Dec. 4–Responding to a scandal that has engulfed the mutual fund industry and tarnished its squeaky-clean image, the Securities and Exchange Commission yesterday rolled out the first of a series ofnew rules that would thwart late trading and market timing and improve oversight at fund companies.
The five SEC commissioners unanimously approved a rule that would require mutual fund shares to be priced by 4 p.m. Eastern time. The step could eliminate a loophole that enables some traders to place trades after the 4 p.m. end of trading and still make use of the previous day’s pricing. Traders would no longer be able to use third parties, such as brokerages, to make trades under the old prices and profit from after-hours news that moves the markets.
The commissioners also approved a requirement that mutual funds have a compliance officer, or securities law watchdog, who would report directly to the board of directors, rather than management. They also proposed improved disclosure of market timing rules to investors, to prevent some from engaging in rapid, market-timed trades in funds intended for long-term investing.
The proposals get 60 days for public comment, after which they may be formally adopted.
“The recent spate of mutual fund scandals are deeply disturbing to me,” said SEC chairman William H. Donaldson. “We have seen a betrayal of individual investors.”
The meeting yesterday was the first of three at which the agency will propose a long slate of rules to prevent the abuses that have rocked the industry in the past few months. The scandal broke when New York Attorney General Eliot Spitzer charged a hedge fund, Canary Capital Partners LLC, with engaging in improper market-timed trades with a number of mutual fund companies.
Since then, many firms have been subpoenaed by Spitzer and other investigators, and several have been charged. The SEC and Massachusetts Secretary of State William F. Galvin last month charged Boston’s Putnam Investments with trading improprieties, including allowing a handful of portfolio managers to make rapid market-timed trades in their own funds.
On Tuesday, Spitzer and the SEC filed civil charges against Invesco Funds Group and its chief executive, Ray Cunningham. The firm has denied the charges and said it stands by its leader.
Kunal Kapoor, associate director of fund analysis at Morningstar Inc., a Chicago fund research company, said the steps proposed yesterday by the SEC are “no brainers.” “This move is a good one,” said Kapoor. “Those who say they would have a hard time complying with it will take the measures to abide by the new rule. The thing to remember, and it’s sad to say, this should have been required a long time ago by the fund companies themselves.”
Legislators who have questioned the SEC’s regulatory oversight said the steps don’t go far enough.
“Beyond simply adopting new rules, the SEC must reconceptualize its role as a protector of the marketplace,” said US Senator Joseph I.
Lieberman, a Connecticut Democrat and ranking member of the Governmental Affairs Committee. “It should not simply address the illegal practices uncovered but must be bolder in its oversight of the mutual fund industry overall.”
US Senator Susan M. Collins, a Maine Republican and chairwoman of the committee, called the proposed rules “a good first step.” She too questioned whether the agency has been aggressive enough in its policing of the industry. “It appears that the commission has not responded quickly and decisively to allegations of unscrupulous industry practices,” she said.
At the SEC’s next open meeting Jan. 14, commissioners will consider a rule requiring portfolio managers to report their personal trading in the funds they oversee. Disclosure of such personal trading records could play an important role in eliminating improper trading. In addition, the 1940 Investment Company Act, which set many of the rules regulating mutual funds, contains an enormous loophole: insiders such as portfolio managers have to report their investment activities on a quarterly basis, but shares in most mutual funds are exempt from the reporting requirement. That exemption may have made it easier for some portfolio managers to trade undetected in their own funds.
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