SEC Attacks Fund Abuses
The Securities and Exchange Commission on Wednesday launched a regulatory strike against the illicit practices that have rattled the mutual fund industry in recent months and shaken public faith in an investment once viewed as a haven from financial trickery.
Reacting to the ongoing barrage of scandals that have reached deeply into the $7-trillion fund industry, the SEC proposed new measures to prevent after-hours trading and other improper practices. The commission also ruled that fund firms must appoint an internal watchdog who would report directly to the board of directors, bypassing potentially corrupt fund managers.
The 5-0 votes represent the SEC’s most visible attempt to tighten its rules governing mutual funds since revelations began surfacing three months ago of widespread trading abuses in the industry.
SEC Chairman William H. Donaldson said the measures acted on Wednesday were the first in a series of new rules planned for the fund industry in coming months.
“The recent spate of mutual fund scandals are deeply disturbing to me,” said Donaldson, who also outlined coming proposals for greater disclosure of the fees paid by fund investors and increased independence of fund directors.
“We have seen a betrayal of individual investors who entrusted their confidence, the fruits of their labor, their hopes and dreams for the future to this industry for safekeeping.”
Since New York Atty. Gen Eliot Spitzer unveiled his probe of the fund industry Sept. 3, more than a dozen companies have been tarred by the scandal, including some of the biggest names in the business: Janus Capital Group Inc., Charles Schwab Corp. and Putnam Investments. More than 50 fund industry employees have lost their jobs, ranging from brokers to Putnam Chief Executive Lawrence J. Lasser.
On Tuesday, Spitzer and the SEC charged Invesco Funds Group and its chief executive with civil fraud, alleging that they allowed dozens of investors to make improper trades. The same day, Richard Strong, a high-profile name in the industry, stepped down as chairman of Strong Financial Corp., which has been investigated by Spitzer.
The scandals have caught the attention of Congress, where lawmakers are keenly aware that half of U.S. households invest in mutual funds. The House of Representatives, goaded by almost daily stories of wrongdoing, last month passed a previously stalled package of fund reforms.
The mutual fund mess also has drawn the ire of critics who complain that the SEC has failed to adequately police the industry, leaving Spitzer and other state officials to fill the vacuum.
“These are proposals that consumer advocates have been pushing the SEC to do for years,” said Mercer Bullard, an assistant law professor at the University of Mississippi. “The question now is: Do we leave it to the SEC or do we look to Congress to solve the problems we’ve had for so long?”
Investigators are zeroing in on two industry practices. The first, market timing, occurs when a fund allows favored investors to rapidly buy and sell funds in an attempt to profit from price inefficiencies -- a tactic typically forbidden for regular investors. The second is late trading, in which some investors are allowed to trade funds after the stock market’s 4 p.m. Eastern time closing bell but still receive that day’s closing price.
Market timing isn’t necessarily illegal, but allowing some investors to do it while barring others may constitute fraud. And the practice can run up the operating expenses paid by all of a fund’s shareholders. Late trading is against the law.
The SEC is proposing that buy and sell orders from mutual fund investors must be delivered to the mutual fund company or be well on their way to the fund by the closing bell. Currently, fund companies can process trades received after 4 p.m. as long as the order originally was placed before the market closed.
Some have argued that the strict deadline would put at a disadvantage investors who own mutual funds through an intermediary such as a 401(k) retirement plan or a fund “supermarket” such as Schwab. It can take hours for intermediaries to process and bundle trades before sending them on to the fund companies -- meaning that a much earlier deadline could be set for these investors, especially those on the West Coast.
“It’s a good idea,” said Barbara Kelley, executive vice president at Glendale-based Pacific Global Investment Management Co., which runs the Pacific Advisors funds. However, “it would create a problem for some investors who need extra time. There are some groups of investors who would be at a disadvantage, and their issues need to be discussed.”
SEC Commissioner Cynthia A. Glassman said she “would have preferred a less-prescriptive approach” but “the current environment seems to require a hard and fast approach.”
Vanguard Group, the nation’s second-largest mutual fund company, said Wednesday that it supported the proposed rule, which would face a final SEC vote after a 45-day public comment period.
Besides adopting the rule requiring fund companies to hire a compliance officer, the commission also proposed a regulation that would require fund firms to disclose their policies on market timing to investors.
The SEC this month is scheduled to consider a requirement that funds clearly disclose so-called breakpoint discounts given to large investors. In mid-January will come proposals requiring portfolio managers to disclose personal trading in the funds they manage and mandating independent chairmen for fund boards of directors.
The SEC also plans to consider making funds spell out more clearly the sales commissions and other fees investors pay when buying funds.
In February, the agency plans to consider a mandatory fee on short-term trading, a further effort to curb market timing. The fund industry’s trade group has recommended that a 2% redemption fee be charged when fund shares are resold within five days of purchase.
“Clearly, we have a lot of work ahead of us,” Donaldson said. “And we are committed to working quickly and expeditiously to ensure that investors receive the added protections they need and deserve now.”
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Times staff writer Josh Friedman contributed to this report.
