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SEC to Curb Mutual Fund Abuses

Dec 3, 2003 | AP

Federal regulators are moving to stanch a tide of trading abuses in mutual funds with new curbs on after-hours trading which brings profits to a favored few fund investors.

As the mutual fund scandal widens, the Securities and Exchange Commission was tentatively adopting on Wednesday new trading rules to prevent future abuses in a planned overhaul of how the $7 trillion fund industry operates.

To stem illegal late trading, the SEC moved toward imposing 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 chance buying 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 proposals could be formally adopted by the five-member SEC after the commission gathers public comment for several weeks. They are meant "to provide immediate reassurances and protection to mutual fund investors," SEC Chairman William Donaldson said in Senate testimony last month.

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.

Some 95 million Americans half of all households invest in mutual funds. For many, they are the principal vehicle for retirement savings and college funds. Before the scandal erupted in early September, they generally were regarded as safe investments.

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.

The lawmakers and regulators are acting as problems spread through the mutual fund and brokerage industries, more big-name companies are cited for allowing special trading deals that disadvantage ordinary investors and a money stampede continues out of implicated funds.

In the latest enforcement, the SEC and New York Attorney General Eliot 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.

Also to curb late trading, the SEC is weighing new rules requiring mutual fund companies to clearly disclose their market-timing policies and procedures in sales material. Market timing, which capitalizes on short-term movements in stock prices with quick "in and out" trading of shares, is not illegal but violates the rules of most fund companies.

In addition, the agency is considering imposing a redemption fee on short-term transactions to discourage market timing.

The newly passed House bill goes further, prohibiting market-timing trades by mutual fund insiders.

Early next year, the SEC will consider a requirement that board chairmen of fund companies be wholly independent from the companies managing the funds. It also will could consider requiring that three-quarters of the directors sitting on a fund company board be independent, up from the currently required 50 percent.


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