Fund Managers Required to Disclose Personal Trades

The Securities and Exchange Commission ruled Wednesday that mutual fund managers must report any personal trading they do in the funds they oversee, counting on greater disclosure to help prevent trading abuses that plunged the industry into scandal last year.

The SEC on a 4-0 vote approved the disclosure condition as part of a rule requiring investment companies to adopt codes of ethics to combat misconduct in the mutual fund industry.

Investment advisors “owe their clients more than mere honesty and good faith,” said SEC Chairman William H. Donaldson, alluding to a spate of revelations about trading abuses among mutual funds. “Recent experience suggests that all too many advisors were delivering much less.”

In a separate action, the SEC ordered mutual fund companies to clearly inform customers of discounts for which they may qualify; the agency had found that many customers missed out on lower rates they should have gotten.

Misconduct in the $7.6-trillion mutual fund industry, once considered a model of integrity, emerged as a major concern after disclosures of wrongdoing in cases filed by New York Atty. Gen. Eliot Spitzer. Since then, the SEC has been working on a dozen proposals for reform.

The changes approved Wednesday were designed to prevent abusive trading strategies, including the rapid in-and-out trading technique known as market timing, which burdens funds with extra costs and siphons profits from other shareholders. Regulators also want to crack down on after-hours trading, in which favored investors are allowed to unfairly exploit price changes after the market close.

Investigations of mutual fund abuses turned up various examples of managers profiting from improper trading strategies with their own funds. Under the new rule, managers would have to report personal trades to their firm’s compliance officer, making it easier for regulators to track any misconduct.

Just last week, state and federal regulators levied a $60-million fine against Richard Strong, founder of Strong Financial Corp., for personally profiting from improper trades in his own funds. (On Wednesday, Wells Fargo & Co. said it would buy key assets of Strong’s company.)

Under the ethics rule, companies would be required to establish and enforce their own codes of ethics. The codes would include provisions intended to prevent misuse of the firm’s private financial information, such as its investment recommendations or the holdings of its clients.

Such codes also would require certain managers to get advance approval of their investment in initial public offerings from their company’s chief compliance officer. In addition, investment company managers would have to report violations of the code to their firm’s compliance officer.

In a recent interview, Donaldson said he wanted companies to establish the sort of ethical culture in which their employees stop well short of the “red line” of misconduct rather than test the limits of the law.

On Wednesday, Donaldson cited codes of conduct as a means toward that goal: “As much as we might wish to, we will never be able to set and enforce rules that govern every situation in which an investment advisor’s employees might be tempted to exploit the advisor’s clients for personal profit,” he said.

“We have no choice but to rely on the advisory firms themselves to step into the breach -- establishing a culture where the highest standards of behavior are practiced.”

Although the notion of codes of ethics is not controversial, some have cautioned that it is far from a cure-all for companies that lack integrity.

“An effective ethics program requires continual reinforcement of strong values by management.... Neither a code of ethics nor detailed compliance procedures, however, are a substitute for good and honorable management and employees,” said Stuart C. Gilman, president of the Ethics Resource Center, and Edward L. Pittman, an attorney with Thelen Reid & Priest, in a recent letter to the SEC.

In a separate vote Wednesday, commissioners ruled 4-0 that mutual funds should lay out in their prospectuses details about discounts for large purchases known as “breakpoints.” Typically, companies provide such information only at the customer’s request.

This year, the SEC and the National Assn. of Securities Dealers levied penalties of $21.5 million on 15 firms, including Wachovia Securities, UBS Financial Services and American Express Financial Advisors, to settle charges that they did not provide breakpoints to eligible customers in 2001 and 2002. The overcharges averaged $243, regulators said.

Citing such problems, SEC Commissioner Harvey J. Goldschmid described the requirements for disclosure as a step toward “fairness and decency and trust, which the mutual fund industry very much needs.”