MIAMI -- When assessing the problems plaguing the mutual fund industry, you'll hear plenty of chatter about imposing stiffer penalties and introducing more stringent regulation.

Certainly, these are effective deterrents for bad behavior, but not all fund shops are guilty of conspiring to defraud investors. In fact, at most fund houses impropriety seems to be more of a function of the disconnect that exists between fund boards and compliance departments as opposed to collusion and cover-up. So the question for fund shops has become, "Do we have the proper systems in place to mitigate the risk of being hit with fraud charges?"

Previously, the consensus among mutual fund complexes was that existing back-office systems were adequate enough and that any upgrades would be too costly. However, the wave of investigations and fraud charges would suggest otherwise. While industry bigs and investor advocates debate the merits of new rules, some firms have decided to take matters into their own hands by investing in tools that enable them to be more vigilant about their in-house activities.

One such tool available is SalesVision, a Web-based platform launched by Access Data that enables investment managers and their respective boards to collect, track and manage data to improve compliance through a neutral party. The product has been available for the last 2-1/2 years but has garnered more attention of late. That was evident at a recent NICSA conference, where the firm's exhibit was getting a ton of traffic.

The product uses the Pittsburgh-based firm's proprietary FlexRules technology to generate customized reports on finance, sales trends, wholesaler compensation, compliance and revenue-sharing arrangements. With respect to compliance procedures, the tool can be used to police trading activity, including market timing and late trading. Each individual user is able to customize their view of the information and log in every morning to see the reports on their homepage.

A portfolio manager logging into the system can customize his reports to show the top firms based on assets or sales-trend analysis by product type, including exchange-traded funds, managed accounts and mutual funds. The manager could also access sales across the entire fund organization, such as sales by distribution channel, region or territory.

A compliance officer has the ability to monitor the number of exchanges or round-trip trades within an account, account balance patterns, and a list of heavy hitters, i.e., those who place orders of say $20,000 or more, and various other parameters to detect timers. The system can be set up to send reports directly to operations once a red flag has been raised.

A wholesaler logging into the system may be interested in seeing who is placing orders in his particular region or comparing actual sales to projected sales. "Wholesalers generally are frustrated with most of the firms they work for because the clients are calling them and saying, Hey, I sent you a big trade. Why didn't you call me?' By the time they find out, weeks have gone by," said Frank Polefrone, a senior vice president at the firm. "With this tool, you can call them the next day to thank them and stay on top of your business."

Failed Compliance

The failure of existing fund compliance systems stems from what Access Data President and CEO James Dolan calls "the Balkanization of the service end of the industry." By that, he is referring to companies developing proprietary shareholder information systems that are not compatible with each other, or sub-accounting, retirement and wrap account systems that collect data outside the scope of fund managers and boards.

According to a white paper issued by the firm last month, some mutual fund companies hold up to half of their detailed shareholder information outside of a fund's transfer agency. This creates a very fuzzy picture of a fund's trading and sales operations. Further, various distribution schemes have spurred product differentiation, fee structures and sub-systems. Dolan characterizes this as a "financial services Tower of Babel."

Another handcuffing aspect of current technology is the fact the industry has outdated systems that serve as effective accounting tools but do not provide the necessary information and analysis funds need.

"Firms have spent tens of millions of dollars trying to get all this data from their transfer agent and piece it together to meet regulatory requirements," Polefrone said. "With this tool, you can do it in a very automated, streamlined way." He noted that many funds have to follow an endless trail of Excel spreadsheets when tracking transactions and the flow of money.

SalesVision enables fund managers to track and analyze detailed trading information from all sources across all product lines against an established set of variables, including number of trades within a specific time period, trades by account type, trades across fund families, trading patterns of sales reps, or other parameters tailored to whatever regulatory requirements are imposed.

Breakpoint Breakdown

Another hot topic is funds' failure to deliver on breakpoint discounts. Investors purchasing Class A shares are entitled to lower sales charge when they buy in bulk. Oftentimes, however, they do not know this until after the wrong sales charge has been applied. SalesVision gives managers the ability to record and aggregate all purchases that qualify for a lower sales load. It could also empower them to assign a breakpoint schedule by product and share class and calculate breakpoints based on total number of assets.

Lawmakers and regulators are also delving into revenue-sharing agreements between fund shops and brokerages, a probe that will likely prompt stricter oversight of the practice. Secret payments and kickbacks for shelf space are perhaps the most egregious abuse in the fund business, therefore making it imperative that companies are able to trace every penny spent on distribution.

"It's essential that accurate records and a complete audit of every payment can be produced at every level," Dolan said. This includes service charges, 12b-1 fees and marketing allowances just to name a few. "Because these [revenue-sharing] arrangements vary greatly from distributor to distributor, mutual fund managers need a reporting system that is flexible enough to capture all the required information, and which is also able to disseminate it in a way that's meaningful to the average shareholder," Dolan said.

Companies can acquire the product in two ways. They can either license the software and pay maintenance fees, or outsource the technology. In the latter scenario, Access Data can bring in feeds and run them for a monthly implementation fee. State Street Global Advisors and FleetBoston's Columbia Funds are its two biggest clients in the licensing arena, an option that is geared toward the top 50 asset management firms. In the outsourcing department, BISYS is a key partner.

The implementation process takes about four to five months, and once it is in place, adding to the existing rules does not require re-configuration. "So, if Spitzer creates a new set of criteria he wants in New York, the rules are pretty easy to adapt," Dolan said.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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