US Regulatory Brief: House passes bill to deter mutual fund abuse

Along with making it more difficult to engage in market timing and late trading in the USD 7 trillion mutual funds industry, the bill mandates an audit trail and strict monitoring of brokers and other intermediaries who might engage in late trading, the illegal practice of getting the current day’s price on orders to buy or sell shares placed after the close of New York markets.

In addition, the bill aims to ban insider trading in mutual funds and prohibits the same manager from running a hedge fund and mutual fund. Mutual funds would have to hire a chief compliance officer who would report directly to independent directors.

Those provisions were added to the original House version of the bill introduced by Rep. Richard Baker (R., La.), which also calls for providing investors more information on fees, strengthening director oversight of brokerage fee arrangements and mandating that two-thirds of board members be independent directors.

Wide bipartisan passage of the bill, by a vote of 418-2, puts pressure on the Senate to consider similar changes to address the mutual fund scandal. Not enough time remains in this year’s session to complete legislative action, but the Senate Banking Committee will hold a series of hearings in advance of members introducing a mutual fund bill early next year.

Rep. Michael Oxley (R., Ohio), chairman of the Financial Services Committee, said: "We are not talking about the actions of a few ‘boiler room’ operations. We are talking about pervasive financial fraud by all segments of the fund industry, including the most trusted companies."

To discourage market timing, the bill allows, but doesn’t require, funds to charge more than the 2 per cent fee currently permitted for shareholders to redeem holdings.

The measure directs the Securities and Exchange Commission to issue clearer rules to encourage fair-value pricing of mutual fund assets, which eliminates lagging prices that can make rapid-fire market timing trading profitable.

Following lobbying by the mutual fund industry, an earlier provision that would have required mutual fund chairmen to be independent has been dropped from the bill. The industry successfully argued that fund chairmen, most of whom also hold the chief executive job, should have expertise and intimate knowledge of fund operations, although this has not demonstrably prevented the recent spate of market timing and late trading abuses.

copyright hedgeweek 2003