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Officials Planning Mutual-Fund Reforms

Nov 2, 2003 | 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 traditionally has 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.

Companies must be forced to pay back to investors the hefty fees received for managing mutual funds during the time they allowed fund trading abuses to occur, Spitzer said Sunday.

"If they're expecting to get settlements (with regulators) they're going to have to give much more back than just (investors') losses. They're going to be paying stiff fines and giving back their management fees. They violated their trust with the American investor," the attorney general told The Associated Press in an interview.

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

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. He 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.

A spokesman for Spitzer called Strong's resignation from the board alone an "inadequate" step. He remains as chairman and CEO of Strong Capital Management, the company he founded that is responsible for the day-to-day management of the 66 funds with some $42 billion in assets.

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.

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.

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.

"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 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 Senate hearing, Spitzer says chairmen of fund company boards should be wholly independent from the management companies that run the mutual funds. He also was urging that, besides repayment of management fees, fund companies be compelled to make restitution to their shareholders of profits made from alleged improper trading

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