How the Fund Scam Works

To lessen this risk, rogue fund companies give the hedge fund the current fund holdings, allowing the trader to make the perfect hedge and short the fund's holdings directly at the opportune time. This also allowed for profits in a down market.

The trader could short all the fund's holdings and own the fund -- a neutral position. Then, based on after-market action, decide to keep the fund and maintain the position if it looked like the market might go up the next day. If after the market closed it looked like the market would fall the next day, the trader could decide to sell the fund after the news, profiting from the weaker open being net short the funds holdings with no offsetting long in the fund.

For these trades to go on undiscovered and with minimal impact to the fund requires a small hedge fund and a large mutual fund to diminish the watering-down effect of returns-theft.

While the scheme is complicated, for mutual fund companies, the effect is no different than letting someone take money from fund shareholders for a cut of the loot. To enable the ripoff, funds took these bold steps:

Selectively waive fund redemption fees

Ignore restrictions normally placed on active traders

Allow post-NAV calculation trading

Give the fund's current holdings to the trader to hedge out risk

Kickbacks included parking excess cash with the fund, overpaying fees for services and otherwise sharing some of the hedge funds ill-gotten gains.

Why would fund companies allow the looting of their own shareholders and also hurt their fund's performance figures? Apparently at some fund companies it's OK to skim money from investors who just lost 40% of their retirement savings to prop up their own shrinking bonus in a bear market.

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