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Fund veterans outline plan to clean up industry

Two U.S. mutual fund veterans Monday outlined 11 measures they said would eliminate "serious flaws" that helped create the scandals still rocking the $7 trillion industry.
/ Source: Reuters

Two U.S. mutual fund veterans, both former chairmen of the Investment Company Institute, on Monday outlined 11 measures they said would eliminate "serious flaws" that helped create the scandals still rocking the $7 trillion industry.

Changes urged by former Oppenheimer Funds Inc. CEO Jon Fossel and former Van Kampen Investments CEO Don Powell include the ending of all "soft dollar" payments for research, a severe cut in marketing costs and much higher early redemption fees to discourage rapid trading of funds.

"It is time to speak out," Fossel said in a telephone interview. "We have to keep short-term traders out of mutual funds because they cost long-term investors money.

"There are three themes here: expenses must be lowered, disclosure must be far more open, and conflicts of interest must be eliminated."

The rapid trading of funds to profit from stale prices on securities, often called "market timing," has been at the heart of ongoing improper trading scandals in the mutual funds industry.

Market timing is not illegal but is discouraged by regulators and fund firms as it can reduce returns for long-term mutual fund shareholders.

In a lengthy statement, Fossel and Powell called soft dollar payments "a pervasive evil that confounds every effort to curtail their many abuses." Under soft dollar arrangements, fund companies indirectly fund research by paying higher commissions or directing more trading business to a broker.

"Soft dollar payments are nothing but the use of shareholder assets to pay for 'research' that advisors decline to pay for out of their own pockets," the fund veterans said in the statement.

Fossel and Powell also called for quarterly disclosures of after-tax fund returns, regular disclosure of portfolio holdings in excess of 1 percent, a 4 percent fee on stock fund redemptions made within 10 days of purchase, and a ban on fund company payments for "shelf space" with brokers.

The veterans further urged the adoption of rules to address potential money manager conflicts that could arise within mutual fund firms managing other types of investments such as pensions, hedge funds and private accounts.

They called for "disclosure to mutual fund directors all other accounts managed by each mutual fund portfolio manager and all holdings, transactions and investment performance of the other accounts."

Fossel and Powell said fund companies should follow the code of ethics issued from the ICI, which requires all senior executives, portfolio managers and analysts to pre-clear all trades and regularly disclose all personal holdings in funds connected to their company.

"Since the opportunity for conflict between management and the fund shareholders in IPO allocations, front-running, etc., is considerable, full and timely disclosure is appropriate," the veterans said. "Annual prospectus disclosure is not adequate."

Fossel is still an independent board trustee of 35 Oppenheimer mutual and variable annuity funds. The veterans' statement said at least two-thirds of every fund board should be independent, and that compensation structures be disclosed to shareholders.

Fossel said it was unacceptable that the assets and profitability of the mutual funds industry had increased dramatically but costs to shareholders typically had not decreased.

He said that mutual funds should, where possible, keep the prices of their underlying securities up to date by adopting the "fair value pricing" valuation method to limit opportunities for rapid traders. "The trouble is that it (fair value pricing) can never be perfect," said Fossel.