Fund Industry Group Proposes Reforms

Times Staff Writer

The mutual fund industry’s chief trade group on Thursday proposed new rules to combat trading abuses in fund shares, including a strict deadline for entering buy and sell orders and a 2% fee on rapid traders.

But by reducing millions of individual investors’ flexibility in their fund transactions, the cure could be worse than the disease, some industry critics warned.

The plan put forth by the Washington-based Investment Company Institute comes nearly two months after New York Atty. Gen. Eliot Spitzer stunned the $7-trillion fund industry by announcing a widespread probe into its practices.

The investigation by Spitzer and tandem probes by Massachusetts and by the Securities and Exchange Commission have led to charges against several fund executives and portfolio managers, and this week implicated Putnam Investments, the fifth-largest fund firm, and the head of Strong Capital Management Inc.


The allegations of misconduct center on fund trades by certain investors and by some portfolio managers that produced fast profits for them at the expense of average investors.

Struggling to get ahead of the scandal, the institute offered three recommendations to the SEC, which is the primary regulator of the fund industry and is drawing up its own proposals:

* Establish a “firm” 4 p.m. Eastern time deadline for entering all fund trades. The 4 p.m. cutoff would apply to the receipt of purchase or sale orders at fund companies. That would be a major change from current practices, which allow retirement plans and other investors to send orders much later than 4 p.m. while still being guaranteed that day’s closing prices.

The leeway that many fund firms have given investors stems from the complexity of processing millions of transactions late in the day, particularly orders from retirement plans that have strict record-keeping rules.

But regulators say that leeway has allowed some savvy investors to corrupt the system, entering orders after the close of trading to take advantage of late-breaking news.

Paul G. Haaga Jr., the institute’s chairman and an executive at American Funds of Los Angeles, said the proposal would “slam the late-trading window shut.” But he acknowledged that a 4 p.m. deadline at the fund level could mean that retirement plans would have to set much earlier daily deadlines for individuals to send in their orders.

Robert G. Wuelfing, president of the SPARK Institute, which represents 300 firms involved in 401(k) retirement plan services, said imposing a 4 p.m. deadline would be “unworkable” and would hurt the 44 million Americans with 401(k) accounts.

* Require all investors to pay a minimum 2% redemption fee if they sell any stock or bond fund within five days of purchase. The fee, which would go back into the fund, would be aimed at making it more costly for investors to engage in so-called market timing, meaning trading over short periods for quick profit.


Regulators have alleged that some fund companies have permitted certain investors to engage in extensive timing trades at the expense of long-term investors, while the companies’ official stance has been that timing is discouraged. Also this week, the SEC charged two Putnam fund managers with market-timing funds for their own accounts.

“We think this would be a great deterrent” against short-term timing, Jack Brennan, chairman of Vanguard Group, said of the institute’s proposal.

Many analysts said the minimum holding period to avoid a redemption fee wouldn’t cause problems for most investors, because the vast majority hold their funds for months or years.

“All of our studies tell us ... there is a small number of investors who do a lot of trading,” said Matthew P. Fink, institute president.


* Recommend that fund companies “clarify or amend” their ethics codes to include oversight of personal trading by fund officers. Many fund companies have rules governing officers’ trading of individual stocks but not trading in shares of their own funds.

But Don Phillips, managing director of fund tracker Morningstar Inc., said the institute’s proposal on ethics lacked teeth. He noted that the group stopped short of suggesting that fund executives and managers be required to publicly report all of their personal trades in their own funds, just as executives of regular companies must report to the SEC any trades in their companies’ shares.

“Why not hold [fund] companies to the same standard?” Phillips said.