Mutual Fund Trading Abuses: Lessons Can Be Learned from SEC Not Having Detected Violations at an Earlier Stage
Highlights
Recent violations uncovered in the mutual fund industry raised questions about the ethical practices of the industry and the quality of its oversight. A widespread abuse involved mutual fund companies' investment advisers (firms that provide management and other services to funds) entering into undisclosed arrangements with favored customers to permit market timing (frequent trading to profit from short-term pricing discrepancies) in contravention of stated trading limits. These arrangements harmed long-term mutual fund shareholders by increasing transaction costs and lowering fund returns. Questions have also been raised as to why the New York State Attorney General's Office disclosed the trading abuses in September 2003 before the Securities and Exchange Commission (SEC), which is the mutual fund industry's primary regulator. Accordingly, this report (1) identifies the reasons that SEC did not detect the abuses at an earlier stage and the lessons learned in not doing so, and (2) assesses the steps that SEC has taken to strengthen its mutual fund oversight program and improve mutual fund company operations.
Recommendations
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| United States Securities and Exchange Commission | To enhance the effectiveness of SEC's mutual fund oversight program and help strengthen company operations, the Chairman, SEC, consistent with the agency's legal authority, should request lists of all compliance-related internal company reports during the examination planning process and review such reports as necessary to obtain a broad perspective on the risks identified by individual companies and the adequacy of controls in place to monitor those risks. |
Closed – Implemented
In April 2006, SEC implemented examination guidance that requires examiners to request information on internal compliance reviews that were conducted by mutual funds and advisers. Examiners, under the guidance, are to determine what reviews were conducted, what were the key findings, what were the recommendations, and what was the status of the recommendations' implementation, among others.
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| United States Securities and Exchange Commission | To enhance the effectiveness of SEC's mutual fund oversight program and help strengthen company operations, the Chairman, SEC, should ensure that examination staff assess the independence and effectiveness of mutual fund company chief compliance officers as a component of all mutual fund company examinations. |
Closed – Implemented
SEC has developed examination procedures that direct staff to review the operations and effectiveness of investment adviser and mutual fund company compliance officers. This procedures are consistent with the GAO recommendation.
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| United States Securities and Exchange Commission | To enhance the effectiveness of SEC's mutual fund oversight program and help strengthen company operations, the Chairman, SEC, should develop a plan to receive and review mutual fund company and adviser annual compliance reports, or the material findings thereof, on an ongoing basis. |
Closed – Not Implemented
SEC disagrees with this recommendation as it would require the promulgation of a rule requiring firms to file their annual compliance reports with the agency. SEC is concerned this would not be consistent with the Paperwork Reduction Act.
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