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Regulation and Compliance > Federal Regulation > SEC

Clean Up Your Act, SEC Tells Fund Industry

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After a year of uncovering some of the worst mutual fund scandals, Paul Roye, the SEC’s director of investment management, told mutual funds May 20 that the industry is now at a “crossroads,” and that it’s up to all mutual fund companies to “rekindle the [industry's] reputation of integrity.”

The scandals “reveal a need to reform the fund industry and hopefully reorient its focus on integrity and investment stewardship,” Roye told attendees at the Investment Company Institute’s annual meeting in Washington. While it took only 25 firms to ruin the entire industry’s reputation, he said, it’s time for the industry to “sink or swim together.” Roye told fund companies that it’s time to examine their “moral DNA,” and that true reform cannot come from SEC regulation and legislation alone. The industry must reestablish a culture of fiduciary responsibility, he said.

If any meaningful change in the industry is going to take place, Roye said, the “spirit of reform must be embraced from the top.” It’s up to management executives, fund directors, and heads of trade associations to steer the industry toward reform, he said.

Investors rightfully feel betrayed by the fund executives who struck “secret deals” favoring certain customers at the expense of average shareholders, Roye said. But he wonders whether the industry “will learn from its past mistakes and take serious steps” to regain its credibility. Will the industry blow “hot air” and get “back to business as usual” without taking any real steps toward reform?” he wondered.

Roye said he has noticed signs already that some in the industry are trying to avoid reform. For instance, he said, some fund groups have “resisted, whined, and complained” about funds’ obligation to fair value their securities, as set out in the Investment Company Act. Firms that failed to do this, he said, did not protect their investors from market timers. Firms complained that there is a lack of guidance by the SEC on fair valuing of securities, so the SEC asked for comments on what types of guidance was needed. The SEC “has received little help,” Roye said, “leading some of us [at the SEC] to wonder whether the complaints were really just an excuse for avoiding responsibility for employing effective fair valuation policies.”

Roye also addressed the controversial SEC proposed rule calling for an independent fund chairman. The proposal begs the question: “Whose fund is it? The management company’s or the fund investors’?'” he asked. If the fund belongs to the investors, he argued, then “why shouldn’t the board be led by an independent chairman?” Is the management company’s ultimate fear that the independent chairman proposal, as well as the proposal to increase the percentage of independent directors to 75%, will give independent directors too much power? Roye asked.

John Brennan, chairman and CEO of Vanguard, said during a separate panel that he thinks an independent chairman “would be unnecessary.” But Michael Oxley, chairman of the House Financial Services Committee, says the SEC should adopt the proposal right away. Oxley’s office just released research showing that nearly 85% of the mutual fund families that were accused of market timing and late trading “had management-affiliated chairmen during the time of the alleged violations.”

Robert Dow, managing partner at Lord, Abbett & Co., who sat on the same panel as Brennan, said he’s against another SEC proposal that would require portfolio managers to disclose their compensation. “Why should everybody know what the portfolio manager makes?” he asked. “It has nothing to do with the way the fund is managed.” Also on the panel was Dawn-Marie Driscoll, an independent director with Scudder Funds. She agreed with Dow that the proposal to increase portfolio managers’ disclosure is “unnecessary,” though she said she supports the SEC’s 4 p.m. hard close proposal for mutual fund trades. “We have to do it,” she said.

The issues swirling around the mutual fund scandals and the SEC’s focus on regulation of advisors continue. On May 26, the SEC will consider adopting rules that would require an open-end management investment company to provide enhanced prospectus disclosure regarding breakpoint discounts on front-end sales loads, as well as the Commission’s rule to require investment advisors to adopt codes of ethics.


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