there would be no further improprieties.

With regards to the Canary Capital matter, Janus ignored many of the early warning signs, which indicated that their actions might not be good for the company. In the spring of 2003, a Janus employee sent numerous emails to then chief executive of Janus International, Richard Garland. The employee wrote "We need to keep our funds clean". Garland responded, "I have no interest in building a business around market-timers, but at the same time I do not want to turn away $10-$20 million!" Garland later gave the approval for additional market-timing capacity (Milstead).

Since the disclosure of Janus' practices, they have begun to initiate a more proactive approach to crisis management, and are now more focused on crisis prevention. The parties responsible for allowing these questionable trades have been asked to resign since the Spitzer report and are no longer working for Janus (Janus. com). By removing the responsible parties Janus is sending an important message to employees that further improprieties will not be tolerated. We believe this is an important step to strengthening investor confidence. In addition, in April of 2004 Janus will launch a new national campaign in hopes to "emphasize a new, wider range of investment choices". After investors withdrew $4 billion in the first two months of 2004 alone, Janus now wants investors to know that they are committed to improving performance.

Janus Chief Marketing Officer Robin Beery explains that the new advertisements are "an important step in demonstrating our commitment to delivering long-term results for investors and earning their confidence in everything we do (Forgrieve 3 C)". In conclusion, Janus acted irresponsibly towards its long-term investors, employees, the mutual fund industry, and the capital markets in general. Each of these groups shared one thing in common; they put their trust in a company that they thought was ethical. Their confidence in Janus has been shaken due to the actions of a few morally corrupt internal representatives who put profits above people. This may be a common current business practices, but the frequency of unethical behavior does not make it acceptable.

Many lives have been irrevocably altered or destroyed due to the lack of long-term focus by companies such as Janus. But how can a company decide unethical actions? One writer puts it like this, "There is a simple test: Would the other party mind? Chances are an investor would mind the dilutive effect of market-timing trades, which one expert has estimated could cost up to 2 percent of assets a year -- or $2,000 on a $100,000 investment (Weinreich)". The fact that investors withdrew over 4 billion dollars from Janus within the first six months of these allegations is evidence that investors do mind. We think it is admirable that Janus is not refuting these allegations.

This display of integrity and responsibility will help to ensure the long-term fiscal solvency of the company. In addition, Janus needs to realize that profits can be made ethically in the financial markets without malfeasance. We think that Janus must also adhere to its prospectus and internal regulations and provide a forum for employees who wish to voice their concerns regarding unethical behavior. Employees must feel safe when reporting questionable activities and even be rewarded for putting the long-term health of the company first. In addition, Janus must be willing to hold employees responsible for their actions, which it appears they have begun to do.

We also believe that Janus must try and prevent unethical behavior before it happens by providing training and counseling to its employees. It is our opinion that unethical conduct is a product of environment and the corporate culture at Janus must be adjusted so that employees put the interest of stakeholders ahead of short-term profit goals. Finally, Janus executives must be consistent and committed to their policies and corporate beliefs. Once these changes are implemented, Janus stakeholders will regain confidence that the company is looking out for their long-term interests. Nevertheless, only when the leadership at Janus begins to stress ethical behavior will the employees of Janus follow suit.

Bibliography

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