Regulators to Probe Mutual Fund Practices

Federal regulators are probing whether some mutual funds use improper--possibly illegal--techniques to boost performance at the end of a reporting period or to spruce up portfolios on the eve of semiannual reports to investors, a U.S. official said.

Gene Gohlke, associate director of the Securities and Exchange Commission’s Office of Compliance, Inspections and Examinations, said the agency has requested trading records from some mutual fund companies as part of investigations of the practices dubbed “portfolio pumping” and “window dressing.”

Portfolio pumping occurs when fund managers try to boost performance toward the end of the quarter or other reporting period by buying more of a stock that a fund already owns to drive up the stock’s price.

Funds may be tempted to pump up a portfolio’s performance because managers’ bonuses often are based on the year-end numbers. Funds also cite performance in advertisements and prospectuses.

“Window dressing” occurs when a fund buys or sells securities just before the date its holdings are disclosed, to create the impression that the fund has been making wise investment decisions for months.

Fund managers may be tempted to sell shares--even at a very low price--of a stock whose price has fallen to eliminate evidence of a fund manager’s mistaken judgment. Managers also might be tempted to buy shares of a particularly successful stock--even at a high price--to create the impression that the fund was in on that company’s success.

Present SEC rules require funds to report all of their holdings to shareholders only twice a year. Critics say as long as portfolio holdings are disclosed infrequently and on dates known in advance, pumping and window dressing will persist.

In a process rarely used with the SEC, 10 U.S. consumer groups petitioned in August to require funds to disclose portfolio holdings within 30 days after the end of each month and on random days throughout the year.

Gohlke, who said the SEC inquiry started three to five months ago, would not comment on how many firms are involved, nor would he discuss any preliminary findings.

In addition to violating anti-fraud statutes, portfolio pumping may constitute market manipulation, Gohlke said. “If you are placing orders with the intent to purposely upset the closing price [of that stock], that may be illegal conduct in and of itself,” he said.