Mutual-Fund Managers Get Scrutiny
New SEC rules will require closer tabs on the personal trading managers do on the side
As Americans pour ever more money into mutual funds, the federal government wants to ensure that fund managers are subject to effective codes of ethics - and are abiding by them.Skip to next paragraph
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By late spring or early summer, the Securities and Exchange Commission (SEC) plans to tighten rules governing trading by mutual-fund managers in securities held in their own personal accounts.
The planned regulatory action is unusual because the SEC finds no major problems with the current rules governing personal trading or with their enforcement. And, although the industry supports the move, it has drawn fire from some mutual-fund workers, who worry about negative and perhaps unintended consequences (see related stories on this page).
But the move is not a question of doing the unnecessary, SEC officials say. Although acknowledging solid adherence to ethics in the mutual-fund industry, SEC officials say the changes are needed to preserve a high level of public trust in mutual funds.
Personal-trading rules discourage portfolio managers (individuals who control investments for thousands of customers) from using their insider status for selfish advantage, often to the detriment of customers.
One notorious abuse is called "front running," where a fund manager buys or sells stock for his or her own account immediately before buying or selling a large amount of that same stock for the mutual fund. The fund manager thereby may influence the stock price in his or her favor.
The key SEC rule changes are:
*Every fund will have to publicly disclose its code of ethics on personal trading by noting in its prospectus that such a code exists and by filing a copy with the SEC, thus making the document public. This is a return to a policy the SEC abandoned some years ago. Under the 1940 Investment Company Act, fund groups are already required to have detailed ethics codes, including on personal trading. The 1940 law prohibits fraudulent, deceptive, or manipulative acts by managers in personal stock trades.
*Each fund's board of directors must review each year the fund's code of ethics and compliance with it.
*Each fund must have a person responsible for reviewing the fund manager's reports on personal trading. Most funds already have such a person.
Mutual-fund company executives say solid ethics already pervade their industry, which they contend is more closely monitored than any other segment of the pooled-investment community.
Barry Barbash, head of the SEC's investment management division in Washington, agrees that the fund industry in fact has been essentially free of major scandal for a long time. He adds that the Investment Company Institute (ICI) in Washington, representing the fund industry, has been very active over the past two years in "developing and promoting better procedures in personal trading." The ICI supports the new SEC changes.
There are two basic reasons why the SEC is acting now to tighten the rules on personal trading. First, mutual funds have become dominant financial institutions in US life. More than 38 million investors have $2.3 trillion in more than 5,000 funds.
In the first four months of this year alone, $99 billion of new money was socked into equity funds. SEC Chairman Arthur Levitt notes that this amounts to 4.4 percent of US personal income, a figure slightly higher than the nation's total annual personal savings rate. "Every single savings dollar that households produced" in this period went into stock mutual funds, he figures.
The other reason behind the rule changes is the pressure of negative publicity. This was triggered first in January 1994, when Invesco Funds of Denver fired prominent fund manager John Kaweske, alleging he had failed to report a number of his personal securities trades. (In February 1995, the SEC initiated court action against this manager.)
Later in 1994, Fidelity Investments Inc. of Boston, the largest US investment company, reviewed and updated its own procedures on personal trading.
Congress got into the act when Rep. Edward Markey (D) of Massachusetts wrote SEC chairman Levitt in January 1994 - soon after Mr. Kaweske was fired - to inquire about the personal-trading issue.
The SEC then did an exhaustive examination of the personal investment activities of mutual-fund personnel, especially fund managers, releasing a report in September 1994. It found no pattern of abuse and few cases of high volumes of personal trading.
At about the same time, the ICI did its own major investigation and report, released in May, 1994. Executives from top US fund groups spearheaded the investigation. The ICI also found no pattern of abuse, and it found that the companies' codes largely exceeded the requirements of law.