investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
investigations of pension fraud, money management abuse, wrongdoing, securities brokerages, pension investment consultants, unethical business practices, benchmark alert, institutional investors, plan sponsors
(July 1, 1998) Mutual Fund Personal Trading Illegalities: Letter to Barry Barbash, Director of Division of Investment Management, Securities and Exchange Commission

Money Matters

Barry Barbash, Esq.
Division of Investment Management
U.S. Securities and Exchange Commission
450 5th Street, N.W.
Washington, DC

Dear Mr. Barbash:

Over the years there has been extensive critical commentary regarding whether the existing mutual fund regulatory structure that permits uniquely incestuous relationships and conflicts of interest adequately protects investors. The truth is that, unlike a typical operating company (such as an industrial corporation) where the goals of management and shareholders are usually the same, in the case of a mutual fund, the goals of the fund and its shareholders on the one hand and the goals of the money manager on the other hand, are not necessarily the same. The conflicts of interest which are indigenous to the mutual fund's relationship with its money manager are unparalleled when compared to those conflicts which arise out of the typical operating company's relationships.

For example, the money manager which manages the mutual fund's portfolio is permitted under the federal securities laws to personally profit by purchasing or selling for himself the very same securities that he is purchasing or selling on behalf of the fund. By placing his personal stock trades before his clients' (front-running), delaying client orders and misappropriating investment opportunities that properly belong to the mutual fund, a manager can cause substantial, quantifiable harm to the fund. While the manager is required by the SEC to comply with an internal code of ethics regarding his personal trading activity which has been approved by the mutual fund's board of directors, since mutual fund directors are in essence chosen by the manager, board approval of a code does not guarantee that it provides any real protection to the fund. Furthermore, the SEC has not established any rigorous requirements that these codes must meet. Rather, the Commission has left it up to mutual fund managers to establish their own standards. Despite the fact the managers themselves write their own internal personal trading codes and these codes place only minimal constraints on managers, the opportunities presented to managers for personal profiting are so tempting that compliance with even the minimal requirements of these codes is often willfully ignored.

Within large mutual fund organizations, only in- house legal counsel is in a position to monitor manager personal trading compliance with the code of ethics. This individual is almost always an employee of the manager, not the mutual fund. He has a duty to protect the mutual fund shareholders, but he also has a duty to his employer. If his employer is breaking the law with regard to personal trading, causing harm to the fund, the question arises as to which of these two conflicting duties of the lawyer is greater. Should the lawyer's duty to his employer be held to be paramount, despite the fact that this client is committing a crime, then no effective protection of investors has been provided. The manager breaking the law would always be protected and the shareholders would never be. If the money manager's personal trading compliance record is also held to be confidential, subject to the attorney-client privilege, then investors would never learn the extent to which their manager's personal trading activity may be detrimental to them. Believe it or not, these enormously important issues have never been openly addressed by a court of law or regulatory agency. Nevertheless, the correct answer is obvious.

The federal securities laws are premised upon the notion that the investing public should be provided with full disclosure regarding a manager or fund prior to making an investment decision. Managers are not permitted to select for disclosure only the most favorable investment information or results. Furthermore, a manager's compliance history must also be disclosed generally. For example, if clients have lost money as a result of front-running or other trading abuses, that is information that should be disclosed to them. Investors should be told because not only does such activity impact upon the investment results they receive, but it also is material to a determination of whether a manager maintains the ethical standards the investor seeks. To permit a manager to selectively conceal compliance problems and/or actually deny that they exist is not consistent with the regulatory framework.

The Financial Accounting Standards Board recently voted to research the extent to which investors in public companies should be told about illegal activities involving executives within companies and disagreements that a company has with its lawyers. When the public company is in the business of money management, offering its services to the investing public, the degree of disclosure required is far greater because of the multiple securities statutes that apply, i.e., the Investment Company Act and the Investment Advisers Act, as well as the Securities Act and the Exchange Act.

Now that mutual funds are enjoying such widespread popularity and unprecedented levels of assets are rolling into these funds, it is more important than ever that the investing public be made aware of the weaknesses in the regulation of mutual funds and money managers. The ambiguities and oversights in these regulations have given rise to imprudent industry practices that are harmful to investors. The SEC should establish clear minimum standards regarding personal trading that every mutual fund money manager must meet and be more diligent in monitoring compliance with these standards during its inspections of managers. Managers who place their personal financial gain before the best interests of investors should be required to fully disclose their violations and not be permitted to maintain that such information is confidential. The Commission should unambiguously state that whomever is responsible for monitoring personal trading within a mutual fund company has a paramount duty to protect the shareholders of the funds.

The retirement security of several generations of Americans is put at risk by the unsavory mutual fund industry practices that the current regulatory framework permits. The industry should rise to a higher standard and seek to enhance its reputation, rather than continue to profit from lack of comprehensive regulation. Finally, money managers who cannot be relied upon to maintain the highest internal ethical standards should simply not be permitted to offer their services to the investing public.

Very Truly Yours,

Edward A. H. Siedle, Esq.

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