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Steer Clear of Alger Funds

Agreement in principle reached, but our stance unchanged.

On June 9, 2006, Fred Alger Management announced that it had reached an agreement in principle with both the New York Attorney General and the SEC. In the proposed agreement, there is a payment of $40 million and a reduction of management fees of $1 million per year for five years. After a settlement is finalized, we can consider the regulators to be satisfied, but until that time, we cannot assume that stance in this case. The violations at Alger were particularly egregious.

In October 2003, James Connelly, head of fund sales for Fred Alger Management Inc., settled civil charges with the SEC for permitting market-timing, and he pleaded guilty to obstructing the investigation. According to New York Attorney General Eliot Spitzer, Connelly asked subordinates to delete e-mail messages relating to timing arrangements. In addition, Alger said "potential late trading activity by [a] hedge fund" occurred in three accounts from March 2003 to August 2003. (Click here for Alger's statement.) It was a dramatic fall for Connelly, who was named Fund Leader of the Year by Fund Action for 2002; he was asked to resign in 2003 and later served time for his actions. We should note that Connelly is long gone and that we've been impressed with the firm's improved compliance efforts since his departure.

In the SEC's settlement, it found that "From the mid-1990s until 2003, Connelly was involved in allocating timing capacity in Alger mutual funds to timing investors. Connelly regularly authorized select investors to time the Alger Fund. Connelly did this even though he knew that the timers were making substantially more than the permitted six exchanges per year." The funds' prospectus limited investors to six transactions per year.

This indicates there was a longer-running pattern of timing arrangements than any that have come out so far in Spitzer's probe of fund companies. The size is also striking. The SEC said Connelly gradually developed a system for permitting timing in Alger funds, and that by 2003 it had netted the complex $200 million in assets from more than a dozen investors. That was a sizable amount for a firm with just $3 billion in funds.

Given the serious breach of fiduciary duty implied by these events, we recommend that investors consider selling their Alger funds. We don't think the compliance risk is one worth taking. These transgressions were led by the head of mutual fund sales for an extended period, indicating that there were some compliance procedure flaws and cultural flaws.

As always, though, investors should consider their own situation before making a change. If selling would trigger a big tax bill or an Alger fund is one option in a limited lineup in a 401(k), it might be prudent to hold on.

Prior to the news surrounding Connelly, we were lukewarm on Alger funds. Our biggest concern has been costs, as the firm's expense ratio for front-load offerings is high. In addition, performance and management have been okay but not outstanding.