The stock market can enjoy investor confidence only if its rules are clear and equally enforced. That's why recent scandals over insider trading, sweetheart deals for special clients, and accounting "irregularities" are so troubling.
But regulators are now looking into abuses by the $7 trillion mutual-fund industry. Last week, the Securities and Exchange Commission and Massachusetts Secretary of the Commonwealth William Galvin charged that two portfolio managers at Putnam Investments engaged in "market timing." Putnam CEO Lawrence Lasser stepped down Monday.
Meanwhile, the SEC and New York state Attorney General Elliott Spitzer made similar allegations against Strong Financial Inc. (Chairman Richard Strong resigned over the weekend.) Janus Capital Group, Merrill Lynch, Bank of America's Nations Funds, and Bank One's One Group are among other firms under investigation.
But this breach of trust involves more than a few bad eggs. Several newspapers reported Monday that an SEC survey found one-quarter of the country's largest brokerage houses had helped special clients illegally trade mutual funds after hours, while as many as half the 88 largest mutual-fund companies allowed select clients to engage in market timing.
Market timing - which takes advantage of the fact that fund prices are set just once daily, while stock prices move continually - isn't illegal. But companies discourage it because it reduces the amount investors earn. It may also fraudulently violate disclosure rules.
With half the nation's households and some 95 million individual Americans owning mutual funds, this state of affairs is clearly unacceptable. Congress is taking notice through hearings. And investors, especially state pension funds, are reacting as well: They have withdrawn billions from Janus and Putnam.
The Washington Post reports that the SEC is considering several reforms:
• Requiring fund companies to hire a chief compliance officer to police trading practices.
• Requiring more-frequent updates of fund prices.
• Requiring that all mutual fund orders be handed in before 4 p.m. each trading day.
• Slowing the redemption process to discourage investors from buying and selling funds frequently and charging a 2 percent fee on shares sold within five days of purchase.
Regulators should carefully weigh the benefits of the last two points against the inconvenience to the individual investor. But they must act quickly to restore trust in mutual funds and ensure that average Americans get fair and equal treatment in the market.