"I had no idea," the crusading New York attorney general said in a November speech.

"It'll last a week," Spitzer recalled thinking as the investigation of improper fund-trading schemes between hedge fund Canary Capital Partners and four large fund firms got under way in early summer.

Not quite. Four months after exposing what seemed to be isolated trading abuses, federal and state regulators are aggressively widening their scope in ways that should keep fund companies on the defensive — and the snowballing financial scandal in the spotlight — for quite some time.

Regulators are scrutinizing sales practices that not long ago were considered standard procedure in the fund business. Common tactics under fire include using fund assets to pay brokers and fund supermarkets for "shelf space," extra fees for investment research and advice, and "soft dollar" and revenue sharing arrangements that come directly from fund shareholders' returns.

Meanwhile, the Securities and Exchange Commission is floating proposals to combat the main infractions that have marred funds so far: The illegal fund trading after the market's 4 p.m. Eastern close and the rapid-fire "market-timing" trades that are the basis of numerous class-action shareholder lawsuits against fund companies.

The SEC also is attempting to exert greater influence over fund company operations. Among their priorities: Fair pricing of fund portfolios, strengthening of independent fund directors' powers, and making fees and sales commissions more transparent.

What Spitzer and the SEC don't get done, Congress likely will.

The House overwhelmingly approved a broad fund reform bill in November that parallels the regulatory initiatives. The measure would thwart trading abuses, tighten governance standards, and improve fee disclosure.

The Senate, which until recently has been less enthusiastic than the House about legislating the fund business, will have two reform bills on its slate when it reconvenes in January. These efforts take a harder bite than the House legislation, including the possibility of a controversial oversight board to supervise funds.

Trust shattered

The $40 million settlement that Spitzer made with Canary in September blew the lid off a dirty little secret of the fund industry: Fund executives and managers aren't morally superior to the rogues of corporate America. In truth, funds might be even more culpable, given the extraordinary trust — now shattered — that 95 million Americans have given them.

When accounting irregularities tainted Enron and other corporations, the fund industry was unsullied. When Wall Street was pilloried for pumping bullish stock research in exchange for lucrative investment-banking deals, fund leaders rode tall as self-proclaimed protectors of the small investor.

"We are serving shareholders well because the mutual fund industry has avoided the abusive practices that betrayed investors in other parts of the marketplace," Matthew Fink, president of the Investment Company Institute, the industry's lobbying group, boasted to an industry conference in March.

As it turns out, some fund companies did serve shareholders — well cooked. Now leaders of the $7 trillion fund industry are confronting its most serious fiduciary abuses in 70 years.

More than a dozen firms have been implicated in the elaborate, employee-orchestrated schemes that put corporate and personal interests above all else. Company founders and other high-profile executives have been ousted, while regulators press civil, and in some cases criminal, fraud charges.

Over the coming months, the fund scandal's sharpest focus could shift from prosecution of wrongdoing to prevention of it. The next chapters in the fund industry scandal likely will address fair pricing of fund portfolios and the true costs of fund ownership.

Funds are priced at "net asset value" as of the U.S. market close. But in certain portfolios, such as international stock funds, quoted prices at the end of the trading day in New York don't fully reflect the true value of the underlying positions. That's because Asian and European bourses are active when the U.S. market is closed. A trader can buy an international fund during a market-moving day on Wall Street and be reasonably confident that overseas markets will rally in sympathy hours later.

'Stale' prices an issue

This arbitrage of "stale" prices in international funds has become widely known as market timing. Similar inefficiencies are evident in high-yield bond funds.

"Where there is stale pricing, the frame has frozen. You're not getting the true picture," said Roy Weitz, publisher of watchdog fund site FundAlarm.com. "Predators pounce on the frozen price and take advantage of it. Fair pricing closes that window."

'Soft-dollar' impact cited

Regulators also are particularly focused on so-called soft dollar relationships, where fund firms pay brokerages higher commissions or give them increased trading business in exchange for a broad array of goods and services.

Such quid-pro-quo deals are supposed to cover products that benefit shareholders, primarily investment research and advice, but other items including subscriptions, professional development programs and computer software and equipment — such as a Bloomberg terminal — also are considered acceptable — and legal.

Using commission streams as currency instead of cash comes directly out of fund shareholders' pockets. Ted Aronson, a partner at Philadelphia money manager Aronson + Johnson + Ortiz, and a vocal critic of soft-dollar payments, said fund companies on average pay about a nickel a share in commissions on each trade.

By comparison, Aronson noted, "Our average is 1.8 cents."

But soft-dollar details aren't disclosed in a fund's expense ratio. The bill for commission costs is noted in the "statement of additional information," which not many investors read.

Fund firms do an estimated $10 billion a year in such transactions, said Harold Bradley, a senior vice president at American Century Investments, a Kansas City fund family.

"The focus everybody's got on market timing and late trading doesn't hold a candle to the economic impact of soft dollars," he said. "They're like jelly beans on the table, while the impact of soft dollar practices on investor returns is a mountain of gold."

In theory, soft dollars and related revenue-sharing programs with brokerages are designed to attract new money to a fund, spreading costs over a larger shareholder pool and lowering individual fees.

Regulators are concerned that such clubby deals in practice are more helpful to fund companies and brokerages. If a fund company uses its own money for the purchase, it's counted as an operating expense — reducing profits. But commission costs are considered research and charged to fund shareholders.

Preferential deals probed

Investigations also are peering into distribution arrangements where brokers receive incentives to push their own firm's funds or portfolios on a select list — namely, funds from companies that have paid the brokerage firm for such preferential treatment, or "shelf space." The question in these cases is whether fund companies dug into their own pockets or improperly used funds' commission streams to foot the bill.

In truth, the fund industry's problems aren't going away soon, but some welcome solutions appear close.

Regulatory and legislative efforts are sure to impose tighter compliance guidelines that will make firms more accountable, while the idea of an independent oversight body could gain traction.

Fund companies recognize their business is at a turning point.

For straight-laced money managers like Aronson, this is an era that should've ended long ago.

"Boy, did we love those profit margins," he said of his peers, with obvious irony.