WASHINGTON (AP) — As they investigate a widening scandal in mutual funds, long considered a safe-haven investment, federal securities regulators also will consider new curbs on fund trading toprevent future abuses.
Evidence that has surfaced in the Securities and Exchange Commission’s investigation has convinced officials they should consider new rules and restrictions on late trading and market timing of mutual fund shares, Chairman William Donaldson said in statement Thursday.
The move follows recent pledges by three investment companies — including Janus Capital Group and Bank of America Corp. — to make restitution to mutual-fund investors who lost money because of alleged improper trading.
Donaldson said the SEC is “aggressively” investigating the recent allegations of abuse and “is committed to holding those responsible for violating the federal securities laws accountable and seeking restitution for mutual fund investors (who) have been harmed by these abuses.”
The chairman said last month that the agency was investigating alleged abuses in the mutual fund industry, after New York Attorney General Eliot Spitzer charged that illegal trading arrangements between mutual funds and hedge funds could be widespread and costing investors billions of dollars.
By writing new rules for mutual fund trading, the SEC would go beyond punishing violators to changing the laws governing the system. Investor confidence was shaken by last year’s wave of corporate scandals, but mutual funds traditionally have been viewed as a safe, conservative investment. Some 90 million people have money in U.S. stock mutual funds, and investors plowed $5.4 billion into stock-based funds during the week that ended Wednesday, according to market analysts.
By contrast, investors pulled $4.4 billion out of Janus funds in September, most of it after questions were raised about the company’s trading practices.
Donaldson said he and the four other SEC commissioners would consider new rules no later than next month.
Among the changes the SEC is considering is a requirement that mutual funds themselves, rather than third parties such as brokers, receive trading orders before the funds price their shares for the day. That would mean that most mutual funds would have to get the orders by around 4 p.m. in order 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.
Market timing, which aims to take advantage of short-term movements in stock prices with quick “in and out” trading of shares, violates the rules of most mutual fund companies. It can have a detrimental effect on the long-term shareholders for whom mutual funds are designed.
New rules being weighed also include requiring mutual funds to clearly disclose their market-timing policies and procedures in sales material.
The Investment Company Institute, the mutual fund industry’s lobbying group, expressed support for Donaldson’s plan. However, the group said laws alone “cannot ensure that fund shareholders are protected.”
Last month, Canary and its managers agreed to pay $30 million in restitution for profits generated from improper trading, plus a $10 million penalty to settle Spitzer’s allegations. The hedge fund neither admitted to nor denied wrongdoing in the settlement.
Several dozen mutual fund companies, including giants Fidelity Investments and Franklin Resources, and a smaller number of hedge funds have been subpoenaed in Spitzer’s investigation. As the investigations expand, a growing list of mutual fund companies have fired or suspended employees following internal investigations of trading activities. Merrill Lynch, Alliance Capital Management Holding and Prudential Securities have suspended or fired at least 17 employees.
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