IE 11 is not supported. For an optimal experience visit our site on another browser.

Regulators to widen mutual fund probe

Misconduct in the U.S. mutual fund industry is not limited to fund share trading; it's not even limited to funds, say market regulators.
/ Source: Reuters

Misconduct in the U.S. mutual fund industry is not limited to fund share trading; it's not even limited to funds, say market regulators.

As they push investigations of the $7.6 trillion fund business into new areas, regulators say to expect a 2005 focus on the connections between funds and other institutions, such as brokerages, that handle fund shares or process fund orders.

Brokerages control about 87 percent of the order flow in mutual fund shares and investigators are delving increasingly into broker fees, compensation and conflicts of interest.

"We and the (Securities and Exchange Commission) are highly focused on all the potential areas of conflict," said Mary Schapiro, vice chairman of brokerages regulator NASD.

In an interview, she said, conflicts among brokers and funds can never be wholly eliminated, but "to the extent they can be minimized, disclosed and, in some cases prohibited, we'll continue to both be focused in that area."

The scandals that engulfed mutual funds over a year ago centered on improper market timing and illegal late trading. By exploiting pricing inefficiencies, mutual fund and hedge fund managers profited at the expense of average investors.

But investigators are moving beyond these behaviors to other questionable arrangements, such as possible misbehavior by bank lending agents that help funds lend their shares to short-sellers, and how 401(k) retirement plans market funds.

They are also probing gifts of Super Bowl tickets, private jet rides, wines and expensive golf outings by brokerage firms to mutual fund executives to curry favor.

A policy flashpoint next year is likely to be an SEC effort to write a rule requiring brokers to give mutual fund investors a form disclosing potential broker conflicts, such as the various payments that flow between them and fund managers.

The SEC is testing different formats for this "point of sale" disclosure document, but investor activists want it to accomplish more than just talk about possible conflicts.

"This is an historic opportunity to give investors really good information" about hidden mutual fund fees and costs, and how they affect investment performance, said Barbara Roper, investor advocate for the Consumer Federation of America.

The mutual fund industry wants the SEC to complete the point-of-sale form effort as originally proposed and not expand it into a sweeping cost disclosure solution.

Another area on the SEC's agenda is soft dollars -- the credits given to fund managers by brokers that can be used to buy research and other services, said Paul Roye, director of the SEC investment management division.

"It's a front-burner issue for the commission. You're likely to see some movement on that issue in 2005," Roye said.

In addition, the SEC is still working on two proposed rules to stem the illicit fund share trading that was at the core of recent scandals and that led to huge fines for groups such as Bank of America, INVESCO and MFS.

One proposal would bar funds from accepting orders after the market closes, typically at 4 p.m. Eastern time, for trades to be done at that day's price. As written, the proposed rule is aimed at stopping illegal late trading, which often has involved large, omnibus orders assembled by intermediaries.

This "hard 4 close" proposal is being reconsidered by the SEC in the face of many complaints, as is a measure to require that funds impose a 2 percent fee on sales of fund shares held for five or fewer business days. The early redemption fee is aimed at halting rapid market timing trades in fund shares.