A heightened regulatory environment has forever changed the $8 trillion mutual fund industry, as the fallout from a wave of scandal has had a significant impact on its various operating facets, a reality that has put its member firms at the crossroads.

That was the theme of this year's National Investment Company Services Association's annual conference, where more than 600 mutual fund professionals gathered to discuss the challenges facing their industry and pitch their wares and services.

The attendee list was a cross section of fund servicing employees that included those working in transfer agent services, compliance and risk management, distribution, fund accounting, technology, tax and retirement and a host of other service providers.

In a particular panel discussion entitled "Face the Membership," several leading fund industry executives were asked to reflect on the fund trading scandal and how the industry can repair its image and deliver for the investor. The difference of opinions among the panel members on various issues was representative of an industry at the crossroads

When asked by panel moderator and CNBC anchor Tyler Mathisen to identify the most important themes for the industry amid such a difficult period, their answers included addressing the needs of an aging Baby Boomer population, increased regulatory scrutiny, sales practices being challenged and opportunity in overseas markets.

Perhaps the most interesting answer came from Merrill Lynch Senior Vice President Diane Schueneman, who oversees the firm's global operations and infrastructure services. "When do we get back to making a difference?" she asked, referencing their fiduciary duty to the "investor," a word she pointed out that had not been uttered in any of the prior conference sessions.

The variety of the executives' responses illustrates the need for the industry to get on the same page and collectively choose a path upon which it can restore faith and deliver for its clients.

In looking back on the trading scandal, one panel member accused New York Attorney General Eliot Spitzer of creating a "poisonous" element when he publicly rebuked the Securities and Exchange Commission for being behind the eight ball on market timing and late trading.

"He turned this into a shouting match," said Marianne Smythe, a partner at law firm Wilmer Cutler Pickering Hale & Dorr. Several weeks after he launched a widespread investigation of mutual fund trading practices, Spitzer famously declared that "heads should roll at the SEC." That sparked what Smythe dubbed a "political jump ball" among regulators.

Smythe expressed that she has a "serious beef" with the Commission for abandoning its duty to protect members of the industry and its investors in favor of protecting its own rear end, which she poignantly illustrated by standing up and gesturing to her own behind. She further criticized the SEC for "mismanaging and mishandling" revenue sharing, a longstanding industry practice that has become associated with impropriety in recent years.

These practices were ones that the SEC knew about and condoned in the past, she charged. In recent months, the Commission has used the threat of litigation to force fund companies to agree to revenue-sharing settlements that have set a precedent in the industry. Her concern, along with many others in the industry, is that the Commission is overstepping its bounds by regulating through settlement rather than enacting a rule banning a practice and then enforcing it.

Essentially, Smythe was accusing the SEC of practicing ex post facto law by criminalizing conduct that was legal when originally performed. "The SEC and NASD should deal with it in a regulatory way," she said.

Jenny Bolt, senior vice president and chief information officer at Franklin Templeton Investments, noted, "You can't regulate or legislate integrity." No matter how many rules you impose, there will always be individuals who find a loophole, she said, noting that Sarbanes-Oxley would not have prevented the collapse of Enron and WorldCom. "There's a lot of touch involved when interpreting new regulation," she said.

Jonathan Eaton, executive vice president, product marketing at LPL/ Financial Services, said that many of the SEC's rules are "well-intentioned but do not achieve the desired result."

Mathisen's most provocative question thrown at the panel was one that suggested regulators haven't even scratched the surface with its investigations of industry practices. "I'd be very surprised if these murmurings were true," Smythe said She believes that there is an element of McCarthyism at work in the mutual fund industry.

Switching gears, Mathisen asked the panel if the fund industry was experiencing a talent drain, losing talented professionals to hedge funds or separately managed accounts. Bolt acknowledged that some of her peers are moving into the hedge fund world in pursuit of higher compensation and loose regulation. "That's a reality we'll deal with," Bolt said, citing hedge funds' propensity for higher volatility and increased risk of shutting down.

Another topic for discussion was the Bush administration's plan to privatize Social Security. Panelists were asked to comment on whether this would be a boon for the industry. "It's great to have asset inflows but it's a double-edged sword," Schueneman said. "It's certainly an opportunity, but you may be creating greater liability."

An obvious hot-button concern that drummed up plenty of chatter was market timing, the thorny issue that set regulators on a warpath in the first place. Attendees at the conference expressed frustration with the lack of an industrywide definition of market timing, a problem that ends up costing firms time and money when implementing internal controls and technology to curtail frequent trading.

But with 20 different definitions of market timing, the industry can hardly take action. Thus, the panel concluded that both NICSA and the Investment Company Institute should stick out their neck and go to bat for their constituents to resolve this issue.


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