Mr. Arthur Levitt Chairman U.S. Securities and Exchange Commission 450 5th Street, N.W. Washington, D.C. 20036
July 20, 1998
Dear Chairman Levitt: On July 6, 1998, the Securities and Exchange Commission requested public commentary on whether the Commission's 1995 proposed amendments to the rules governing personal trading by mutual fund portfolio managers, would provide information useful to investors or would be unduly burdensome to the mutual fund industry. As the Commission noted in this release, its 1995 proposal "was based upon reports prepared by the Commission's Division of Investment Management and the Investment Company Institute Advisory Group on Personal Investing, which studied the practices and standards governing personal investment activities of fund personnel. These studies followed press reports and Congressional inquiries in the early 1990s regarding the personal investment activities of fund personnel." These studies did not include some of the most sensitive data regarding personal trading violations and investigations within mutual fund organizations available at that time-some of which have been brought to the public's attention only recently or are only now in the process of becoming publicly known.
Around 1995, the Investment Company Institute lobbied the Commission against the imposition of any additional regulation in this area, arguing instead that mutual fund organizations should be free to establish their own standards on personal investing. Furthermore, as recently as May, 1998, the Association for Investment Management and Research, or AIMR, which represents investment management professionals, publicly announced that "abusive (personal trading) practices are rare in the investment industry and that managers avoid trading extensively to benefit their own accounts." Recent revelations regarding personal trading abuses within additional mutual fund organizations once again raise the question of whether the mutual fund industry should be allowed to continue setting its own rules in this area.
Notwithstanding reassurances from the mutual fund industry, money managers trading for personal profit is commonplace. Personal trading by money managers does not in any way benefit investors; rather, it provides the opportunity for significant personal financial gain by the manager at the investor's expense. It is tremendously harmful to investors and undermines the fiduciary relationship between manager and client. Violations of internal codes of ethics are rampant and portfolio managers are loath to meaningfully punish one of their own for such personal trading abuses.
The Commission's proposal is fundamentally flawed. The proposal focuses upon the burden to the mutual fund industry and provides no meaningful additional protection to investors. The Commission's proposal fails to address the one key question involved in this area: Do investors have the right to know about the personal trading activities of the managers they hire and the risks to investors such trading poses? Despite the fact that the federal securities laws are premised upon the notion that there should be disclosure to investors of all material information prior to making an investment decision, today the answer to the above question is "no." The Commission's proposal does nothing to change this state of affairs. In terms of investor information, the Commission's proposal merely requires limited prospectus disclosure indicating the fund has adopted a code of ethics permitting personal trading and that a copy of the code is on public file with the Commission.
In my opinion, investors do want and need to know information regarding a manager's personal trading activity prior to making an investment decision. Any manager who is not prepared to disclose his personal investing activity, should not seek to persuade the investing public to entrust him with their assets. A rational and comprehensive approach to ending managers personally profiting at the expense of investors must include, at a minimum, the following:
1. Mutual funds should be required, upon investor request, to provide to investors a copy of the codes of ethics their boards adopt. This would allow investors to compare manager ethics.
2. Investors should be permitted to view copies of manager personal trading records held at the manager's office. Under existing law these records must be kept internally by the management company. Why not allow investors to view them?
3. Investors should be permitted to view records of any violations of their mutual fund's code of ethics by managers and any action taken to address these violations. This would permit investors to evaluate the personal ethics of their portfolio manager, as well as whether the management company is seriously punishing violators.
4. The Commission should unambiguously state that whomever is responsible for monitoring and enforcing the code of ethics has a paramount duty to the shareholders of the fund. Money managers should be specifically precluded from asserting the attorney-client privilege to prevent disclosure of personal trading violations.
5. There should be limited prospectus disclosure regarding the risks personal trading poses to investors and the sources of information available to investors to evaluate these risks.
This proposal would place virtually no additional burden on the mutual fund industry because, with the exception of the limited prospectus disclosure, all of the above information is currently required to be maintained internally. However, if this proposal were adopted, the above information would finally be made available to investors. After all, it is for the benefit of mutual fund shareholders that these records are required to be kept. This proposal would ensure that money managers become publicly accountable for the ethical standards they adopt. There would be no more secrets, and managers who did not follow the highest ethical standards would be forced to publicly defend their actions. I cannot imagine why the Commission, charged with the "protection of investors," would not embrace this simple proposal for eliminating personal trading abuses. Furthermore, if, as AIMR has stated, managers indeed "avoid trading extensively to benefit their personal accounts" and the personal investment activity of mutual fund money managers "rarely" is harmful to investors, I cannot imagine why the ICI or AIMR would oppose it.
I look forward to the serious consideration of this proposal.
Very Truly Yours, Edward A. H. Siedle, Esq.
Setting Standards For The Investment Management Industry
