Fund testimony tells of after-hours trades

By Chris Mondics
Knight Ridder News Service

WASHINGTON — Nearly a fourth of the biggest brokerage houses taking part in a recent survey allowed the illegal practice of after-hours trading, a top Securities and Exchange Commission official said in Senate testimony yesterday.

The testimony of Stephen M. Cutler, director of enforcement for the SEC, added new heft to widening allegations of improprieties in the mutual fund industry, once thought to have been a haven from the corporate scandals that have plagued American business and drained investor bank accounts.

Cutler said the SEC surveyed the brokerage firms as part of its expanding probe into how mutual funds distribute profits, pay their managers and determine what fees to charge investors.

Cutler said the SEC would seek to punish fund managers engaged in illegal practices.

"We will aggressively pursue those who have violated the law and injured investors," Cutler said.

His comments came amid other developments in the rapidly unfolding scandal over how mutual funds are managed:

• Juan Marcelino, head of the SEC's Boston office, stepped down after disclosures that his office did not respond quickly enough to information of improprieties at Putnam Investments, a huge mutual fund company.
• Putnam's chief executive, Lawrence Lasser, lost his job after an SEC lawsuit alleging improper trading by two of its executives. The decision to replace Lasser came less than a week after federal and Massachusetts regulators accused Putnam of turning a blind eye to short-term trading practices by some fund managers that violated company policy and penalized long-term shareholders. The disclosure prompted pension funds to pull more than $4 billion out of the firm's funds. Putnam lists $272 billion in assets under management.
• Richard Strong resigned Sunday as chairman of Strong Mutual Funds. Strong's company had acknowledged last week that he engaged in short-term trading in company funds and said he would reimburse investors for any losses they suffered as a result. Authorities have estimated the transactions yielded as much as $600,000. Strong remains chairman and CEO of Strong Capital Management, the adviser to the Strong Mutual Funds.

New York Attorney General Eliot Spitzer, whose office has mounted its own investigation, joined Cutler in testifying before the Senate subcommittee on financial management, the budget and international security, along with representatives of the securities industry.

Spitzer, whose office was the first to bring attention to mutual fund mismanagement, said the industry has many of the same problems — lack of oversight by boards of directors and conflicts of interest — that plagued firms such as Enron Corp. and WorldCom Inc.

His office has issued a flurry of subpoenas to mutual funds, including the Vanguard Group of Malvern, Pa., and Lincoln Financial of Philadelphia.

Spitzer said that many of the chairmen of mutual fund boards often are affiliated with the companies that are hired to run the funds, giving boards little incentive to pressure these management firms to reduce fees.

"We have opened up a window on a morass of conflicts," Spitzer said.

Outside the hearing room, Spitzer said the cost to investors of conflicts of interest and other improprieties probably amounted to hundreds of billions of dollars a year.

The Senate witnesses said no single violation of the law or ethics rules was to blame for problems in the industry. But two practices, market timing and late trading, came in for especially harsh criticism.

John C. Bogle, the founder and former chief executive officer of Vanguard, also testified, sharply criticizing conflicts of interest and failures by funds to completely disclose the fees that they charge their investors.

"These conflicts are severe and unacceptable," said Bogle, who no longer has any management role at Vanguard. "They can only be resolved by implementing reforms ... that put the shareholders in the driver's seat."

The issue has gathered momentum because mutual fund ownership is so widespread — about 95 million Americans own shares in mutual funds, using these funds as an entrée into the stock market.

Unlike the corporate scandals that took place last year and in 2001, there has been no hint that alleged ethical improprieties have threatened the funds' financial stability, at least not yet. But critics charge that the mutual funds' reputation for putting the interests of their investors first is undeserved.

The SEC survey found that a fourth of the 34 major brokerage firms that it surveyed had permitted after-hours trading, which is illegal.

A similar survey of 88 mutual funds by the SEC found that late trading may have occurred in as many as 10 percent of the firms surveyed, although the practice was prohibited. It also found widespread market timing among mutual funds.

The Associated Press contributed portions of this report on Putnam Investments.