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Mutual Funds Face New SEC Rule

Starting in December, fund firms must disclose how they will deter market-timing abuses.

April 14, 2004|Jonathan Peterson | Times Staff Writer

WASHINGTON — Federal securities regulators Tuesday ordered mutual fund companies to clearly spell out their policies on in-and-out trading strategies that have figured at the center of scandals in their industry.

The 5-0 vote by the Securities and Exchange Commission was aimed at various trading practices that fall under the header of market timing. The action was among the agency's first rule changes in response to revelations of trading abuses that have shaken public faith in the $7-trillion fund industry.

SEC Chairman William H. Donaldson called Tuesday's vote "a major step forward" in the SEC's effort to ensure integrity among funds and rebuild public confidence in the industry.

In the past, "Murky language and vague phrasing were used to cloak special deals and special treatment for large and influential investors," he said.

Since last year, more than 20 fund companies and other financial services firms have been investigated by state and federal regulators for fund market-timing abuses.

In some cases, fund firms allowed favored investors to engage in rapid-fire trades even though the firms forbade ordinary investors from using such strategies. In other cases, fund employees, including portfolio managers, made such trades for their own accounts, trying to capitalize on short-term market swings.

Market timing with fund shares isn't necessarily illegal, but it can saddle long-term shareholders with added costs -- depressing their fund returns -- while benefiting a favored few.

Under the rule approved Tuesday, fund companies will have to lay out in sales materials what risks shareholders might face from market-timing practices. The companies also will have to explain in fund prospectuses whether a fund board has policies governing market-timing trades -- and if not, why not.

Funds also will have to tell shareholders what procedures may be in place to deter timers.

The rules on disclosure are set to take effect Dec. 5.

The new requirements are part of a push to "promote a culture of integrity, responsibility and accountability in the fund industry," said Paul F. Roye, director of the SEC division that oversees mutual funds.

The SEC was widely criticized last fall when New York Atty. Gen. Eliot Spitzer announced the first public investigation into trading abuses in the fund industry, which had previously enjoyed a relatively clean reputation. Since then, the SEC has sped up enforcement actions and rule making efforts.

On Feb. 11, the SEC approved a new requirement that funds enhance their disclosure of the fees they charge investors -- responding to increasing complaints on Capitol Hill that obscure fees have the effect of skimming significant amounts of money away from shareholders over time.

The SEC also is considering rules to ban special fund sales-incentive payments to brokers, bolster requirements against so-called after-hours trading of fund shares, and mandate that the chairmen of fund boards be independent.

According to an SEC survey, almost 7 in 10 fund companies were aware of market-timing strategies by some of their customers, and some of the firms actively helped traders engage in the practice.

When the new rule on market-timing policy disclosures was first proposed late last year, some fund companies warned that one suggested requirement -- that fund companies explain how they would detect market timing -- could provide would-be timers with useful intelligence on how to pursue their activities without getting caught.

SEC commissioners sought to address those concerns Tuesday by limiting the disclosure to information on how fund firms would "deter" such activities.

The Investment Company Institute, the funds' chief trade group, said Tuesday that it supported the SEC's new disclosure rules.

"The SEC's action will provide investors with additional information on an individual fund's policies and procedures to protect the interests of long-term investors," the group said.

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