U.S. fund abuses rampant

"We believe that we don't have the same level of problem in the Canadian industry as we've seen emerging in the United States," Mr. Pelletier said…While many industry executives have expressed confidence that the types of problems regulators have exposed in the United States are not happening here, they said there is no way of knowing for certain what is going on without some type of industry review.

National Post
November 4, 2003

U.S. fund abuses rampant
Spitzer vows mutual fund penalties 'will be big, will impose pain': SEC says more than 25% of top brokers overcharge
Peter Morton

WASHINGTON - Illegal mutual fund trading is so widespread that more than a quarter of the top U.S. brokerage firms have admitted to making questionable after-hour trades.

The Securities and Exchange Commission told a stunned Congressional committee yesterday that nearly 450 brokerage firms have been overcharging investors for mutual fund purchases and said tens of million of dollars of refunds may be necessary.

"Unfortunately, the mutual fund industry has disintegrated into the world's largest skimming operation,'' said Sen. Peter Fitzgerald, an Illinois Republican and chairman of the Senate subcommittee on financial management. "The mutual fund industry has grown into a US$7-trillion monster that too many people are leeching off."

Eliot Spitzer, the New York State Attorney General, who launched an investigation into questionable mutual fund industry practices in September, testified before the committee.

He said mutual fund companies should be forced to surrender fees made while the abuses were occurring. The penalties, he vowed, "will be big, it will impose pain, and it should." He labelled the mutual fund industry "a cesspool."

"We are going to insist, if any company expects or hopes to settle with my office, that there will be full and complete disgorgement of the fees earned during the period they permitted late trading or timing with respect to the funds that are at issue," Mr. Spitzer said.

He added: "Too many funds have abandoned the interests of their shareholders and instead permitted and indeed fostered an environment that promotes the interests of their managers at the expense of their shareholders. "

Stephen Cutler, the SEC's enforcement director, also testified. He said the SEC found e-mails showing about 10% of the country's 88 mutual fund companies may have been involved in late trading — buying and selling of shares after the market price has been set at the end of the day.

In one instance, customers who placed trades as late as 5:30 p.m. were given that day's 4 p.m. closing price, he said.

The SEC found about 30% of the fund firms had disclosed their portfolio holdings to selected clients more often than normal.

"The commission's investigation of mutual fund trading abuses is continuing on multiple fronts," Mr. Cutler said.

"I can safely predict many more enforcement actions will follow.''

The hearing on Capitol Hill comes after some 30 investment fund managers have quit or been forced out.

Despite a pledge to punish the industry, the SEC again ran into criticism it has been moving too slowly to end the abuses.

"Why did the watchdogs fail to bark?" Sen. Joseph Lieberman, a Democratic presidential candidate, said in a letter to William Donaldson, the SEC chairman, and made public at the hearing. "The SEC was far too late to the table in addressing these problems. The looting has already begun, now we must prevent it from continuing."

Some U.S. politicians are pushing for new laws that would try to curb some of the trading abuses. About half of American households own mutual funds, mostly through their retirement plans.

Mr. Fitzgerald said he and Sen. Daniel Akaka, a Democrat from Hawaii, will introduce a bill not only to end the abuses but cut fees being charged to retail customers.

He said mutual funds charge about 25 basis points more than pension funds fees, costing mutual fund investors about US$10-billion a year.

In the overcharging of customers, the SEC and the National Association of Securities Dealers said investors were not given volume discounts applied to front-end charges investors pay when buying Class A mutual fund shares. The NASD estimated at least US$86-million is owed to investors for 2001 and 2002 alone, the SEC said.

Rep. Richard Baker, chairman of the House of Representative's Financial Services subcommittee on financial markets, is proposing legislation that would insist mutual fund board chairmen be independent of the fund companies.

"Industry leaders, through the ICI, have proposed strong medicine to combat late trading and abusive market timing, namely imposing a 4 o'clock deadline for all trades to be reported at the fund companies and a minimum 2% redemption fee for redemptions made within five days," said Mathew Fink, president of Washington-based Investment Company Institute.

Among some techniques discovered by the SEC were cases where broker-dealers assisted market timers by breaking up large customer orders into smaller sizes to avoid detection by mutual funds or the brokerage firm's surveillance.


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