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 may have been victimized because almost 30 percent of the brokers helped clients circumvent company rules against the practice.
The hearing Monday represents Congress’s first crack at the two-month old mutual fund scandal. SEC enforcement director Stephen M. Cutler is to present the survey results in testimony Monday before the subcommittee. New York Attorney General Eliot L. 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.
“It’s going to be big dollars and it should be big dollars,” Spitzer said. “If you are being paid to act in the interest of investors and you violate that trust, you shouldn’t be paid. We need to revitalize the governance of this industry so that the interest of the investor is paramount.”
Spitzer’s Sept. 3 civil complaint alleging that four major fund companies had cut secret deals with a New Jersey hedge fund has now 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 that 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.
The NASD, an industry regulatory group, is surveying smaller brokers to see if similar problems occurred in their sector, and its enforcers have already opened 30 cases connected to either late trading or market timing, sources said.