Archive for Monday, November 3, 2003

SEC to report illegal mutual fund trading

November 3, 2003


— 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 today, 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 might have been victimized because almost 30 percent of the brokers helped clients circumvent company rules against the practice.

The hearing today will represent Congress's first crack at the 2-month old mutual fund scandal. SEC enforcement director Stephen Cutler is to present the survey results in testimony today before the subcommittee. New York Atty. Gen. Eliot 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 the improper trading occurred. Such a penalty could run into the billions of dollars.

Spitzer's Sept. 3 civil complaint alleging that four major fund companies had cut secret deals with a New Jersey hedge fund has 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 the 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 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.

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