Investors in



funds who have stuck with the firm through thick and thin have been repaid with the double blow of injury and now insult.

First, Janus' dangerous concentration in tech and telecom companies resulted in brutal losses after the bubble burst in 2000. Second, as we learned Wednesday, Janus was allegedly among the bad apples that allowed hedge funds to reap huge profits through illegal arbitrage strategies with the funds, at the expense of the fund holders who remained invested in Janus after the bubble burst.

Here's what Janus did, according to the complaint filed by New York Attorney General Eliot Spitzer's office. In the spring of 2002, Janus gave hedge fund Canary Partners permission to time the Janus Mercury fund, in exchange for Canary's socking away money into a Janus money-market fund. Canary made big profits timing the Mercury fund at the expense of individual investors in the fund. When Canary sought to expand its market-timing capacity in Janus' offshore funds, an employee at the Denver-based fund shop sent concerned emails to Janus Interntional CEO Richard Garland about the volume of market activity. "We need to keep our funds clean," the emailer wrote to Garland.

Garland replied, "I have no interest in building a business around market timers, but at the same time I do not want to turn away $10-$20m!" After learning that the deal could bring in as much as $50 million, Garland gave the go-ahead for additional market-timing capacity on April 3, 2003. The new deal was never finalized. Janus's prospectuses did not disclose the market-timing activity; in fact, the firm's language made it sound as though it policed would-be market timers in its funds.

One can spin an ill-advised investment strategy that led to overexposure in stocks such as


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. Heck, a lot of people drank the Kool-Aid back in 1999; Janus just had seconds. However, there is no spinning this week's news, if the very convincing 44 pages of allegations prove true: Janus demonstrated that it would breach fiduciary responsibility for the right price. There are questionable fund-industry practices that firms can rightly, if cravenly, defend by saying "everybody does it," but this does not appear to be one of them.

In a statement Wednesday, the firm's brief reply was: "Janus Capital Management intends to continue cooperating with the New York Attorney General's inquiry. Janus is reviewing the complaint closely and is committed to ensuring that the company continues to act in the best interest of Janus fund shareholders."

What should Janus fund holders do now? Spitzer told


that investors in Janus -- and, of course,

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-- shouldn't necessarily "run out and sell their funds" on the news.

Janus also hoped to answer this question for shareholders, in a letter to them that was posted on its Web site. Mark Whiston, Janus' chief executive and president, first noted that the firm isn't mentioned in connection with the more onerous after-market trading allegations -- Spitzer only alleged that Janus and others allowed Canary to market-time. Whiston also noted that Spitzer said it was highly likely that other fund firms would be named.

"Like many other reputable mutual fund families, Janus is concerned about market timing in our industry. To that end, we're reviewing instances where frequent trading may have occurred to ensure that we continue to put the best interests of our fund shareholders first," Whiston said. "I realize that these allegations may be troubling, and I want to assure you that we're committed to the highest ethical standards and to acting in the best interests of you -- our fund shareholders."

Vanguard founder John Bogle, one of the greatest advocates for the little investor that America has produced, had his own take on the situation. Bogle's firm, like



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, American Century and many other fund firms, put measures in place to deter market timers from profiting from arbitrage plays on their funds. Janus and the other firms Spitzer discussed made money from this activity.

"Well, it's obviously fair to say these funds aren't going to do it again," Bogle said. "On the other hand, it is a betrayal of trust. If I were a shareholder, I would be discouraged, disgusted and think long and hard about whether I want to remain invested with them."

This presents an enormous problem for Janus, in particular -- a $149.6 billion problem, in fact, based on its assets under management as of July 31. Strong Capital Management is privately held. Bank of America's Nations Funds have $134 billion in assets under management, and Bank One more than $100 billion, but the parents are diversified financial services firms that have too many tentacles -- they don't sink of swim on the basis of their funds. Janus is a pure-breed fund firm, charged only with serving one master: mutual fund investors.

The $149.6 billion is down from more than $300 billion at the peak of the market bubble, but it still represents an enormous amount of investor dollars, both individual and institutional. Janus is already reeling from a bad performance record, a brain drain of fund managers and a vacant slot at the chief investment officer's post. What would happen if the investors who have entrusted Janus with $149.6 billion decided to get out?

"I fear this news will have a major impact on their fund flows," said Matthew Snowling, an analyst at Friedman, Billings Ramsey. "You have a franchise that was already weakened because they are the poster child of dot-com growth funds. Now, the name Janus is going to be in the paper every day as Spitzer goes after them."

Vanguard's Bogle is right -- this won't happen again. However, the issue for Janus isn't about international fund arbitrage plays anymore; it's about trust. As Friedrich Nietzsche once wrote, "What upsets me is not that you lied to me, but that from now on I can no longer believe you."

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