As the investigation widens into mutual fund trading abuses, Securities and Exchange Commission Chairman William Donaldson said the agency’s attention is turning to the unregulated $6 billion hedge fund industry. And as part of the ever-widening probe, regulators are set to file charges Tuesday against Security Trust Co., CNBC reported.
Sources close to the situation told CNBC that three regulators working together will file charges Tuesday against the Phoenix, Ariz.-based company and unnamed individuals. The charges are expected to include securities fraud and other charges.
Security Trust was cited in the original complaint that kicked off the mutual-fund trading scandal back in September. The company services third-party administrators for over 2,300 pension funds.
Sources say Security Trust executed illegal late-day trades for hedge funds, including Canary Capital Partners.
Late-day trading involves buying a fund at the prior day’s price.
Sources close to the situation say the Securities & Exchange Commission, New York Attorney General Eliot Spitzer’s office and the Office of the Comptroller of the Currency will file the charges. The SEC and Spitzer’s office would not comment, and calls to the OCC were not returned. As a trust company, Security Trust is overseen by the OCC.
It’s not known which individuals will be charged. The firm’s former CEO and co-founder, Grant Seeger, resigned in October.
While charges have been filed against individuals and company’s that run mutual funds, this would be first time a company with responsibility for executing transactions for investors has been charged.
Regulating hedge funds
Meanwhile, in an interview on CNBC, Donaldson said the SEC staff has recommended these funds be required to register with the commission and provide information about their holdings.
The SEC’s move to register hedge funds “gives us the right to go inside ... and see exactly what is going on,” he told CNBC. “We have to anticipate more, we have to be able to look around the corner. And in this case, we are seeing that hedge funds are having an impact ... on mutual-fund shareholders.”
Donaldson said the SEC is not interested in forcing disclosure of proprietary investment strategies of hedge funds — which typically are open only to wealthy investors — but the agency does need to know more about how hedge funds are valuing their holdings.
InsertArt(2078084)“If we make the decision to register (hedge funds) we will have to either get new resources or divert resources into this area,” he said. “But we’ve got to be a lot smarter.”
Donaldson said better information about hedge funds could have lead investigators sooner to mutual fund timing by Canary Partners, the hedge fund that was the target of New York Attorney General Eliot Spitzer’s opening salvo in the current probe of fraud and abusive trading practices in the mutual fund industry.
Defending the SEC
Appearing earlier on CNBC, former SEC chairman Harvey Pitt defended the agency’s record in tackling mutual fund fraud, even though New York Attorney General Eliot Spitzer upstaged federal regulators by acting first to clean up the industry.
“The SEC hasn’t been idle,” said Pitt. “And if you look at the activity that the commission has undertaken, it’s been quite forceful.”
Pitt also defended the SEC’s $50 million settlement last week with Putnam Investments, despite criticism from Spitzer that the agency was “caving in” to the mutual fund giant just as it had maximum leverage to impose a larger fine.
“The SEC settlement has been terrific, because it brought to light all of the problems that were then known,” said Pitt. “It put in place an immediate provision to try to get money back into the hands of investors. And it cut off absolutely no investigation. The investigation is continuing, and there will be more actions being brought, arising out of this matter.”
Federal and state regulators charged that Putnam allowed some portfolio managers and certain clients to break company rules by buying and selling mutual fund shares very quickly to profit from stale prices.
As part of its settlement, the fifth-largest U.S. mutual fund company agreed to pay back investors who were hurt by the short-term trading. Putnam neither admitted nor denied wrongdoing in the settlement.
Meanwhile, a majority of executives running pension funds in the U.S. think that the market timing abuses uncovered by regulators are “systemic,” according to a survey by the investment firm Greenwich Associates reported Monday in the Financial Times.
Executives at some 60 percent of the 131 funds surveyed said that improper trading — which is the subject of a major investigation by Spitzer — was systemic to the U.S. mutual fund industry.
The survey included 76 funds with money managed by firms under investigation; of that group, some 71 percent considered the problem to be widespread across the industry.
“When the problem surfaced, the prevailing view was that there were a few bad apples,” John Webster, managing director of Greenwich Associates told the Financial Times. “But that’s not how it’s viewed any more. … People are very angry, and they want to see companies clean up their act.”
Some 54 percent of funds viewed the problem as “very serious.” Around two-thirds of them had discussed the issues with their investment consultant, investment committee or board of trustees.
In a series of follow-up interviews, Greenwich Associates found funds ready to express their dissatisfaction “in no uncertain terms.”
Fund executives wanted mutual fund firms to be “up front, conduct independent and external audits, clearly communicate the problems, and show resolutions to ensure that violations do not occur in the future.”
Criticism of the industry was echoed by Richard Moore, state Treasurer of North Carolina, who also appeared on CNBC. Moore said that, among other reforms, funds should be required to provide better information on how much investors are paying in fees.
“We could not think of another service that consumers in our society purchase where you never see a bill,” he said. “You know that it’s some percentage of the assets you have buried somewhere, but imagine if your credit card company said that, ‘We’re good to charge you 14 percent this month but we’re never really going to tell you what that is, trust us to take it out.’”
Moore said that greater disclosure would help prevent futures abuses.
“I’ve never seen a situation where sunlight did not improve a product, and everybody agrees we need improvements in the product,” he said. “Probably 20 to 40 percent of the funds, they ought to be out of businesses.”