WASHINGTON (AP) – Federal regulators and New York’s top law enforcer, pressing investigations of a mutual fund scandal, also are drawing up an overhaul of the $7 trillion industry that traditionallyhas enjoyed a pristine image.
New York Attorney General Eliot Spitzer is lashing out at the Securities and Exchange Commission for what he calls its failure to detect abuses and act quickly. “Heads should roll” at the agency, he says.
Eclipsed for months by Spitzer, the SEC jumped into the investigation in early September. Dozens of firms have been subpoenaed, including Fidelity Investments, Janus Capital Group, Morgan Stanley and Vanguard Group.
It was Spitzer who first raised the charge that preferential trading deals for big-money customers at mutual fund companies could be siphoning billions of dollars from ordinary investors.
Congress is looking into the scandal and the regulators’ response, with Spitzer and the SEC’s enforcement director, Stephen Cutler, called to testify before a Senate committee on Monday.
In the latest and sharpest enforcement action, the SEC and Massachusetts regulators brought civil fraud charges last week against Putnam Investments, the nation’s fifth-largest mutual fund company.
Pointing their prosecutions toward the top ranks, the regulators charged two senior investment managers at Putnam with using improper trades to profit personally from mutual funds they oversaw.
Boston-based Putnam denied any wrongdoing but confirmed that four money managers had been fired.
Public pension funds in Iowa, Massachusetts, New York, Pennsylvania, Rhode Island and Vermont have announced plans to pull at least $4.4 billion out of Putnam, which lists $272 billion in assets under management.
Several investment companies, including Janus and Bank of America, have pledged to make restitution to mutual fund investors who lost money through alleged improper trading.
More broadly, the scandal has tarred the reputation of mutual funds, traditionally viewed as a safe, conservative investment. Some 90 million people have money in U.S. stock mutual funds; half of all American households invest in them.
“This is the biggest stink that’s ever happened to the mutual fund industry,” said Roy Smith, professor of finance at the Stern School at New York University.
In the process, a political dispute has broken out between Spitzer and the SEC. They already had sparred last summer over legislation to preclude states from signing settlements with Wall Street firms that mandate business changes.
Spitzer is turning up the rhetoric.
“Heads should roll at the SEC,” he said in a newspaper interview last week. “There is a whole division at the SEC that is supposed to be looking at mutual funds. Where have they been?”
That division is headed by Paul Roye, also summoned to testify at Monday’s hearing by a Senate Governmental Affairs subcommittee.
Spitzer, in another interview, called the SEC’s conduct “an outrageous betrayal of the public trust.”
SEC Chairman William Donaldson, asked at a congressional hearing about the criticism, said: “The spectacle of one regulatory agency criticizing another is not healthy.”
Donaldson recently announced that the SEC will consider new curbs on fund trading.
“No regulatory reform – be it structural reform, fund governance or board (of directors) composition – is off the table,” an internal memo prepared for Donaldson says.
One change being considered would require that mutual funds rather than third parties such as brokers, receive trading orders before the funds price their shares for the day. That would mean that most funds would have to get the orders by around 4 p.m. for the investor to receive that day’s price.
In the Bank of America case, for example, a trader at the bank had an agreement with hedge fund Canary Capital Management to trade funds at the 4 p.m. prices hours after the market closed. That allowed Canary to cash in on after-hours news ahead of other investors, who at that hour would be forced to chance buying at the next day’s closing price.
Spitzer is expected to demand that chairmen of fund company boards to be wholly independent from the management companies that run the mutual funds. He may also try to compel fund companies to make restitution to their shareholders for alleged abuses.
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On the Net:
Securities and Exchange Commission: http://www.sec.gov
New York Attorney General’s Office: http://www.oag.state.ny.us
