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So far mutual fund companies have slipped through the regulatory crackdown on Wall Street unscathed. That is about to change. Dramatically.

New York Attorney General Eliot Spitzer said Wednesday that mutual fund companies played a key role in -- and profited from -- a swindle that enabled hedge funds to fleece their own unsuspecting shareholders. The scheme worked because funds allowed select investors to exploit flaws in the fund structure.

Mutual funds are the most popular investment vehicles in the world because they offer diversification, professional management, ease of investing and reasonable costs. But funds have a tragic flaw. A loophole so big you can drive a truck through it -- if fund companies let you.

Unlike closed-end funds, hedge funds and other investment pools, open-ended funds allow investors to buy and sell shares each day at the fund's net asset value, or NAV. The NAV is the current value of all the fund investments divided by the total shares. The benefit from this for shareholders also has a major flaw. When investors move money in and out, they leave a wake of trading costs and tax inefficiencies that must be shared by other investors.

Worse, daily fund pricing is an inexact science, the negative effects of which can be magnified by fund flows. Pricing is particularly troublesome with less liquid investments like micro-cap stocks, municipal and junk bonds, and with foreign securities that trade on markets that close hours before our market opens.

If a fund NAV is off, traders can hop in and out to make free money -- effectively stealing returns from other investors. Funds usually impose Band-Aids to fix this underlying problem with the mutual fund structure. These repairs include short-term redemption fees (unlike loads, these fees get reimbursed to the fund to cover costs) and kicking out active traders.

With these tools at their disposal, fund companies act as fund police, making sure rogue traders don't ruin the fund for others. According to the new allegations, some fund companies selectively allowed a hedge fund to profit from this loophole, in exchange for sharing the free money. Rather then preventing fund exploitation, they looked the other way while select investors were allowed to effectively loot other longer-term fund investors.

Even more egregious are allegations that some mutual funds actually allowed and enabled the hedge fund to buy fund shares a few hours after the daily NAV was calculated. While a few hours may seem insignificant, with the proper help from the fund, it's all that is required to steal profits from other fund shareholders nearly risk-free.

The special investor who can back-date his purchase needs a trigger event like a major tech company's releasing better-than-expected earnings after the market closes. More likely than not, most tech stocks will go up the next day after such news. Buying a tech mutual fund after the big announcement but at the 4 p.m. closing price would mean benefiting from the likely move the next morning.

However, by adding cash to the fund, you water down the pop other investors would have received since the fund manager can't retroactively buy more stock with your new money added at the old, prenews fund and stock prices.

While this is a good trade, it is not a risk-free trade. What if at 2 p.m. the next day there is bad news from

Microsoft

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? Suddenly the profitable trade could slip under water as the hedge fund owns the tech fund and can't sell until 4 p.m. -- the next NAV. The hedge fund could short a tech index like the

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early the next day, locking in gains after the initial pop, but that would mean taking risks that the fund was out of sync with the index. What if one of the fund's holdings releases bad news at 2 p.m. and it's not in the index?

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.

Jonas Max Ferris is co-founder of

MAXfunds.com, a fund research and analysis company, and partner in an investment advisor offering managed accounts in mutual funds. He welcomes column critiques, comments or baseless accusations at

jferris@maxfunds.com.