A matter of trust

May 24, 2004

THE TOP mutual fund trade group held its annual gathering last week in Washington with a telling theme: "Mutual Funds: A Matter of Trust." It certainly is. American workers - increasingly without company pensions or certainty as to Social Security's solvency - have been prodded to pay for their own retirements via workplace savings plans heavily invested in mutual funds. They've placed their trust in these vehicles to the tune of $2 trillion in retirement savings - part of a total of $7.5 trillion invested in more than 8,000 funds by 90 million Americans.

Last fall's fund scandals - leading to various charges of misconduct against half of the 25 largest firms - raised doubts about whether the industry warrants that trust. And its opposition to a key reform proposal before the Securities and Exchange Commission - to require fund boards to be led by independent chairmen - casts further doubt.

Among the revealed abuses that aided fund managers and big traders at the expense of average shareholders were late trading, market timing, undisclosed payments to brokers, and selective disclosure of holdings. That's on top of the widespread practice of charging investors fees that often are far higher than warranted and that cut heavily into returns.

In response, the Securities and Exchange Commission has proposed about a dozen new rules. The mutual fund industry essentially supports all but one: requiring that fund board chairmen have no other financial relationship with the funds or their management. The industry and the Bush administration reportedly have been pressuring SEC Chairman William H. Donaldson to pull back on that reform.

Mr. Donaldson should reject the pressure. Funds are owned by their investors. But, while fund boards now must be composed of a majority of independent members, powerful board chairmen too often are officers of the management companies hired to operate the funds. John C. Bogle, founder and former CEO of the Vanguard Group, the nation's second-largest fund firm, has called this "corporate incest" - in which investors' interest in stewardship conflicts with managers' interest in profits.

A study released last week by Rep. Michael G. Oxley, an Ohio Republican who chairs the House Financial Services Committee, shows that the vast majority of the fund groups involved in last fall's scandals had management-related chairmen during the period of their alleged violations. Among them was Richard S. Strong, founder and once chairman of the Strong funds, who last week agreed to a lifetime ban from the industry along with personal and corporate fines totaling $140 million and reduced fund fees to settle charges that he engaged in market timing in making his own trades in funds he led.

Requiring independent board chairmen may not fix all that ails mutual funds. But that added layer of independent oversight would go a long way. It's a matter of trust.

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