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SEC: Fund Fraud Is Widespread

Nov 3, 2003 | Fraudulent trading in mutual funds is far more widespread than previously thought, with one in four of the nation's largest broker-dealers engaging in illegal late trading of funds, federal securities regulators said Monday as Congress opened a series of hearings into fund-industry abuses.

The SEC based its findings on the results of a preliminary survey of the broker-dealers and the nation's 88 largest mutual fund companies. The probe was prompted by an investigation by New York Attorney General Eliot Spitzer's office earlier this year.

The fund companies surveyed manage 90 percent of the industry's assets. Ten percent submitted e-mails showing that they may have allowed trades to be placed after the 4 p.m. market close.

In addition, half of the funds let certain shareholders engage in short-term "market-timing" trades that are supposedly banned by the funds and are not available to retail investors, the SEC said.

Many of those favored shareholders have proposed investing in one of the fund companies' other funds in order to get preferential short-term trading treatment.

"We are aggressively following up on these arrangements," SEC Enforcement chief Stephen Cutler told a Senate panel in prepared testimony.

Cutler added that funds and fund managers that engaged in illegal late trading, market timing, or self-dealing "will be identified and will be held fully accountable."

In addition, the SEC said that more than 30 percent of the funds admitted that their managers gave sensitive portfolio information to favored shareholders.

The SEC also has multiple investigations under way into fund sales practices, including revenue sharing arrangements between fund companies and brokers.

On Monday, the Senate Subcommittee on Financial Management launched a hearing into fund abuses. The House Subcommittee on Capital Markets is holding hearings Tuesday and Thursday.

New York Attorney General Eliot Spitzer, who first unveiled fund abuses two months ago, is testifying at both hearings.

In remarks Monday, he said too many funds have permitted and fostered an environment that promotes the interests of their managers at the expense of their shareholders. He called it "grotesque arrogance."

Spitzer chastised fund boards for failing investors and criticized conflicts of interests at the board level that have generated higher fees.

"The governing structure we have has failed," Spitzer said.

He recommended that chairman of fund boards should have no ties to the advisory and management company. He also suggested that fund companies should be required to demonstrate they negotiated fees for services in the best interest of shareholders.

The unfolding fund scandal has claimed many big industry names.

Putnam Investments CEO Lawrence Lasser resigned Monday after his company was charged with wrongdoing. See full story. On Sunday, Richard Strong resigned as chairman of Strong Mutual Funds after a probe showed that he had broken trading rules to benefit his own personal account.

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