Turning up heat on fund industry

Vigorous efforts on Capitol Hill to clamp down on the $7 trillion mutual fund industry are intensifying now that state and federal regulators are investigating fraudulent trading practices at some large mutual funds.

Rep. Richard H. Baker, R-La., who is chairman of the House Financial Services subcommittee on capital markets, is “sharpening his pencil” with regard to a bill that would give investors better information on fund fees and strengthen corporate governance, according to Linda Dallas Rich, a senior counsel with the House Financial Services Committee.

Ms. Rich, speaking last week at a forum for mutual fund directors in New York, also suggested that the committee might hold hearings into mutual fund trading practices, possibly as soon as next month.

“It’s very hard to tell what Congress is going to do,” she said. “Clearly, these events have brought the level of interest and concern on the part of all of the members of Congress that I work for to a much greater level.”

When Mr. Baker in June introduced HR 2420 – the Mutual Fund Integrity and Fee Transparency Act of 2003 – he was worried that it may have gone “too far,” said Ms. Rich.

“Now he is concerned that the bill may not go far enough,” she said, adding that Mr. Baker had recently asked William Donaldson, the Securities and Exchange Commission chairman, to provide him with recommendations on modifications to the bill.

Jay Baris, a mutual fund lawyer at Kramer Levin Naftalis & Frankel LLP in New York, says any move by Congress is ominous.

“When you start tinkering with laws, you don’t know what’s going to come out,” he says. “You just don’t know where the political forces are going to take you.”

Still, Mr. Baker has a long row to hoe when it comes to getting any version of the bill turned into law. For starters, the House of Representatives has yet to vote on the current version of the bill.

It is also doubtful whether the Senate shares the House committee’s enthusiasm over more legislation governing the fund industry, observers say. Currently, there is no legislation equivalent to Mr. Baker’s in the Senate.

On Sept. 30, however, the Senate Banking Committee’s chairman, Richard C. Shelby, R-Ala., will hold a hearing that will focus on the securities industry. Slated for discussion is the state of the mutual fund industry, says Andrew Gray, a spokesman for the committee.

Nevertheless, Mr. Gray says, the committee is unlikely to propose legislation based on allegations by New York attorney general Eliot L. Spitzer – at least not anytime soon.

“We’re just not there right now,” he says. “While we are certainly aware of the investigation by Mr. Spitzer and the SEC, our response is going to be to listen to the SEC and get their input.”

As originally proposed, HR 2420 would have significantly increased transparency among mutual funds. Among other mandates, funds would have been required to supply investors with an estimate of their share of operating expenses, in dollar amounts, and show portfolio transaction costs in a way that allowed easy comparison between funds.

The bill also would have required funds to provide information on how pay for portfolio managers was determined, and whether soft-dollar or revenue sharing arrangements between funds and brokers existed.

In terms of governance, the bill would have required funds to raise the percentage of independent board members on a fund to 66%, from 40%. It also would have required mutual fund boards to have an independent chairman.

By the time the bill was approved by the House Financial Services Committee in July, however, some measures proposed in the original bill had been softened or eliminated.

For example, funds would no longer be required to disclose fees as personalized dollar cost estimates. Instead, they would be required to show costs in dollars for every $1,000 investment.

Lawmakers also stripped the requirement that independent directors would head fund boards.

barb for institute

“The watering-down of the Baker bill will go down as the last hurrah of the Investment Company Institute’s agenda for the last decade,” says Don Phillips, a managing director at fund tracker Morningstar Inc. of Chicago, in a reference to the fund industry’s powerful trade group in Washington.

“That agenda has been to defend the weakest practices of its members,” he adds.

Now it appears that Mr. Baker is seizing on the hoopla surrounding investigations by Mr. Spitzer and the SEC into allegations of improper market timing and illegal after-hours trading at a number of fund companies, to add more teeth to HR 2420.

His revisions may coincide with an Oct. 1 deadline for the SEC to report its progress on fund disclosure issues set by him and Rep. Michael G. Oxley, R-Ohio.

“Whether or not a bill goes through, the role of the committee is important,” said Meyer Eisenberg, deputy general counsel for the SEC, at last week’s conference.

The SEC “has to respond to the committee’s interests, to their letters and to their discussions. I think we are pretty much on the same page as the committee with its concerns,” he added.