The Securities and Exchange Commission will issue rules next month to curb trading abuses in the mutual fund industry that favor large institutional investors over individual shareholders, Chairman William H. Donaldson said yesterday.
Donaldson said the rules stem from evidence found so far in an investigation of the industry that the SEC began in September, after New York state Attorney General Eliot L. Spitzer discovered problems and made them public.
SEC sources said that the agency does not yet know how widespread the abuses are but that preliminary evidence suggests they are common enough to warrant the new rules. Mutual fund managers have argued against the need for more regulation and greater disclosure on the grounds that the industry has never had a major scandal.
One abuse is known as late trading. It involves giving hedge funds -- largely unregulated pools of money catering to wealthy investors -- or other large traders close-of-market prices on mutual fund shares even when they place trade orders after -- sometimes several hours after -- the 4 p.m. close of stock exchanges. After-hours orders are supposed to be executed at the next day's opening-of-market price -- and are for individuals who want to buy or sell mutual fund shares.
The practice is illegal because, for example, companies and government regulators often wait until markets close to disclose bad news that could affect the prices of stocks held by mutual funds, and as a consequence, the prices of the fund shares. At such times trades in fund shares executed the next day will be at lower prices those traded at the previous day's closing prices.
Another abuse involves buying and selling based on small, temporary differences in price for shares in the same mutual fund, a practice known as market timing. Though not illegal on its face, the practice does run afoul of the law when fund managers allow large customers to engage in it but not smaller shareholders. The problem is compounded if a money manager's mutual fund has a written policy against market-timing trading.
"Recent allegations regarding the sale of mutual fund shares point to abuses in connection with late trading and market timing of fund shares," Donaldson said in a prepared statement. "Our staff is aggressively investigating these allegations and is committed to holding those responsible for violating the federal securities laws accountable and seeking restitution for mutual fund investors that have been harmed by these abuses.
"It is clear from information developed thus far that there are additional regulatory actions that the Commission should consider in seeking to eliminate or significantly curb late trading and market timing abuses in the future," Donaldson said.
Once the proposed rules are made public, the SEC will seek comment before making them final. Donaldson said more proposals will be made if investigators find more abuses.
The Justice Department and several states have joined the SEC and Spitzer in investigating mutual fund managers. Mutual funds, which are investor-owned pools of stocks or bonds or both, are how most middle-class people participate in the stock market. Nearly 95 million households own shares.
Five fund companies and three brokerage firms have been accused of trading abuses in court documents or have disciplined employees for such arrangements, and regulators expect more cases.
The Investment Company Institute, the lobby for mutual fund companies, said it supports Donaldson's actions but cautioned that new rules alone cannot ensure investor protection.
Donaldson said the rules stem from evidence found so far in an investigation of the industry that the SEC began in September, after New York state Attorney General Eliot L. Spitzer discovered problems and made them public.
SEC sources said that the agency does not yet know how widespread the abuses are but that preliminary evidence suggests they are common enough to warrant the new rules. Mutual fund managers have argued against the need for more regulation and greater disclosure on the grounds that the industry has never had a major scandal.
One abuse is known as late trading. It involves giving hedge funds -- largely unregulated pools of money catering to wealthy investors -- or other large traders close-of-market prices on mutual fund shares even when they place trade orders after -- sometimes several hours after -- the 4 p.m. close of stock exchanges. After-hours orders are supposed to be executed at the next day's opening-of-market price -- and are for individuals who want to buy or sell mutual fund shares.
The practice is illegal because, for example, companies and government regulators often wait until markets close to disclose bad news that could affect the prices of stocks held by mutual funds, and as a consequence, the prices of the fund shares. At such times trades in fund shares executed the next day will be at lower prices those traded at the previous day's closing prices.
Another abuse involves buying and selling based on small, temporary differences in price for shares in the same mutual fund, a practice known as market timing. Though not illegal on its face, the practice does run afoul of the law when fund managers allow large customers to engage in it but not smaller shareholders. The problem is compounded if a money manager's mutual fund has a written policy against market-timing trading.
"Recent allegations regarding the sale of mutual fund shares point to abuses in connection with late trading and market timing of fund shares," Donaldson said in a prepared statement. "Our staff is aggressively investigating these allegations and is committed to holding those responsible for violating the federal securities laws accountable and seeking restitution for mutual fund investors that have been harmed by these abuses.
"It is clear from information developed thus far that there are additional regulatory actions that the Commission should consider in seeking to eliminate or significantly curb late trading and market timing abuses in the future," Donaldson said.
Once the proposed rules are made public, the SEC will seek comment before making them final. Donaldson said more proposals will be made if investigators find more abuses.
The Justice Department and several states have joined the SEC and Spitzer in investigating mutual fund managers. Mutual funds, which are investor-owned pools of stocks or bonds or both, are how most middle-class people participate in the stock market. Nearly 95 million households own shares.
Five fund companies and three brokerage firms have been accused of trading abuses in court documents or have disciplined employees for such arrangements, and regulators expect more cases.
The Investment Company Institute, the lobby for mutual fund companies, said it supports Donaldson's actions but cautioned that new rules alone cannot ensure investor protection.
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