The riskiness of 401(k) accounts as substitutes for traditional defined benefit plans --- plans like the Central Pension Fund and those maintained by IUOE Local Unions throughout the United States and Canada --- have been well documented. Now comes a new risk: mutual fund fraud and abuse.

The major risks faced by 401(k) participants are three in number. The first is the Savings Risk; that is, the risk that you won’t save enough money in your 401(k) account. The second is the Investment Risk; that is, the risk that while you may save enough you won’t invest it properly and you will fail to accumulate sufficient earnings for retirement. The third is the Longevity Risk; that is, the risk that even if you save enough and invest it wisely you will outlive the money. Put another way, you would have had a nice retirement if you just hadn’t lived so long.

In 2001 and 2002 the collapse of Enron, WorldCom, Global Crossing, Adelphia and many other companies made it painfully clear to 401(k) participants how easily their retirement plans could be destroyed by corporate fraud. While all investors face the risk that they may make imprudent investment choices, there is no way to make prudent choices if the corporations you choose to invest in are cooking the books.

To minimize the risk of picking the wrong companies to invest in, most small investors --- the bulk of all 401(k) participants --- invest in mutual funds. By investing in a mutual fund, you are not buying shares of particular companies but rather shares of the mutual fund. The mutual fund employs investment professionals who, in turn, buy shares of a wide variety of companies that are held by the mutual fund itself. It has been widely believed that this type of investing minimizes the Investment Risk of 401(k) accounts through broadly diversified holdings selected by investment professionals.

However, in September and October of this year, New York Attorney General Elliot Spitzer filed charges against a number of large and prominent mutual fund companies alleging that they had systematically permitted big investors to reap big mutual fund profits at the expense of small investors.

Not surprisingly, it is alleged that these mutual fund companies permitted the big investors to profit at the expense of small investors in return for the big investors providing more business --- and profits --- to the mutual fund companies. It is the same old story “you scratch my back and I’ll scratch yours --- and to heck with the little guys.”

The schemes that were concocted were very simple: the mutual fund companies permitted certain big investors to make trades in the mutual funds at times when all other investors were prohibited from doing so. This allowed the big investors to make profits that were unavailable to all of the other mutual fund investors. They skimmed the most profitable transactions leaving the less profitable ones for everyone else.

In return for this favorable treatment, the big investors agreed to invest large additional amounts of their money in other mutual funds managed by the mutual fund companies. Since the fund companies make their money by charging fees that are percentages of funds under management, they made additional profits through these schemes.

The U.S. Securities and Exchange Commission (SEC) is aggressively following up Mr. Spitzer’s revelations with its own investigation, and it is likely that the extent of mutual fund abuse will ultimately be much broader than that already exposed.

While it is a sad commentary that these schemes were fostered by large and previously reputable mutual funds, it is sadder still that they were not uncovered earlier. These mutual funds are operated by very bright people who must have known that what was going on was wrong, but they let it happen to further line their own pockets. All of this was done at the expense of small investors, who are predominately 401(k) participants. The rich once again got richer while retirement security for working Americans once again got poorer.