Fund Overhaul Rises on Congress’ To-Do List

The $7-trillion mutual fund industry has been largely sheltered from the wave of congressional reform that came in the wake of scandals at Enron Corp., WorldCom Inc. and other companies.

But that may be about to change.

With the fund industry under siege by state and federal investigators, members of Congress have begun a new push to overhaul the practices that have entangled many fund companies in controversy, including late trading and other strategies that reward favored investors at the expense of the less connected.

Now that only weeks remain before Congress plans to adjourn, advocates of mutual fund reform face an uphill fight to achieve their aims this year. What is noteworthy, however, is that any serious effort has emerged at all. Until recently, a major fund reform bill, by Rep. Richard H. Baker (R-La.), had been languishing.

But three days of hearings on Capitol Hill last week, which featured jarring testimony from New York Atty. Gen. Eliot Spitzer and Securities and Exchange Commission enforcement director Stephen M. Cutler about the extent of the industry’s problems, provided ample fuel for reform advocates.

“I had no idea we were going to find that fund abuses were so widespread,” said Sen. Susan Collins (R-Maine), herself a former financial regulator, pointing to feelings of shock in Congress. “This isn’t just one or two funds abusing their investors. The evidence is of one betrayal of trust after another.”

By week’s end, Rep. Michael G. Oxley (R-Ohio), co-author of the landmark Sarbanes-Oxley corporate reform law, was predicting that the House might pass a mutual fund reform bill by Thanksgiving. And a similar measure has been launched in the Senate.

The revelations also have raised questions about the adequacy of SEC regulation and enforcement and revived calls for greater congressional scrutiny of the nation’s top securities cop.

As some see it, the SEC’s failure to prevent the improper mutual fund practices is a fundamental part of the problem. It didn’t help that Spitzer has led the way in the mutual fund investigations, beating the feds to the scene of an alleged Wall Street crime as he did last year with his probe of stock analyst conflicts of interest.

“It’s one thing for Congress to ask why has the SEC not acted and why are the regulations insufficient,” said Jacob S. Frenkel, a former prosecutor and SEC enforcement attorney now at Smith Gambrell & Russell in Washington. “The bigger question is whether congressional committees will stay on this issue long enough and aggressively enough to demand accountability” from the SEC.

Feeling the heat, the SEC has pledged to unveil a set of new regulatory proposals this month. Although the details are not yet public, the rules are expected to address such issues as disclosure of fees and costs, conflicts of interest by brokers and late trading.

With 95 million Americans owning mutual funds, which for many have become the savings vehicle of choice for retirement and college, the uproar over the fund industry and its regulation is tough for Congress to ignore.

Although it’s not possible to predict the future, “people are going to be extremely attuned to 95 million investors,” said Peggy A. Peterson, communications director for the House Committee on Financial Services. “They are now.”

In fact, there had been a strong tendency on Capitol Hill to do little, at least until recently.

On July 23, the financial services panel approved Baker’s bill, which seeks more explicit disclosures in a range of areas related to fees and potential conflicts of interest, and also would increase the independence of board members.

But after that, the bill seemed to disappear -- until Spitzer and his fellow regulators began chipping away at the fund industry’s relatively unmarked facade.

A House Republican aide familiar with some of the discussions taking place underlined how recent revelations have transformed the atmosphere surrounding mutual fund reform.

“It’s all very new,” said the aide, who spoke on condition of anonymity. “There is a growing consensus behind a legislative fix,” he added, while noting some concerns among lawmakers that legislation may not be necessary.

Baker, for his part, has said he planned to toughen up his bill, adding provisions to require that the chairman of a fund’s board of directors be independent of the fund’s management company and to make clear that insider trading was prohibited.

Another reason the mutual fund reform drive may not die soon is that the issue hits lawmakers on a personal level. They not only are investors, like much of the public, but they also bought into the soothing promise of mutual funds as a safe refuge from the slick dealing that often characterizes stock investing.

“As a mutual fund investor myself, I’m now more aware of the questions I should ask, and I think other people will be too,” said Rep. Barney Frank (D-Mass.).

Members of Congress were chagrined to hear testimony that seemingly small amounts skimmed from profits added up to substantial losses over time. For example, Spitzer testified that if the management fees that funds charge their shareholders were cut by as little as a quarter of 1%, the annual savings to shareholders would be $10 billion.

Further keeping the issue alive are revelations from an SEC survey that more than one-fourth of major brokerage firms have allowed customers to trade mutual funds after hours, and almost 70% are aware of market-timing activities. (Late trading is typically illegal, and market timing may cost other investors money and violate the terms laid out in a fund’s prospectus.)

Although the Senate has lagged behind the House on the matter, activity in that chamber is picking up.

Just two days after the SEC’s Cutler released some of the survey information in the Senate, Sen. Daniel K. Akaka (D-Hawaii) introduced a bill to improve mutual fund disclosures and governance, and Sens. Peter Fitzgerald (R-Ill.) and Joe Lieberman (D-Conn.) signed on as co-sponsors.

The Senate Banking Committee plans to hold a hearing on mutual funds, which would be the fourth congressional hearing on the subject this month.

“We’re going to be very diligent in ensuring that the mutual fund industry is operating the way it should be,” said Andrew Gray, a spokesman for Sen. Richard C. Shelby (R-Ala.), chairman of the committee.