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A Distracted SEC Failed to Find Abuses


Thu Apr 21, 9:14 PM ET White House - AP Cabinet & State

By MARCY GORDON, AP Business Writer

WASHINGTON - The Securities and Exchange Commission failed to uncover trading abuses throughout the mutual fund industry that cost investors billions because it had other priorities, congressional investigators have found.

Congress' Government Accountability Office (GAO), in a report being released Friday, said the SEC's inspectors should have detected the market-timing abuses prior to September 2003, when New York Attorney General Eliot Spitzer brought the violations to light and regulators began an industry wide crackdown.

The chairman and the senior Democrat on the House Judiciary Committee seized on the GAO report to roundly criticize the SEC. Such concerted bipartisan attacks on the agency have been rare in recent years.

"The SEC was years late in uncovering these massive abuses that are nothing short of theft," panel chairman Rep. James Sensenbrenner, R-Wis., said in a statement. "The SEC must take a stronger position on finding, preventing and punishing abuses by insiders, or Congress will be forced to take another look at how mutual funds are examined and regulated."

The ranking Democrat, Rep. John Conyers of Michigan, said the report shows that the SEC "was asleep at the switch."

Market timing of mutual funds, which involves rapid in-and-out trades, is not illegal but is prohibited by many funds because it can disadvantage ordinary shareholders. In many of the cases brought by Spitzer and the SEC, mutual fund companies allowed favored clients such as hedge funds to engage in market timing.

Before September 2003, the SEC "did not examine (funds) for market-timing abuses because agency officials viewed other activities as representing higher risks," the GAO report says. "SEC can strengthen its capacity to identify and assess evidence of potential risks."

The SEC staff believed that fund companies "had financial incentives to establish effective controls" against trading abuses, according to the report.

The report cited estimates that market-timing abuses in the $7 trillion mutual fund industry — which it called a "persistent risk" before September 2003 — cost fund investors some $5 billion a year.

The GAO's findings point especially to the SEC's Office of Compliance Inspections and Examinations, known as OCIE.

Its director, Lori Richards, in a recent letter to the GAO investigators, said that after the fund misconduct came to light, "the SEC took comprehensive action, including ... enhanced examination oversight."

"The SEC's examination program has adopted a risk-based approach to oversight that emphasizes the prompt identification and investigation of emerging compliance risks," Richards wrote.

SEC spokesman John Nester declined further comment Thursday.

The National Association of Securities Dealers, which is the brokerage industry's self-policing organization, also failed to detect the trading abuses prior to September 2003 in its inspections of brokerage firms selling mutual funds, the GAO report noted.

NASD spokesmen couldn't be reached for comment Thursday evening.

Spitzer's office discovered the misconduct during the summer of 2003 by following up on a tip from a hedge fund insider.

The scandal spread rapidly across the mutual fund industry, which had long enjoyed an untarnished reputation. Dozens of fund companies, including some of the nation's largest, were fined in civil settlements with the SEC, authorities in New York and Massachusetts and other regulators.

In addition, investors nationwide are suing Janus Capital Group Inc., Strong Capital Management Inc., Bank One Corp., Bank of America Corp., Putnam Investments and Alliance Capital Holding in private litigation.
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On the Net:

Securities and Exchange Commission: http://www.sec.gov

Government Accountability Office: http://www.gao.gov