January 21, 2005
Pax World Tells Its Shareowners That Market Timers Hit Its High Yield Fund in 2003
by William Baue
In a letter to shareowners, Pax said it believes the market timing differed from the abusive forms
associated with the mutual funds scandal and that shareowners did not suffer any material losses.
In a December 15, 2004 letter, Pax World
Funds Chair Laurence Shadek and President Thomas Grant informed fund shareowners that the Pax
World High Yield Fund (ticker: PAXHX) had been hit by market
timing in 2003, as revealed in an article in yesterday's Chicago Tribune. Market timing is not technically illegal,
except in abusive forms such as those exhibited in the mutual funds scandal of late 2003 involving
insider collusion or late-trading that exploits market developments after mutual funds set their
net asset value (NAV) at the end of the day.
The market timing occurring at Pax
did not involve late-trading or trading by Pax employees, according to the letter.
got blindsided by this--we were victims," Mr. Shadek told SocialFunds.com. "We're substantial
holders of the funds ourselves."
Pax is the first socially responsible investing (SRI)
firm to be associated with market timing in the aftermath of the 2003 scandal. The issue came to
light in a May 2004 call from the US Securities and Exchange Commission (SEC) Division of Investment Management alerting Pax to heavy trading
trends in the fund in 2003 (the high yield asset class was a popular target of market timers in
2003). The SEC asked Pax to investigate the matter and provide a written explanation.
In response, Pax conducted an internal investigation that found evidence of market timing, so
Pax management hired the independent accounting firm Eisner & Co. (at its own expense instead of
shareowners') to examine daily activity in the High Yield Fund.
"When we saw the whole
year laid out in front of us, it became obvious that we had market timing, so we went ahead and put
in safeguards to catch it, but it's not always catchable," said Mr. Shadek. "Trades from financial
intermediaries such as Schwab show up as one order that may include up to fifty accounts, some that
may be market timers and some may be longterm holders."
Safeguards instituted in the wake
of discovering market timing include the issuance of "unusual activity reports."
there's an inflow or outflow of more than $100,000 for the High Yield Fund on any given day, an
unusual activity report is issued to our compliance officer in Portsmouth and our compliance team
in New York," explained Mr. Shadek. "On the second day after the trade, we can identify the
individual accounts coming in from financial intermediaries, so then we can see who that is, we can
look for a pattern."
Market timers were also able to park and switch money from other Pax
funds by taking advantage of Pax rules allowing shareowners to shift assets amongst its funds
without incurring the redemption fee intended to prevent market timing by making it prohibitively
expensive. Pax is in the process of restricting these "round trips" within its funds to once every
"We were trying to help our shareholders out, and it facilitated market timers,"
Mr. Shadek lamented. "There were a couple of instances where somebody called up and said 'I have
market timing money coming in'--there was no quid pro quo, so does that constitute an agreement or
"We don't believe it does, but I can't categorically say that the SEC will agree
with us," Mr. Shadek said.
In September 2004, the SEC Office of Compliance Inspections and
Examination sent Pax a deficiency letter, which results from an SEC inspection that identifies a
"The percentage of inspections that resulted in deficiency letters ran
to about 51 percent in fiscal 2004," said John Heine, an SEC spokesperson. "When a deficiency
letter is issued, the recipient is given a chance to correct the deficiency," and if they do so to
the SEC's satisfaction, "then that would resolve the issue."
"We don't comment on
specific instances where deficiency letters are issued, as it is not a public process," Mr. Heine
told SocialFunds.com when asked about the Pax case.
Mr. Shadek is confident that Pax will
be able to put this unfortunate development behind it.
"We've had no market timer trading,
as far as we can tell, for over a year," said Mr. Shadek. "We believe, after our own internal
investigation, that our shareholders were not materially damaged, but that's our opinion."
"There's a school of thought that rapid trading in and out of a fund, even if it's of a legal
variety, does hurt the long-term shareholder," Mr. Shadek added. "If the SEC deems that there has
been damage to the shareholders, we're prepared to make restitution and pay fines and move on, but
we hope it doesn't come to that."