As the Securities and Exchange Commission Wednesday took its first steps toward tightening rules aimed at preventing a handful of savvy traders from profiting at the expense of the nearly 100 million U.S. mutual fund investors, investigators continue to pursue fresh leads in the widening scandal.
The commission voted, 5-0, to propose new trading rules to stanch a tide of trading abuses as part of a planned overhaul the $7 trillion fund industry.
“We have seen a betrayal of individual investors, who entrusted their confidence, the fruits of their labor, their hopes and dreams for the future to this industry for safekeeping,” SEC chairman William Donaldson said before the vote at the public meeting.
The new rules, which are now subject to several weeks of public comment before being formally adopted, would impose a “hard cutoff” of 4 p.m. Eastern time for pricing of fund shares. By going through brokerage firms and other third parties, some big investors such as hedge funds are able to cash in on after-hours news ahead of most shareholders, who at that hour would be forced to buy at the next day’s closing price.
Under the rules, mutual funds rather than third parties would have to receive trading orders by 4 p.m., before the funds price their shares for the day. So the order must be in by then for the investor to receive that day’s price.
The embattled mutual fund industry has embraced the proposals, announced in October. But brokerage firms, which sell some 80 percent of all mutual fund shares and collect billions in fees annually for those sales, are opposed.
A recent SEC review found a quarter of the nation’s largest brokerage houses helped some clients illegally trade mutual funds after hours.
‘Fresh leads’
New York State Attorney General Eliot Spitzer, whose office has lead the way in attacking the trading scandal, said that it’s too soon to say when the investigation will get to the bottom of the problem.
“It is disconcerting to me, obviously, as I think about capital markets, that there continue to be fresh leads that come in pointing in other directions,” he told CNBC. “But we have to begin to think about how we put the pieces back together.”
Spitzer said that while tighter rules governing fund pricing was a good start, an number of additional reforms are needed.
“Fees continue, in my mind, to be the largest issue that investors should be thinking about — the lack of disclosure of fees, the lack of mutual fund board action to ensure that fees are where they should be,” he said. “And so I think that while I’ve not had a chance to parse what the SEC proposed today, it’s a beginning. I think we may be looking at some slightly more aggressive ideas down the road.”
Indeed, the SEC said at Wednesday’s meeting that it is considering other measures. The Commission also voted unanimously to order mutual funds to appoint “chief compliance officers.” These internal watchdogs would probably work for the companies that manage mutual funds, but would answer to the funds’ boards, SEC staffers said.
SEC Chairman William Donaldson said the commission over the next three months will consider other mutual fund reforms. Later this month, he said, it will look at measures to improve fund disclosure of “breakpoint” discounts offered to large fund share purchasers, as well as transaction costs.
In January, the SEC will evaluate requiring that three-fourths of all board members of a fund — and the board’s chairman — be independent of the fund company.
In February, the commission will consider a “mandatory redemption fee,” or charge assessed against investors who jump in and out of mutual funds. The fee would target market timing abuses in mutual fund shares.
The SEC move comes two weeks after the House overwhelmingly passed legislation requiring mutual fund companies to disclose more information to investors about fees and operations, and making directors on fund company boards more independent from fund managers.
In the latest enforcement, the SEC and Spitzer charged Invesco Funds Group Inc. and its chief executive with civil fraud on Tuesday. They said the company devised a system to recruit big-money market timers despite complaints from its own employees that shareholders were being harmed.
The regulators accused Raymond Cunningham and his Denver-based company of defrauding ordinary shareholders by allowing certain big clients to engage in market timing — rapid, short-term trading that skimmed profits from long-term shareholders — despite fund policies against the practice. Invesco denies any wrongdoing.
Fund companies named in the probe continue to feel its effects. The exodus from Putnam Investments continued Wednesday, as Anglo-Dutch consumer goods giant Unilever confirmed it had sacked the fifth-biggest U.S. mutual fund from managing part of its UK pension fund.
Putnam, a unit of U.S. insurer Marsh & McLennan Cos., is being investigated by U.S. regulators for civil securities fraud in a widening probe into the U.S. mutual fund industry.
“We took appropriate advice and determined that the most prudent and appropriate course of action was to terminate the Unilever Pension Fund mandate with Putnam,” Unilever, the maker of Dove soap and Knorr soup, said in a statement.
A Putnam spokeswoman, Laura McNamara, said the fund company was “disappointed about their decision, but hope that we will have the opportunity to manage investments for them again in the future.”
Putnam said on Monday its total assets under management fell by $32 billion to $245 billion in November.
The Associated Press and Reuters contributed to this report.