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SEC Proposes Code for Investment Firms

Jan 14, 2004 | AP

Federal regulators responded to the mutual fund scandal with proposals Wednesday that would require ethics codes for fund-managing investment firms and would bolster the independence of fund board chairmen and directors.

At the same time, the Securities and Exchange Commission was widening its fund investigation by looking into several cases in which brokerage firms steered clients toward certain funds in exchange for payments inadequately disclosed from those fund companies.

As part of the proposals put out for public comment Wednesday, the agency would require that fund investors get more information about such arrangements, even before they buy funds.

The SEC's inspection of brokerage houses that sell mutual funds has uncovered widespread payments to the brokerages from the firms that manage funds, in return for favorable treatment of specific funds.

Agency officials say they are concerned that fund investors, who represent half of all U.S. households, are not being told about the potential conflicts of interest that such arrangements can bring. Investors can be hurt by that concealment, as well as by being directed into higher-cost or worse performing funds, the officials maintain.

Investors "deserve to know how much their broker stands to benefit from their purchase of a particular fund," the SEC chairman, William Donaldson, said at a public meeting.

The SEC has come under pressure to act from state regulators, especially New York Attorney General Eliot Spitzer. Spitzer, who began the investigation of mutual fund trading abuses in September, has criticized the federal agency. He and the SEC have quarreled over whether regulators should force mutual fund companies to cut excessive fees as part of legal settlements.

Donaldson told reporters that the cleanup of the $7 trillion fund industry cannot wait for Congress to act. The House passed overhaul legislation in November nearly unanimously; the Senate is expected to act on its own version of such proposals this year.

"We have got to move as swiftly as we can," Donaldson said.

Critics of the SEC under Donaldson continued to berate the agency for its actions regarding mutual fund abuses, saying that payments to brokers inciting them to push certain funds should be prohibited outright rather than just disclosed.

"The SEC needs to meet these unconscionable abuses head on," said Sen. Joseph Lieberman, D-Conn., a contender for the Democratic presidential nomination. "Requiring yet another disclosure that ordinary investors may not read or understand is no remedy. The most egregious conflicts of interest must be banned."

The agency's actions Wednesday, in a series of votes by the five SEC commissioners, built on its tentative approval last month of a rule imposing a cutoff of 4 p.m. Eastern time for pricing of fund shares to stem illegal after-hours trading. The proposals could become final after the SEC gathers public comment.

The SEC proposed the ethics codes for investment advisers, which would require employees of investment advisory firms to report their personal trading including in any mutual funds managed by their firms.

Investment advisers are required by law to protect the interests of their clients, the mutual funds they manage, in what is called a fiduciary relationship.

In one of the biggest mutual fund cases, investment adviser Alliance Capital Management last month agreed to a $600 million penalty to resolve regulators' allegations of improper fund trading and violating its fiduciary duty.

The SEC proposals also include requirements that board chairmen of fund companies be independent from the companies managing the funds, and that three-quarters of the directors on a fund company board also be independent, compared with half now.

The proposal for independent chairmen, which represents a change in the SEC's earlier position, is fiercely opposed by the mutual fund industry. At the meeting, one commissioner, Cynthia Glassman, suggested it could give investors "a false sense of confidence."

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