Mutual fund cleanup: Washington's surprisingly slow-motion efforts at reform

International Economy, The, Wntr, 2004 by Roger M. Kubarych

It is clear in each of the cases under investigation that board members had not been informed of the shady activities of either market timers or the fund managers' efforts to facilitate their questionable activities. It would be interesting whether any of the independent directors ever bothered to ask about the danger of returns to retail shareholders being diluted by such activities. And since there are no examinations or other tests of the ability of independent directors to fulfill their obligations, it is impossible to know how many are truly qualified.

PREVENTING FUTURE ABUSES

It has by now become a cliche for industry apologists to say that you cannot legislate morality. But you can put in place mechanisms to detect law-breaking or behavior proscribed by a fund's own prospectus and take steps to end it. These regulatory measures should include:

* Compel all mutual funds to introduce stiff redemption fees, rather than merely allowing larger fees to be applied (as would be authorized under the Oxley bill).

* Bar round-tripping altogether by banning in-and-out trades within a day or a week.

* Bar large investments in mutual funds. If a fund complex wished to set up a separate "clone" fund for institutional investors, that should be possible (that's the way it's done in the United Kingdom, for instance). But investments above, say, $1 million have no place in a fund meant for the little guy.

* Get rid of the 4:00 p.m. fixing and mandate fair market value pricing on a continuous basis wherever implementation is practical.

* Support the SEC's hard 4:00 p.m. time limit for transactions, even for the bundling of 401(k)-type actions which at present are allowed to be effected after 4:00 p.m. if the retirement plan participant had initiated the request for the transaction before 4:00 p.m.

* Beef up the SEC's examiners for investment companies. There are well over ten thousand bank examiners in the country to oversee the banking system. The mutual fund industry has just about the same amount of assets, but there are something like 350 examiners to do the same kind of work. That is not enough.

* Outside the 401(k) market, an estimated 80 percent of mutual funds are sold through brokers. Make the brokers liable for damages for selling any mutual funds that they know are involved in corrupt practices.

Regulatory improvement would be worthwhile, but for there to be fundamental change, the corporate governance of mutual funds has to be radically redesigned. One way would be to eliminate mutual fund boards. The fund management companies would then become the sole entity with which the individual shareholder must contend. To make sure the shareholder is not abused by the inherent conflicts of interest, there would be two alternatives. Either the fund company would put the funds under the supervision of a Master Trustee, who would be charged with overseeing the operations, fees, and practices solely on behalf of the shareholders and could demand changes. Or the fund could pay a fee and ask the SEC to perform that function.