Stake in Hot IPO Forces IAI to Close Fund

Investment Advisers has closed its (IASKX)IAI Growth & Income fund to new investors while it fights a lawsuit over the way it handled shares of a hot Internet IPO.

The $29 million fund closed on Feb. 17 to "prevent speculation on the pending IPO," according to a company spokeswoman. The action was disclosed in a March 7 filing with the Securities and Exchange Commission.

The IPO, or initial public offering, in question is MatrixOne (MONE), a provider of Internet business software that went public on March 1 at 25 and closed Wednesday at 69.

Growth & Income bought pre-IPO shares of the company in a private placement. Last October, the fund entered into a 90-day agreement with an undisclosed party to sell its MatrixOne shares at a price that would have been substantially below the stock's offering price, according to an IAI filing with the SEC.

IAI's filing says the buyer let the agreement lapse. But a lawsuit filed last month by the buyer maintains that the sale should have gone through. IAI won't say who has filed the lawsuit and won't comment on the pending litigation.

Even though MatrixOne already has gone public, company spokeswoman Connha Classon says the fund will remain closed to new investors until the lawsuit is resolved. "We expect that the lawsuit will be settled shortly," Classon says.

Not only is IAI not letting new shareholders into the fund, but current shareholders can get new shares only through dividend reinvestment or a systematic investment plan.

Investing in illiquid, pre-IPO companies can be fraught with risk. "There have been a number of lawsuits recently targeted around issues like valuation and how the manager handles the investment portfolio and whether it's fair to investors," says Edward Siedle, a Florida-based lawyer who works on shareholder suits.

IAI, which offers 11 mutual funds totaling $423 million in assets, has a penchant for taking stakes in pre-IPO or thinly traded companies. At one point last year, its (IAAPX)Value fund had 65% of its assets in thinly traded securities.

This is not the first time the firm has been burned by the practice.

In 1997 and 1998, the Value fund bought shares of Pathnet, a telecom concern, when it was a private company. That buy was so successful it caused the fund to gain 28% in one day when Pathnet filed for a public offering. (It later cancelled the IPO.) A shareholder who had cashed out of the fund before the run-up filed a lawsuit contending IAI undervalued those shares. The lawsuit is still pending.

In 1999, the Value fund and another IAI fund, (IAEGX)Emerging Growth, took pre-IPO stakes in Tut Systems (TUTS), a high-speed Internet provider. The offer did well initially but later took a slide, and IAI had an agreement with Tut not to sell its shares for six months.

IAI recently decided to stop investing in illiquid securities, and is in the process of unwinding its existing positions.

With the success of MatrixOne's IPO, the stock now accounts for 12% of the Growth & Income fund's holdings. The large-cap fund is up a healthy 10.5% this year through Wednesday, but its 6% 1999 return ranks in the bottom 10% of its category, according to Morningstar.

What's curious is that the gates are still closed, even though MatrixOne has completed its IPO. A flood of assets hardly seems to be IAI's problem. Despite its solid return this year, the fund appears to have lost assets. On Dec. 31, it stood at $32 million, according to the company. Morningstar says its now at $29 million.

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