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House passes mutual fund legislation

Even as more mutual fund firms were cited in a widening probe into trading abuses, the House of Representatives voted overwhelmingly Wednesday to approve broad new legislation for the fund industry.
/ Source: staff and news service reports

As more big-name mutual fund companies were cited Wednesday by authorities in a widening probe into trading abuses, the U.S. House of Representatives voted overwhelmingly to approve broad new legislation for the fund industry, mandating harsher penalties for rule violations and greater disclosure for investors.

The 418-2 vote came as mutual fund scandals escalate, more big-name companies are cited by authorities and a money stampede continues out of implicated funds.

The legislation, proposed by Rep. Richard Baker, R-La., also makes directors on fund company boards more independent from fund managers.

In addition, the bill prohibits short-term trading by fund insiders, a practice under scrutiny in many of the recent cases. The quick trades, known as market timing, aren’t illegal, but most funds don’t allow them because they skim profits from longer-term shareholders.

The aim of the new measure, Baker said, was to “help bring the bright light of truth into fund fees, clean up the way funds are managed, and eliminate the conflicts of interest and utter disregard of [fund directors’] duty to mutual fund investors that plague this industry.”

The issue still needs approval in the Senate, where several different versions have been proposed. No action is expected before next year.

“More must be done to assure mutual fund investors that their trust has not been misplaced,” said Sen. Joseph Lieberman, D-Conn., a co-sponsor of one of the Senate proposals.

Lawmakers of both parties took the House floor in succession Wednesday to assure the 95 million Americans who invest in mutual funds — half of all U.S. households — that the legislation would help them.

The bill “will provide Americans with a clear understanding” of mutual fund operations and fees, said Rep. Katherine Harris, R-Fla.

Mutual funds are often a principal vehicle for retirement savings and college funds. Before the mutual fund scandal erupted in early September, they were traditionally regarded as safe investments.

The scandal has exposed “pervasive financial fraud by all segments of the fund industry,” including some trusted companies, said Rep. Michael Oxley, R-Ohio, chairman of the House Financial Services Committee.

The House lawmakers were acting ahead of the SEC, which plans to make changes in how fund companies govern themselves and other areas through new rules it will consider in the coming months.

The proposed changes include a requirement that board chairmen of fund companies be wholly independent from the companies managing the funds — a reversal of the SEC’s previous position.

Also, three-quarters of the directors sitting on a fund company board would have to be independent, up from the currently required 50 percent of directors, SEC Chairman William Donaldson told the Senate Banking Committee at a hearing Tuesday.InsertArt(2073609)

Fidelity, John Hancock subpoened
But as lawmakers moved to curb trading abuses in the mutual fund business, more fund companies said they had received a fresh round of subpoenas from industry watchdogs.

Massachusetts regulators subpoenaed Fidelity Investments, the nation’s largest mutual fund company, and John Hancock Funds to supply more information about their trading practices, as part of a probe of the mutual fund industry, the two companies said.

The Boston Globe reported Wednesday that other Boston-based companies — MFS Investment Management, Loomis Sayles & Co., Pioneer Investment Management Inc., and Scudder Investments — were also subpoenaed. Franklin Templeton Investments also said it had received a subpoena.

“Fidelity did receive a request from Massachusetts seeking trading information from some fund managers,” said Fidelity spokeswoman Anne Crowley, adding that the subpoena, received by Fidelity from Massachusetts Secretary of the Commonwealth William Galvin, did not allege any wrongdoing.

John Hancock Funds also received a subpoena.

In a statement the company said, “It is our understanding that these requests are not the result of any specific information or allegations concerning John Hancock. We believe, instead, these requests are part of an overall, broad-based fact-finding process initiated by federal and state authorities. We will respond and cooperate fully.”

The new requests are part of a broader investigation, spearheaded in Massachusetts by Galvin, into improper trading practices in the $7 trillion mutual fund industry.

The Globe reported that Galvin has joined forces with regulators in nearby New Hampshire to probe the industry, which employs hundreds of thousands of people in the Boston area. Some mutual fund companies, including Fidelity, also have operations in New Hampshire.

Another strong executive ensnared
Meanwhile, a report in Wednesday’s Wall Street Journal said another top executive at Strong Capital Management has reportedly been ensnared in the scandal over “rapid trading” of mutual funds.

The newspaper said Anthony D’Amato, a member of Strong’s office of the chief executive, was involved in a deal to allow hedge fund Canary Capital Partners LLC to rapidly trade shares of Strong’s mutual funds and at the same time make investments in a hedge fund run by Strong.

In October 2002, Mr. D’Amato met with Canary head Edward Stern to discuss allowing Canary to conduct the trades, the newspaper reported.

The rapid trading, commonly known as market timing, was designed to take advantage of expected moves in the prices of the funds’ shares, producing profits for Canary at the expense of Strong’s long-term fund shareholders, the paper said.

The report follows recent allegations by investigators that Richard Strong, the firm’s founder, personally profited from short-term trading in Strong mutual funds.

Mr. Strong has admitted he performed the trades, but has denied that his actions were disruptive. He has since stepped down as chairman of Strong’s board, but retains a director’s seat and continues in his duties as head of Strong Capital Management.

In a separate report by CNBC, New York Attorney General Eliot Spitzer is said to be looking into whether Richard Strong engaged in an illegal investment practice is known as “front running,” in which a financial professional trades stocks using information not yet available to clients.

Strong allegedly took large positions in certain small-cap stocks in the knowledge that his firm’s funds were about to make large purchases of the same stocks, CNBC said Wednesday.

Spitzer first brought to light fund trading abuses in the mutual fund industry in early September, charging that a Canary Capital received special trading privileges from three mutual fund groups, including Strong Capital. The abuses may have cost individual investors billions of dollars, Spitzer said.

In another report Wednesday, the Journal said the New York attorney general’s office has met with Putnam Investments’ former chief of compliance, Edward Siedle, to investigate claims that during the 1980s some senior fund managers at Putnam asked colleagues to hold off on trades for clients so that managers could complete trades in the same stocks for themselves.

It was not known whether the attorney general’s office would pursue the matter, the paper said. Last month, Putnam was charged with failing to stop market timing in its funds.

Merrill chief sees scandal widening
Merrill Lynch’s Chief Executive Stan O’Neal said Wednesday he believes the focus of the current mutual fund scandal will not be limited to trading practices, and that the financial industry, not regulators, is ultimately responsible for cleaning up the mess.

Speaking at a Merrill Lynch financial conference in New York, O’Neal said, “I don’t know that there’s clarity yet in terms of what the scope ultimately will be. I do believe that it will widen beyond just the trading practices.” He added that regulatory action stemming from the current probes could have “far-reaching consequences” for the financial industry.

“I think we’ll see more investigations,” former SEC chairman David Ruder told CNBC Wednesday.

Ruder said he expects the fund business to see more regulation as a result of the industry probe, adding that the industry’s fee structure is likely to come under attack, and that in turn could mean fund firms become less profitable than in the past.

As the scandal has broadened, money has flowed from those fund groups singled out for special investigation by lawmakers and regulators.

Pharmaceutical giant Merck has become the latest company to drop Putnam Investments funds from its 401(k) plan, citing concerns about alleged improper trading practices. Effective Nov. 20, the company would cease to offer the Putnam International Capital Opportunities Fund and the Putnam Global Equity Fund.

It was a further blow to Boston-based Putnam, the nation’s fifth-largest mutual fund company, which as already seen investors remove about 8 percent of its assets under management since allegations of trading abuses at the fund firm first surfaced last month.

The Associated Press and Reuters contributed to this report.