Fund scandal: Did it have to be so bad?

Some state regulators say a 1996 law kept them from finding the abuses

Industry officials skeptical

Maryland is among states called protective of funds they charter

December 28, 2003|By Bill Atkinson | Bill Atkinson,SUN STAFF

The scandal that has enveloped some of the country's biggest mutual fund houses and has cheated investors out of hundreds of millions of dollars might have been detected earlier if state securities regulators hadn't been stripped of powers to oversee funds, state regulators and experts contend.

A bill championed in 1996 by the mutual fund industry's powerful lobbying group blocked states from conducting regular reviews of mutual fund companies' prospectuses and helped create an atmosphere in which problems could flourish undetected, they said.

As a result, the industry has been rocked by a widening scandal that has shaken investor confidence.

A number of prominent mutual fund companies, including Putnam Investments, Strong Capital Management Inc. and Pilgrim Baxter & Associates Ltd., have come under pressure. All three firms have ousted their top executives, some of whom were engaged in improper trading.

Huge fines have been levied and there is a threat of criminal charges against employees and executives. One executive at Fred Alger Management Inc. has already received jail time.

Some state regulators are shaking their heads, saying they might have made a difference in ferreting out abuses such as late trading, marketing timing, excessive fees and improper disclosure had not so much of their authority been stripped away in recent years.

They note that it has been the states - New York Attorney General Eliot Spitzer and Massachusetts Secretary of the Commonwealth William Galvin - that have spearheaded the key investigations into the mutual fund industry, embarrassing the Securities and Exchange Commission, which has lagged far behind in the crackdown.

"If we would have retained the jurisdiction to review mutual fund activity ... as we did a few years ago, I really don't think we would see problems of this depth," said Denise Voigt Crawford, the securities commissioner of Texas.

"Anytime there is no serious threat of enforcement action, an environment is created ... where abuse of investors is much more likely to occur. There has been hardly any segment of the industry that has been less subject to enforcement action than the mutual fund industry."

Barbara Roper, director of investor protection with the Consumer Federation of America, said more states might have looked for abuses, specifically late trading and market timing, if they had the authority.

Market timing is an attempt by investors to make rapid-fire trades in and out of funds, a practice that can raise fund costs and hurt a fund's performance over time.

Late trading allows investors to place trades after the 4 p.m. closing bell, giving them an unfair advantage over other investors because they can act on late corporate news while others cannot.

"I can't tell whether the states would have uncovered the problems, but had we had more regulators looking over the fund companies' shoulders there might have been a better chance that the abuses would have been detected" sooner, Roper said.

Mutual fund industry officials, however, say that even when the states had broader powers over mutual funds the powers were barely used, and it is unlikely the states would have uncovered abuses any earlier.

"I just think it is disingenuous to say but for that, state regulators would have somehow caught this," said Craig Tyle, general counsel of the Investment Company Institute (ICI), the mutual fund industry trade group that represents the $7 trillion industry.

"I don't know how they could have caught it," said Henry H. Hopkins, chief legal counsel at T. Rowe Price Associates Inc., a Baltimore-based mutual fund company. "I can never remember a state securities department conducting an examination at our offices with maybe one exception, nor did they ever really conduct an examination of mutual funds."

Mercer E. Bullard, a former SEC attorney and founder of Fund Democracy, a shareholder advocacy group in Oxford, Miss., agrees that state regulators probably would have made little difference. But, he said, they would have provided him and other experts who were warning about abuses with another source to which to turn when federal regulators weren't listening.

"The difference would have been consumer advocates would have had another entity to go to, to address these problems," Bullard said. "If I had had state regulators ... I would have had another avenue, but Congress removed that ability."

States have always fought to preserve their regulatory powers. They have battled the federal government on banking oversight, the environment, consumer protection and mutual funds.

Some state officials argue that power to probe further into mutual funds was bled with the passage of the National Securities Markets Improvement Act, which was enacted in October 1996.

The act was championed by the investment institute, which wanted state powers repealed because different requirements governing mutual funds were cumbersome, time consuming and made little sense.

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