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Mutual fund probes expand

/ Source: news services

Mutual fund investors learned Monday of a widening scope of trading abuses in the $7 trillion industry — the most recent corner of the investment world hit by scandal. The SEC’s top cop told Congress that more than a quarter of top brokerages have allowed big customers to trade fund shares illegally after the close of trading. In a separate move, regulators announced actions against brokerages that overcharged small investors for mutual fund trades, saying nearly 450 securities firms must notify customers about possible refunds.

At a hearing on Capitol Hill, the Securities and Exchange Commission’s director of enforcement, Stephen Cutler, presented findings of recent document searches that targeted 34 brokerages and 88 top mutual fund firms. The searches were part of the agency’s investigation of abuses known as late trading and market timing.

Amid criticism that the SEC has done too little to stem the practice, Cutler said “almost 30 percent of ... broker-dealers indicate that they assisted market timers in some way.”

Market timing involves buying and selling shares of mutual funds very quickly to try to profit from stale prices. While the practice is not illegal, fund companies say they discourage it because it drives up trading costs and waters down the profits of long-term investors.

More broadly, the scandal has tarred the reputation of mutual funds, traditionally viewed as a safe, conservative investment. Some 90 million people have money in U.S. stock mutual funds; half of all American households invest in them.

Cutler said the SEC found e-mails showing about 10 percent of fund groups may have been involved in late trading, an illegal practice that allows favored investors to trade after daily share prices have been set at 4 pm ET. The SEC also found about 30 percent of the fund firms had disclosed their portfolio holdings to selected clients more often than normal, he said.

As Cutler gave his findings to the Senate Subcommittee on Financial Management, he was flanked at the witness table by New York Attorney General Eliot Spitzer and Massachusetts Secretary of the Commonwealth William Galvin.

Spitzer’s office months ago raised the charge that preferential trading deals for big-money customers at mutual fund companies could be siphoning billions of dollars from ordinary investors.

Eclipsed for months by Spitzer in the pursuit of conflicts of interest and abuses by Wall Street investment firms, the SEC jumped into the mutual fund investigation in early September. Dozens of firms have been subpoenaed, including Fidelity Investments, Janus Capital Group, Morgan Stanley and Vanguard Group.

At Monday’s hearing, Spitzer sought to downplay the political dispute that has broken out between his office and SEC officials. The two agencies have already had sparred over legislation last summer to preclude states from signing settlements with Wall Street firms that mandate business changes.

Watchdogs didn't bark
But some members of Congress sharply criticized the SEC Monday for failing act sooner against the mutual fund industry. As first reported by, the SEC’s public statements to the industry, warning money managers to clean up their act, indicate that the commission knew about trading abuses as long ago as 1997.

“It is appalling to me that these practices, which benefit a select group of individuals at the expense of the vast majority of mutual fund investors, continue,” Sen. Susan Collins, R-Maine, head of the Senate Governmental Affairs Committee, said at a hearing by the panel. “I question why the Securities and Exchange Commission ... has failed to detect these practices, to impose appropriate restrictions on them, or to penalize those who appear to be misusing investors’ money.”

Democratic presidential candidate Sen. Joseph Lieberman, D-Conn., and a committee member, told SEC Chairman William Donaldson in a blistering letter that the agency “was far too late to the table in addressing these problems.” He requested detailed information on the SEC’s response and plans.

“Why did the watchdogs fail to bark?” asked Lieberman in a letter to Donaldson that was distributed Monday. “The looting has already begun, now we must prevent it from continuing.”

Putnam chief ousted
The gathering turmoil Monday swept another fund company CEO from his post. Putnam Investments chief Lawrence J. Lasser was forced out by Putnam’s parent company, the insurance broker Marsh & McLennan. Boston-based Putnam, the fifth largest U.S. fund manager, faces federal and state civil fraud charges over market timing. The company allegedly let certain investors move rapidly in and out of selected funds — in violation of fund prospectuses.

Lasser, a 33-year veteran of the firm, was paid $163 million by Putnam over the past six years. He is the highest-ranking fund executive to lose his job in the scandals.

Pension plans in at least six states have pulled more than $4.3 billion of investments out of Putnam after the company was accused of securities fraud last week. Putnam manages $272 billion in assets.

The company may also face criminal investigations as federal prosecutors in New York subpoenaed records last week. On Monday, The Boston Globe reported that Massachusetts regulators had subpoenaed Lasser’s own trading records, taking a step that industry analysts said may lead to more revelations.

Charles Haldeman, 55, who joined Putnam last year as senior managing director and co-head of investments, was tapped to succeed Lasser as Putnam’s president and CEO.

Yesterday, Strong Mutual Funds chairman Richard S. Strong stepped down from the boards of his Milwaukee company’s funds, but he remains corporate chairman. Strong resigned amid multiple investigations into his personal trading of the company’s funds. Last week, Strong acknowledged trading in some of the firm’s funds and said he would reimburse investors for any losses they may have sustained because of his trades. Strong is under investigation by the SEC, by Spitzer’s office and by Wisconsin financial regulators for alleged improper trading that officials say may have benefited him and his friends and family.

State regulators continue to push ahead with more enforcement actions. Massachusetts securities regulators will file fraud charges related to market timing of fund shares against as many as six former Prudential Securities brokers, a spokesman said Monday.

A spokesman for Wachovia Corp., Prudential’s parent company, declined to comment on the matter. Prudential, a unit of Prudential Financial, said it was cooperating with Galvin’s probe but declined to comment on any charges.

Fund refunds?
Federal regulators also announced Monday actions related to brokerages overcharging investors for mutual fund purchases, saying nearly 450 securities firms must notify customers about possible refunds. The move, announced jointly by the SEC and the National Association of Securities Dealers, relates to failures to provide investors with so-called breakpoint discounts, or volume discounts given to investors who purchase Class A mutual fund shares.

Overall, the SEC and NASD said, discounts were not delivered in about one of five eligible transactions. The average amount overcharged per transaction was $243, and ranged up to $10,000, according to their statement. NASD estimates that at least $86 million is owed to investors for 2001 and 2002 alone, the statement said.

Management fees reaped by mutual fund companies totaled more than $50 billion last year, according to Spitzer.

NASD is directing nearly 175 of the roughly 450 securities firms with “poor records of providing breakpoint discounts” to review transactions dating back to the beginning of 2001, the statement said.

The SEC will soon warn brokerage firms of possible action against them for failing to give discounts when they were due.

“This week, together with the NASD, we will be issuing Wells Notices to a significant number of brokerage firms for their failure in this regard,” Cutler told the Senate panel.

A Wells Notice, allowing a company or brokerage to defend itself before formal action is taken, has already been sent to a major financial institution over failure to disclose incentives to promote certain mutual funds to investors, Cutler added.

Several investment companies, including Janus and Bank of America, have pledged to make restitution to mutual fund investors who lost money through alleged improper trading.

The Associated Press and Reuters contributed to this report.