Public wants action on scandal

By Marcy Gordon
Associated Press

WASHINGTON — Public outrage is building over the mutual fund scandal, and investors in implicated funds are voting massively with their feet: some $10 billion was yanked out of funds of one big-name company alone in the weeks since regulators filed civil fraud charges alleging trading abuses there.

Skeptics point to a Congress awash in campaign donations from the well-heeled mutual fund and brokerage industries, and an SEC widely criticized as slow to respond to abuses at Wall Street investment firms and in fund trading.

It was New York Attorney General Eliot Spitzer who first raised the charge in September that preferential trading deals for big-money customers of many mutual fund companies could be siphoning billions of dollars from ordinary investors.

As the scandal widened, it took on more damaging dimensions. Regulators' allegations that someone as highly placed as Richard Strong, founder of the Strong mutual fund family, was involved came as shocking news. And at Putnam Investments, the nation's fifth-largest mutual fund company, two international fund managers allegedly reaped hundreds of thousands of dollars each with excessive short-term trades in Putnam funds they managed.

Furious investors withdrew $10 billion or so from Putnam funds, but many aren't likely to be satisfied until Washington makes major reforms in rules governing mutual funds

"I think there is a strong likelihood that we will get fairly significant reforms (from the SEC) targeted specifically at preventing" fund trading abuses, said Barbara Roper, director of investor protection for the Consumer Federation of America, a research and consumer advocacy group.

"What's less clear is whether we'll see serious proposals advanced to deal with the total failure of mutual fund boards of directors to fulfill their responsibilities to shareholders to oversee mutual fund operations."

Last year, as accounting scandals raged and investor confidence dropped along with the Dow average, Congress enacted the most sweeping changes in corporate responsibility since the Depression. Changes included new penalties for corporate fraud, new duties for company directors and auditors, and a new board to oversee the accounting industry.

Now, two immutable facts are giving impetus to mutual fund reform: Half of all U.S. households invest in mutual funds, and 2004 is an election year.

"I'm hopeful we can keep the spotlight on this issue," Sen. Peter Fitzgerald, R-Ill., said in a recent interview. "Delay only benefits the brokers and dealers who are on the gravy train" — a reference to the billions of dollars in fees collected annually by brokerage firms, which sell some 80 percent of all mutual fund shares.

Among the Democrats, Sens. Daniel Akaka of Hawai'i and Joseph Lieberman of Connecticut are putting forward similar legislation; Sens. Jon Corzine of New Jersey and Christopher Dodd of Connecticut last week announced their proposal to "clean up" the mutual fund industry.

Fitzgerald, who recently conducted a Senate hearing bristling with TV cameras, is proposing legislation that would require fund companies to disclose more information to investors and make company directors more independent from fund managers.

Fitzgerald is also considering a provision to abolish the term "mutual fund" as misleading to investors because they don't collectively own the fund companies — "mutual" refers to funds that allow large numbers of people to pool their money for investment in a wide range of securities.

Across the Capitol in the House, Rep. Richard Baker, R-La., is leading a push for mutual fund legislation in a similar bill, which is supported by Democrats.

But Sens. Richard Shelby, R-Ala., and Paul Sarbanes, D-Md., chairman and senior Democrat respectively of the Senate Banking Committee, which has jurisdiction over mutual fund issues, aren't rushing to legislate. They want to hear first from all interested parties, including the mutual fund and brokerage industries, and the panel has scheduled hearings for this coming week.

At the SEC, Chairman William Donaldson already has announced that the agency soon will consider new curbs to prevent illegal late trading — after-hours trades at prices closed to most fund shareholders — and to restrict market timing of mutual fund shares.

The new trading rules that emerge must be "strong and very tight," SEC Commissioner Harvey Goldschmid said in an interview. Beyond those rules, he said, the agency must do much more to address problems and conflicts that stem from the fund industry's structure.

The fund scandal represents "an egregious breach of trust and we've got to clean it up in a serious way," said Goldschmid.

Later, the SEC will work on more far-reaching changes in how mutual fund companies govern themselves. Donaldson has said that no reform, whether touching on the industry's structure, company governance or the makeup of boards of directors, is off limits.

Some critical SEC-watchers believe the agency could end up with a watered-down initiative amid pressure from the mutual fund industry and possibly resistant SEC commissioners.

"The SEC has recently been an impediment to improving fund governance," said Mercer Bullard, founder and president of Fund Democracy, an investors' advocacy group, who teaches securities law at the University of Mississippi. "The SEC has almost made itself irrelevant because of its ineffectiveness."