Outrage Over Scandal Grows, But Reforms May Take Time

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Outrage Over Scandal Grows, But Reforms May Take Time

The Wall Street Journal

November 16, 2003

Public outrage is building over the mutual-fund scandal, and investors in implicated funds are voting with their feet: Some $10 billion was yanked from one big-name company after regulators filed fraud charges.

Underscoring the urgency of the situation, a special presidential advisory group met Friday to discuss the mutual-fund debacle and initiatives to overhaul the way the $7 trillion fund industry operates. The group, established in response to the stock-market collapse in 1987, includes Federal Reserve Chairman Alan Greenspan, Treasury Secretary John Snow and William Donaldson, chairman of the Securities and Exchange Commission.

Mr. Donaldson "is very focused on cracking down on wrongdoing," Mr. Snow said afterward, and he added that he was sure wrongdoers would be punished and investors would be protected.

Momentum is mounting for action by both Congress and the SEC. But the question is how swiftly and forcefully lawmakers and regulators will act to stiffen punishment and require changes in fund company operations.
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.

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.

The scandal widened. Regulators' allegations that someone as highly placed as Richard Strong, founder of the Strong mutual-fund family, was involved came as shocking news. At Putnam Investments, the nation's fifth-largest mutual-fund company, two international fund managers were alleged to have reaped hundreds of thousands of dollars each with excessive short-term trades in funds they managed.

Furious investors withdrew $10 billion or so from Putnam funds, and demands increased for 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, Congress enacted the most sweeping changes in corporate responsibility since the Depression, including new penalties for corporate fraud, new duties for company directors and auditors and a new board to oversee the accounting industry.

Now, two facts are giving impetus to further changes: 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% of all mutual-fund shares.

Among the Democrats, Sens. Daniel Akaka of Hawaii, Joe Lieberman of Connecticut and John Kerry of Massachusetts are putting forward similar legislation; Sens. Jon Corzine of New Jersey and Christopher Dodd of Connecticut on Thursday announced their proposal to "clean up" the mutual-fund industry.

Sen. 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.

He 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 similar legislation, 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 next week.

At the SEC, Mr. 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.

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

Later, the SEC will work on more far-reaching changes in how mutual-fund companies govern themselves. Mr. 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.
Experts disagree on whether some changes require legislation or should be made through SEC rules.

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."

Mr. Bullard cited the SEC's opposition last summer to the idea of requiring board chairmen of mutual-fund companies to be independent from the companies managing the funds.