Chairman says SEC oversight of mutual funds was lacking

Market timing wasn't seen as priority, legislators hear

October 31, 2003|By BLOOMBERG NEWS

WASHINGTON - The U.S. Securities and Exchange Commission should have done a better job overseeing the $7 trillion mutual fund industry and detecting trading abuses that may have harmed long-term investors, SEC Chairman William Donaldson said yesterday.

"There's no doubt about the fact that we can improve our methodology," Donaldson told a congressional hearing. "We probably have not had the issue of market timing as high in our priorities as we should have."

The SEC lagged behind New York Attorney General Eliot Spitzer in uncovering mutual fund trading abuses, which Donaldson said were "quite widespread."

Commenting on the SEC's oversight lapses, Spitzer said "heads should roll" at the SEC office responsible for mutual fund supervision.

Donaldson addressed Spitzer's criticism during and after the SEC chairman testified before the House Financial Services subcommittee on capital markets. While agreeing that the SEC's oversight should have been more thorough, Donaldson said regulatory agencies should not criticize one another.

"This should not be a competitive situation between regulators," Donaldson said. "The spectacle of one regulatory agency criticizing another is not healthy."

The growing mutual fund scandal was uncovered last month by Spitzer, who also unearthed the analyst conflicts of interest on Wall Street that led to a $1.4 billion settlement this year. The two cases have prompted criticism that the SEC hasn't been vigilant enough in protecting investors.

This week, Massachusetts regulators brought fraud charges against Putman Investments, the fifth-biggest U.S. mutual fund company, based on a tip from a whistleblower who had originally taken his allegations to the SEC. The SEC lodged its own charges on the same day over alleged self-dealing by Putnam and two of its former managers.

"We should be concentrating on the perpetrators, the people who are breaking the law," Donaldson said after the House hearing. "To comment on the other police force is counterproductive."

Last month, the SEC joined the mutual fund investigation after Spitzer announced a $40 million settlement with hedge fund Canary Capital Partners LLC over mutual fund trading abuses. The SEC asked 88 mutual funds to provide information on their trading practices. About half have indicated they found market-timing arrangements with one or more customers, giving them trading advantages over long-term investors.

Market timing involves making short-term trades in a mutual fund to take advantage of pricing discrepancies in underlying fund investments. Because the practice can raise a fund's transaction costs and dilute the gains of long-term holders, funds often discourage investors from engaging in market timing.

"We believe, as a result of the net we cast, that the market timing and late trading issues are quite widespread," Donaldson said. "We're still gathering data on this, but I think it's more widespread than we originally anticipated."

Unlike market timing, late trading is explicitly illegal. It refers to a practice in which funds allow certain investors to buy or sell their shares after U.S. markets have closed at 4 p.m. The late trading allows the investor to benefit from news that will affect the price of the mutual fund shares the following day.

Donaldson said the SEC is trying to improve coordination between the SEC office responsible for overseeing mutual funds and the office that conducts inspections. "We're working toward better synergy with the Division of Investment Management and inspections," he said.

Eric Zitzewitz, an assistant professor of economics at Stanford University, estimated last year that long-term mutual fund investors lose $4 billion annually in dilution resulting from market timing by investors.

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