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Congress Joins Probe of Mutual Fund Scam

Nov 3, 2003 | AP

Congress is examining a widening mutual fund scandal that has implicated top industry executives, as regulators investigate and draw up a major overhaul of the $7 trillion industry with a traditionally pristine image.

Companies must be forced to pay back to investors the hefty fees received for managing mutual funds while they allowed fund trading abuses to occur, New York Attorney General Eliot Spitzer said Sunday in an interview with The Associated Press.

"If they're expecting to get settlements (with regulators) they're going to have to give much more back than just (investors') losses," Spitzer said. "They're going to be paying stiff fines and giving back their management fees. They violated their trust with the American investor."

Management fees reaped by mutual fund companies totaled more than $50 billion last year, Spitzer noted.

Repayment of management fees would be in addition to restitution to shareholders of profits made from alleged improper trading, Spitzer said in testimony prepared for a Senate Governmental Affairs subcommittee hearing Monday.

The Securities and Exchange Commission's enforcement director, Stephen Cutler, was set to testify as well. A House subcommittee also is holding hearings on the burgeoning scandal this week.

Cutler planned to present a survey detailing widespread industry abuses, including a finding that one-quarter of the nation's largest brokerage houses helped clients illegally trade mutual funds after hours, The Washington Post reported.

In the latest jolt, Strong Mutual Funds said Sunday that its board chairman, Richard S. Strong, had resigned amid multiple investigations into his personal trading of the company's funds. Last week Strong acknowledged trading in some of the Menomonee Falls, Wis., firm's funds and said he would reimburse investors for any losses they may have sustained because of his trades.

Strong is under investigation by the SEC, Spitzer's office and Wisconsin financial regulators for alleged improper trading that officials say may have benefited him and his friends and family.

Spitzer has lashed out at the SEC for what he calls its failure to detect abuses and act quickly. "Heads should roll" at the federal agency, he says.

Eclipsed for months by Spitzer in the pursuit of conflicts of interest and abuses by Wall Street investment firms, the SEC jumped into the mutual fund 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.

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.

Two senior investment managers at Putnam were charged 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.

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.

In the process, a political dispute has broken out between Spitzer and SEC officials. They already had sparred last summer over legislation to preclude states from signing settlements with Wall Street firms that mandate business changes.

This time Spitzer increased 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, who also was testifying at Monday's Senate hearing.

Spitzer, in the AP interview, said he has no doubt the SEC "wants to play the appropriate role here in ensuring the integrity of the mutual fund industry. That doesn't mean we'll agree on everything, but I'm quite sure that they now believe that there are some significant structural problems that need to be fixed."

SEC Chairman William 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.

In testimony prepared for Monday's hearing, Spitzer also said board chairmen of mutual fund companies should be wholly independent from the management companies that run the funds.


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