SEC: Fund directors shirking duties

Independent mutual fund directors are dropping the ball as fiduciaries for their funds, and some portfolio managers may be doing even worse, according to a top SEC official.

A Securities and Exchange Commission task force has “identified a number of funds” that may be engaged in portfolio pumping, according to Lori Richards, director of the SEC’s office of compliance inspections and examinations.

The practice deceives investors who also are getting short shrift in some cases from independent directors, Ms. Richards told the second annual Mutual Fund Directors Education Council policy conference in Washington this month.

Directors “can and should do a lot more than they’re doing now,” she said.

Ms. Richards provided an update on the investigation into portfolio pumping and called on directors to work harder to get the best trade execution for funds they oversee.

Both matters have received wider public attention lately, especially in the wake of last year’s down market. InvestmentNews broke the news about the investigation in its Nov. 27 issue.

The task force, Ms.Richards confirmed, has encountered some cases in which net asset values have increased by as much as 5 percentage points on the last day of a quarter, when fund performance figures are calculated.

But fund watchers say it will be difficult for the SEC to bring cases.

Even if the SEC finds that fund managers have engaged in unusual stock trading at the end of a performance-reporting period, that’s still not enough to make a case, according to Mercer Bullard, founder of Fund Democracy LLC, a shareholder advocacy group in Chevy Chase, Md.

As fiduciaries for their funds, portfolio managers are also responsible for deciding the best execution alternative for the fund, Ms. Richards said.

“They have to have identified factors that are most important for a fund in routing the fund’s brokerage to either a particular wirehouse or to an [electronic communications network],” she added.

While many factors go into evaluating the best execution, they are easy to identify, she said.

They include getting the best price for the security traded and avoiding influencing markets when large blocks of stock are traded.

Managers should also weigh how much their brokers charge and whether brokers take their calls and execute their trades efficiently.

The brokerage house should also commit its own capital to make a market when it’s needed and provide access to initial public offerings.

If a broker sells a fund’s shares, however, that “raises lots of issues” over potential conflicts of interest, Ms. Richards said.

She said an SEC study found that it was not always clear that advisers consider alternatives. Some of them simply say, “`That’s the way we’ve always done it,”‘ she said.

She also cautioned managers against committing a percentage of their brokerage to particular traders in advance, because traders would have little incentive to provide better execution.

Ms. Richards suggested that directors meet with portfolio managers and traders annually to ask them what factors they consider to judge best execution and how they manage potential conflicts of interest.

“There is no completely satisfactory way to measure best execution,” said Kenneth Scott, professor of law and business at Stanford Law School and an independent director with American Century Funds and Dresdner RCM Capital Funds.

“The tendency has been to focus a lot on the commission,” he said.

Ms. Richards noted that trading costs have stayed at 6 cents a share since the beginning of the 1990s in what should be a very competitive market.

But large institutions often receive rebates from traders, and electronic networks now charge as little as 1 to 2 cents per share, said Mr. Scott.

“Better execution is complicated. It really is a matter for the trader’s judgment,” he said. “I don’t think directors are in a very good position to second-guess that.”