Senate to consider mutual fund reforms

WASHINGTON, Nov. 13 (UPI) -- In an attempt to restore quickly tumbling investor confidence in mutual funds after recent allegations of impropriety plagued the industry, two U.S. senators announced Thursday that they intend to propose legislation to bolster government oversight of the fund business and protect investors from fraud in the future.

Senators Jon Corzine, D-N.J., and Christopher Dodd, D-Conn., said that while the majority of investment professionals were scrupulous with investors' money, a few instances of misconduct have made many consumers wary of mutual funds.

"Now, it seems, each day brings new allegations of fraud, market-timing misconduct or backroom dealings that allow privileged clients to reap benefits at the expense of average shareholders," Corzine said.

Chief among the allegations levied against the mutual fund industry is that fund companies gave large investors an advantage over smaller investors by permitting late trading, the tool by which investors place orders long after the closing bell but still get the previous day's price, and market timing, where investors buy and sell shares in funds comprised of international issues after the foreign markets close but before the American exchanges do.

Market timing virtually guarantees making a profit when the fund is priced the next day. Some analysts have likened the practice to betting on a horse race that's already over.

Among the giants of the industry implicated so far are Bank of America, Bank One, Strong Capital Management, Janus Capital Group and Prudential Securities.

"Millions of Americans rely on mutual funds for their financial security, and while you can't guarantee their success, it's absolutely imperative that we guarantee a fair and level playing field to ensure greater investor confidence," said Dodd.

"You have a situation where you have one scandal after another," said Bill Mann, senior editor for investing at the advice firm Motley Fool, Inc. "I think that with this issue with the mutual funds, most people are really shocked. It's the fact of it, not the amounts, that's shocking to people."

"Everyone knew what the rules were," said New York securities attorney Charles J. Hecht. "The problem is that legislation cannot change the moral fiber of executives and management."

"On the enforcement front," Mann says, "it needs to be much more painful from a financial standpoint for the individuals."

Although a bevy of investment options are available to individual investors, including index funds and individual stocks, "Mutual funds are the primary means for small investors to participate in the market," Corzine said.

About 95 million Americans have invested almost $7 trillion in mutual funds, including through 401(k) accounts and other retirement plans. Mutual fund tracker Morningstar and some financial advisers have advised their clients to consider selling their stakes in the recently-implicated funds or holding off on investing any more money in mutual funds.

"Look at the management, look at the quality of the portfolio," Hecht suggests. "Are these the kind of stocks I want to be in?"

But Mann is not optimistic on the long-term future of mutual funds. "We have always advocated for people to get into index funds, not actively managed funds," Mann says. "What you want in a mutual fund manager is someone who will think of your money as being your money, not his money."

Corzine, the former co-chairman and co-CEO of investment firm Goldman Sachs, and Dodd introduced legislation in March 2002 to contend with the crisis facing the accounting industry that became the basis for the Sarbanes-Oxley Act, which prohibited companies from making loans to insiders, reformed disclosure and financial reporting rules and required executives to certify their companies' public reports.

Critics of Sarbanes-Oxley say the expensive reforms it mandates are forcing smaller companies out of the marketplace. The Corzine-Dodd legislation proposes similar reforms for the mutual fund industry, and some believe that smaller players could be shut out there, too.

But perhaps the most significant damage, Hecht says, is the harm done to the international reputation of the American mutual fund industry. "Foreigners would be willing invest in America because they could trust our numbers," he said. "People that say live in, say, Spain, and have $1 million to invest are going to think twice."

"Now who are they going to trust with their money?" asks Hecht. "They're going to put it under the mattress."