Fund-industry regulation to be overhauled

Donaldson laments 'betrayal' of investors

November 08, 2003|By NEW YORK TIMES NEWS SERVICE

WASHINGTON - The head of the Securities and Exchange Commission, in response to the growing scandals in the mutual fund industry, said yesterday that the agency intends to overhaul the regulation of the industry soon by adopting measures restraining abusive trading, clarifying conflicts of interest rules and compelling better disclosure on fees.

William H. Donaldson sharply rebuked Wall Street in his debut appearance as chairman of the commission at the annual meeting of the Securities Industry Association in Boca Raton, Fla. He criticized the profession for its role in the mutual funds scandals on top of "a laundry list of wrongdoing" that has been exposed in corruption cases involving analysts' conflicts of interest and fraudulent public stock offerings.

Donaldson, a founder of a major brokerage house and former head of the New York Stock Exchange, said the totality of the scandals represented "a fundamental betrayal of our nation's investors, and are symptomatic of a disease that has afflicted far too many in the industry."

"The securities industry has found itself stuck in a legal and ethical quagmire, but I am confident that the industry will work together to pull the industry out of the muck and live up to a higher ethical standard," Donaldson said, according to a text of the speech released by his office in Washington. "You can be sure that if you don't, those of us in government will."

His speech was in sharp contrast to last year's address by his predecessor, Harvey L. Pitt, who used his appearance three days after announcing his resignation, after a series of political blunders, to emphasize that he did not believe laying down new rules would bring back investors.

At that meeting, Pitt was embraced by the industry - which gave him a standing ovation - and was highly praised by such leaders as Richard A. Grasso, who then was head of the NYSE and was frequently mentioned as a possible candidate for the job that ultimately went to Donaldson.

Donaldson's speech came as the commission is facing growing pressure from both Capitol Hill and state regulators to take more aggressive steps at combating corruption in the mutual funds industry. As lawmakers have begun to consider new legislation to tighten the oversight of the industry, state prosecutors in New York and Massachusetts have moved swiftly to bring cases against major funds, a move that embarrassed the SEC and suggested it was not responding quickly enough.

In the case of New York, its attorney general, Eliot Spitzer, has been critical of the commission for failing to catch industry problems. In the case of Massachusetts, state regulators made a case against Putnam Investments, the nation's fifth-largest mutual fund company, after a whistle-blower had months earlier tried to alert SEC officials but was apparently ignored. The SEC ultimately did bring a case against Putnam, but not until after it learned that the whistle-blower had gone to Massachusetts state authorities.

Responding to news accounts describing how the New England office of the SEC may have not adequately responded to a tip involving Putnam, the commission announced Monday that Juan M. Marcelino, the head of that office for the past 10 years, was stepping down.

Donaldson said yesterday the agency will be reviewing how it handles the thousands of tips of wrongdoing it receives each week.

"Tips from whistle-blowers are critical to our mission of pursuing violations of the federal securities laws," Donaldson said. "I want to be sure that there is appropriate follow-through on this type of information and that they are given expedited treatment."

He said that in a few weeks, the commission will consider a package of proposals to limit late trading and improper market timing in mutual funds. He said one of the rules under consideration would impose a "hard cutoff" that would "effectively limit the potential for late trading" of mutual funds.

A growing number of firms have been found to permit certain investors to buy or sell shares of a fund at the 4 p.m. closing price at some point later in the day. The proposal under consideration would require a mutual fund, rather than a broker, to receive buy and sell orders by 4 p.m. Eastern time in order to receive that day's price.

He also said rules would be proposed to require funds to disclose market-timing policies and rules governing the selective disclosure of portfolio information. The agency would also improve the disclosure of fees charged to investors to reduce conflicts of interests of brokers who sell funds, he said.

"These disclosures would enable investors to assess a fund's practices in these areas and determine if they are in line with their expectations," he said.

Donaldson's speech did not address calls in Congress to require the funds to have more independent directors, including an independent chairman. But he said the rules would require mutual funds to employ a chief compliance officer who would report to directors about efforts to curtail abusive trading. And he emphasized that the commission would consider broader governance issues.

"No reform - whether structural, fund governance or board composition - is off the table," he said.

He said the findings of a recent industry survey were "damning."

The survey found that more than 25 percent of brokerage firms that sell mutual funds and 10 percent of the funds surveyed had permitted customers to engage in late trading. It also found that more than 30 percent of the fund companies had disclosed information about their portfolios selectively, to certain shareholders, giving them the ability to place advantageous trades.

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