SEC fund reform: Is it stalling?

Weakening: Many critics say the SEC's effort to clean up the mutual fund industry is losing steam.

May 11, 2004|By Paul Adams | Paul Adams,SUN STAFF

Tainted employees have been fired, high-level executives charged with crimes, more than a billion dollars in penalties assessed and countless witnesses paraded before congressional panels.

But eight months after widespread trading scandals rocked the $7.5 trillion mutual fund industry, many critics and insiders give the Securities and Exchange Commission a mixed grade for its efforts to clean up an industry on which nearly half of American households rely.

Too many of the SEC's proposals treat the symptoms and not the underlying disease, they say.

And with Congress indicating it won't pass legislation this year, many worry that the reform effort is losing momentum as the nation's attention focuses on the turmoil in Iraq and the presidential election.

"I think it's lost a lot of steam," said John Bogle, founder of Vanguard Group, the nation's No. 2 mutual fund company, and an advocate of industry reforms that would hold mutual fund boards accountable to shareholders.

Bogle said the industry needs Congress to pass legislation that would outline the responsibility mutual fund boards have to look out for investors, but neither the House nor Senate appears willing to do so and the SEC is facing intense political pressure from both the industry and lawmakers.

"If mutual funds had been operating on that principle, we wouldn't have any need for reform at all," Bogle said.

Regulatory reform will be at the forefront as the National Association of Securities Dealers, which has been criticized for its scant policing of the mutual fund industry in past years, begins a three-day conference in Baltimore today.

The conference will feature workshops aimed at helping industry officials deal with new regulatory compliance requirements, among other topics.

"Things that used to be accepted aren't accepted anymore," said Douglas H. Shulman, president of NASD's Regulatory Services and Operation division. "We as regulators have dug up a lot of behavior that we thought was inappropriate and a lot of rules have been put in place."

Limited value

But while critics debate reform, some industry officials warn that new regulations can't prevent all trading abuses from occurring.

"We need to understand ... that ethical behavior cannot be regulated," said James Riepe, vice chairman of T. Rowe Price, the Baltimore mutual fund company. "So this is not something that's cured totally by having reform after reform after reform."

Some legal analysts counter that industry watchdogs need new tools to bring the industry back into line after years of lax oversight.

Kathryn B. McGrath, a securities attorney who was head of the SEC's Division of Investment Management from 1983 to 1990, said that until now, the SEC has been too understaffed to prevent abuses. And the NASD, she said, did a poor job of policing the industry.

"It was a non-regulating regulator if I ever saw one," McGrath said of the NASD prior to the scandals. "It did nothing in the mutual fund area."

That has improved since Mary L. Schapiro, NASD vice chairman, took the helm, putting more teeth into the industry's efforts to punish wrongdoers, McGrath said. And an SEC proposal requiring mutual fund companies to have a compliance officer who reports directly to the board of directors should go a long way toward preventing future scandals, she added.

"Can this happen again?" McGrath said. "Sure it can. But there will be more eyes watching out for it more closely now. The big, fat directors got a wake-up call."

Some high marks

Most give the SEC high marks for going after market timing and late trading - the two abuses at the heart of the scandals. Market timing is when traders make rapid in-and-out trades in mutual funds in an effort to take advantage of pricing inefficiencies.

Most mutual fund companies say they discourage the practice, which hurts long-term investors by increasing fund expenses. The SEC has proposed that funds impose a 2 percent redemption fee on investors who sell their shares within five days of purchase.

In theory, the fee will erase the profit motive for most market timers. Several mutual fund companies, including T. Rowe Price, already impose redemption fees on some funds.

"In the market timing area, what the SEC has proposed I think is an effective response," said Richard M. Phillips, a San Francisco attorney and former SEC official.

Same-day pricing

To combat late trading, the SEC has proposed that investors get same-day pricing of a mutual fund only if their buy order arrives at the fund before the 4 p.m. market close. The scandals exposed instances when traders were able to post trades after 4 p.m., allowing them to take advantage of late news that has the potential to raise or lower stock prices the next day.

New York Attorney General Eliot Spitzer, who exposed trading abuses at several funds, likened it to betting on a horse after the race was over.

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