Survey Discloses After-Hours Deals
A quarter of the nation's largest brokerage houses helped clients trade mutual funds after hours, a practice that is illegal, a Securities and Exchange Commission survey has found.
The survey, to be disclosed at a Senate governmental affairs subcommittee hearing Monday, found that after-hours trading and other abuses were widespread in the $7 trillion mutual fund industry, shortchanging a majority of fund customers. Half of the 88 largest mutual fund companies had arrangements that allowed select customers to use a trading technique known as "market timing," a legal short-term trading strategy that exploits the fact that mutual fund prices are set once a day but stock prices change continually.
Most funds say they discourage these quick in-and-out trades by imposing high fees, but the survey found that some companies cut special deals with wealthy investors that may have violated disclosure rules.
Preliminary data also suggest that employees at 10 percent of the fund companies knew some customers were violating the rules against "late trading." And even fund companies that did not allow market timing may have been victimized because almost 30 percent of the brokers helped clients circumvent company rules against the practice.
The hearing Monday represents Congress's first crack at the two-month-old mutual fund scandal. SEC enforcement director Stephen M. Cutler is to present the survey results in testimony before the subcommittee. New York Attorney General Eliot L. Spitzer, who also is to appear before the subcommittee, said in an interview Sunday that he plans to use the occasion to call for major penalties to be imposed on the industry.
Spitzer, who launched the first mutual fund trading case in early September, said every mutual fund company that allowed improper trading should be forced to give back the management fees it received for the period when such trading occurred. Such a penalty could run into the billions of dollars.
"It's going to be big dollars and it should be big dollars," Spitzer said. "If you are being paid to act in the interest of investors and you violate that trust, you shouldn't be paid. We need to revitalize the governance of this industry so that the interest of the investor is paramount."
Spitzer's Sept. 3 civil complaint alleging that four major fund companies had cut secret deals with a New Jersey hedge fund has now sparked six state, federal and industry probes focused on late trading and market timing. The SEC then demanded information about both practices from the nation's 34 largest securities dealers and 88 largest fund companies, which manage $5.7 trillion of the industry's $7 trillion in assets.
The SEC launched its comprehensive survey in September and found that late trading was surprisingly common. A 1968 law requires fund customers who place orders after 4 p.m. to get the next day's price, but the SEC found that seven large brokerage houses out of 34 had allowed customers to place or cancel orders after that deadline, allowing them to illegally exploit news announced after the New York stock markets closed.
The NASD, an industry regulatory group, is surveying smaller brokers to see if similar problems occurred in their sector, and its enforcers have already opened 30 cases connected to either late trading or market timing, sources said.
In the SEC survey, about 70 percent of the brokers said they were aware that some of their customers were timing the market and 30 percent said their employees had helped clients carry out that task. Most mutual fund companies say they discourage market timing because of its costs to ordinary investors, who would otherwise get the profits that traders take.
The SEC also found that one-third of fund companies shared detailed information about their fund portfolios with favored customers. That selective disclosure may be illegal and certainly made it easier to engage in market timing and other improper trading.
Sen. Peter Fitzgerald (R-Ill.), who is to chair the hearing on Capitol Hill, "believes the results are troubling and they underscore the urgent need for significant reforms in the mutual fund industry," Fitzgerald's spokesman Dan Curry said.
A spokesman for the Investment Company Institute, the main mutual fund trade group, said Sunday he had not seen the survey results and could not comment.
But the Investment Company Institute had a harsh reaction to Spitzer's proposal for docking management fees. Those "fees are a mutual fund company's revenues, not its profits. . . . [That's] the money that pays lawyers and compliance officials and the staff. We thought the New York attorney general wanted to strengthen mutual funds, not cripple them," a spokesman said.
The institute's president, Matthew P. Fink, yesterday called for a firm 4 p.m. deadline for all mutual trades to be reported to fund firms and a mandatory 2 percent fee on nearly all fund sales for a minimum of five days after purchases. In the current scandal, some brokers filed late orders and falsely claimed the orders were placed before 4 p.m.
Paul Roye, director of the SEC's division of Investment Management, said he could not comment on the survey or other enforcement activities. He said, however, that the commission is ready to make major changes in fund governance if that proves to be the best solution. The SEC already has come out in favor of having 66 percent, rather than half, of all directors be independent and would be open to the idea of requiring the board chairman to be independent, Roye said in an interview. "Nothing is off the table. We want a framework that doesn't allow these abuses to go on," he said.
A quarter of the nation's largest brokerage houses helped clients trade mutual funds after hours, a practice that is illegal, a Securities and Exchange Commission survey has found.
The survey, to be disclosed at a Senate governmental affairs subcommittee hearing Monday, found that after-hours trading and other abuses were widespread in the $7 trillion mutual fund industry, shortchanging a majority of fund customers. Half of the 88 largest mutual fund companies had arrangements that allowed select customers to use a trading technique known as "market timing," a legal short-term trading strategy that exploits the fact that mutual fund prices are set once a day but stock prices change continually.
Most funds say they discourage these quick in-and-out trades by imposing high fees, but the survey found that some companies cut special deals with wealthy investors that may have violated disclosure rules.
Preliminary data also suggest that employees at 10 percent of the fund companies knew some customers were violating the rules against "late trading." And even fund companies that did not allow market timing may have been victimized because almost 30 percent of the brokers helped clients circumvent company rules against the practice.
The hearing Monday represents Congress's first crack at the two-month-old mutual fund scandal. SEC enforcement director Stephen M. Cutler is to present the survey results in testimony before the subcommittee. New York Attorney General Eliot L. Spitzer, who also is to appear before the subcommittee, said in an interview Sunday that he plans to use the occasion to call for major penalties to be imposed on the industry.
Spitzer, who launched the first mutual fund trading case in early September, said every mutual fund company that allowed improper trading should be forced to give back the management fees it received for the period when such trading occurred. Such a penalty could run into the billions of dollars.
"It's going to be big dollars and it should be big dollars," Spitzer said. "If you are being paid to act in the interest of investors and you violate that trust, you shouldn't be paid. We need to revitalize the governance of this industry so that the interest of the investor is paramount."
Spitzer's Sept. 3 civil complaint alleging that four major fund companies had cut secret deals with a New Jersey hedge fund has now sparked six state, federal and industry probes focused on late trading and market timing. The SEC then demanded information about both practices from the nation's 34 largest securities dealers and 88 largest fund companies, which manage $5.7 trillion of the industry's $7 trillion in assets.
The SEC launched its comprehensive survey in September and found that late trading was surprisingly common. A 1968 law requires fund customers who place orders after 4 p.m. to get the next day's price, but the SEC found that seven large brokerage houses out of 34 had allowed customers to place or cancel orders after that deadline, allowing them to illegally exploit news announced after the New York stock markets closed.
The NASD, an industry regulatory group, is surveying smaller brokers to see if similar problems occurred in their sector, and its enforcers have already opened 30 cases connected to either late trading or market timing, sources said.
In the SEC survey, about 70 percent of the brokers said they were aware that some of their customers were timing the market and 30 percent said their employees had helped clients carry out that task. Most mutual fund companies say they discourage market timing because of its costs to ordinary investors, who would otherwise get the profits that traders take.
The SEC also found that one-third of fund companies shared detailed information about their fund portfolios with favored customers. That selective disclosure may be illegal and certainly made it easier to engage in market timing and other improper trading.
Sen. Peter Fitzgerald (R-Ill.), who is to chair the hearing on Capitol Hill, "believes the results are troubling and they underscore the urgent need for significant reforms in the mutual fund industry," Fitzgerald's spokesman Dan Curry said.
A spokesman for the Investment Company Institute, the main mutual fund trade group, said Sunday he had not seen the survey results and could not comment.
But the Investment Company Institute had a harsh reaction to Spitzer's proposal for docking management fees. Those "fees are a mutual fund company's revenues, not its profits. . . . [That's] the money that pays lawyers and compliance officials and the staff. We thought the New York attorney general wanted to strengthen mutual funds, not cripple them," a spokesman said.
The institute's president, Matthew P. Fink, yesterday called for a firm 4 p.m. deadline for all mutual trades to be reported to fund firms and a mandatory 2 percent fee on nearly all fund sales for a minimum of five days after purchases. In the current scandal, some brokers filed late orders and falsely claimed the orders were placed before 4 p.m.
Paul Roye, director of the SEC's division of Investment Management, said he could not comment on the survey or other enforcement activities. He said, however, that the commission is ready to make major changes in fund governance if that proves to be the best solution. The SEC already has come out in favor of having 66 percent, rather than half, of all directors be independent and would be open to the idea of requiring the board chairman to be independent, Roye said in an interview. "Nothing is off the table. We want a framework that doesn't allow these abuses to go on," he said.
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