The Good, Bad and Criminal Among Mutual Funds

I left the SEC's Division of Investment Management and started Fund Democracy in January 2000 in order to fill that void. Fund Democracy's members are large organizations such as the AFL-CIO, the Consumer Federation of America and the Financial Planning Association. Its purpose is to provide those organizations with a specialized expertise needed to effectively lobby the SEC on certain mutual fund regulatory issues.

Mutual fund law is an esoteric area, and it's too complicated to expect consumer and employee groups, let alone individuals, to understand the inner workings of most mutual fund rules.

2. The fund industry, until quite recently, has had a fairly pristine reputation. Do you think it deserves that reputation?

Yes. The fund industry's relatively scandal free reputation is deserved. Most of the credit, however, goes to the regulatory scheme under which it operates and the effectiveness of the Securities and Exchange Commission in enforcing the regulations.

3. Has the SEC done enough to police the mutual fund industry?

In light of Spitzer's complaint, it's easy to point out lapses in the SEC's enforcement program. But on the whole, the SEC deserves most of the credit for the growth of the industry and its relatively scandal-free reputation.

Criticism of the SEC's handling of stale pricing and late trading shouldn't distort the bigger picture, which is that the SEC continues to be our most effective federal agency. I'm proud to be an SEC alumnus.

4. Is the unfolding scandal over abusive market-timing and illegal late trading of funds the tip of the iceberg, or is this the work of a few bad apples?

With seven or eight major firms already implicated, we're pretty well into the iceberg. But the real question is when will the other regulatory shoe drop with Spitzer's and the SEC's final responses to these frauds. The question regarding Spitzer is: What kind of settlement will he reach with the fund managers? The question for the SEC is: What new regulations and guidance will it issue in the wake of this scandal?

5. Have the boards of directors at mutual fund companies done enough to protect investors?

What's really most disheartening about this is the continued irrelevance of fund directors. The Spitzer allegations evidence an inexcusable lapse by directors. It is Compliance 101 that fund directors must take steps to ensure fund managers are updating their prices and not cheating their own funds' shareholders. Directors should be making spot checks to ensure that fund managers are complying with the law, which includes investors' receiving the commission breakpoints they are entitled to, pricing the fund accurately, and preventing buying fund shares after the 4:00 deadline.

Part of the problem with directors is that there's a strong reluctance on the part of judges and regulators to hold directors personally responsible. That has got to change -- and this applies across Corporate America, not just with mutual fund companies.

Thirty years ago, it was clear that directors had to make specific inquiries to management and follow up to ensure that the firm was in compliance -- that's no longer the case. And fund directors are merely living down to the lowered expectations we've set for them.

6. What will spur a change?

Some heads have to roll. In particular, you need to the SEC to tack some director hides to the wall. And I think the SEC is going to tack some hides to the wall. The first may be some of the independent directors of the Heartland funds. Now going on three years after causing a 70%, one-day, mispricing loss to investors, the board is still almost unchanged.

7. What other questionable fund activities do you think will be unearthed as the fund industry comes under greater scrutiny?

The big issue is really fee disclosure. Going forward, it's vital that the SEC or Congress improve the transparency of the costs of owning funds. Toward that end, two parts of the Baker bill would have an impact that would make Spitzer's allegation look like minor irritations.

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