Market timing. The mutual fund industry has not heard the end of this phrase, ever since New York Attorney General Eliot Spitzer, in 2003, unearthed shady trading practices through which fund companies allowed some investors to rapidly trade in and out of funds. The practice, commonly known as market timing, raises expenses for the fund and hurts long-term shareholders.

The SEC adopted a new disclosure rule, which took effect May 28, 2004, requiring a fund to disclose in its prospectus and statement of additional information its market-timing risks; policies and procedures adopted, if any, by the board of directors, aimed at deterring market-timing; and any arrangement that permits it.

A follow-up to the SEC holdings and compensation disclosure rule, which took place on Oct. 1, 2004, now also requires mutual fund companies to disclose in their prospectuses, the names, compensation structure and method and securities holdings in the fund of all of its portfolio managers, who oversee the day-to-day management of the funds' portfolios. Companies will also have to tell investors whether their managers also manage other investment vehicles such as hedge funds and pension funds, so that investors get a sense of any potential conflicts of interest.

In the aftermath of the trading scandals, regulators realized that no one was manning the control switch. The SEC passed one of its most controversial, hotly debated and feared rules, which took effect on Oct. 5, 2004, requiring fund companies to create a new position, chief compliance officer, who reports directly to the fund's board, not to its management.

The CCO's job is to ensure that the fund follows government regulations and internal policies. His/her pay is set by the board.

Unlike the previous top legal eagle at fund complexes, the general counsel, these new chief compliance officers are responsible - much in the same vein as CFOs in the aftermath of Sarbanes-Oxley - for all legal and regulatory implications of any activity related to running a mutual fund and investment advisor.

To say the CCO is on the hot seat, is putting it mildly.

The SEC also banned a widespread practice known as directed brokerage, in which a fund sends some of its portfolio trades to brokerage firms that agree to tout its funds over competing funds, usually without the investor's knowledge. The SEC considered the practice a potential abuse of shareholder assets and a conflict of interest. This rule took effect on Oct. 14, 2004.

Starting Jan. 1, 2006, mutual fund boards must have at least 75% independent directors, including the chairman. Some fund groups, led by Fidelity Investments, fiercely oppose the independent chairman rule, which the SEC approved on a 3-2 vote. The U.S. Chamber of Commerce has sued to overturn the rule. Furthermore, Congress recently passed a law requiring the SEC to compare the performance and fees of funds with and without an independent chairman.

The SEC mandated last year that mutual fund companies to disclose breakpoint discounts on front-end sales loads. The rule, which took effect on July 23, 2004, requires fund companies to describe in their prospectuses any arrangements that result in breakpoints in sales loads and to provide an outline for shareholder eligibility requirements.

To combat short-term trading, the SEC has given funds the option of charging a mandatory 2% redemption fee to investors who sell funds within five days of buying them. Some argue that this would penalize investors who need to sell quickly for honest reasons.


The SEC has proposed but not implemented a rule that would require brokers to provide fund investors with certain information about distribution-related costs and potential conflicts of interest such as revenue sharing at the point of sale. Currently, brokers don't have to disclose this information until after the sale, if at all.

In its efforts to combat late trading, the SEC has proposed a hard 4 p.m. close that would prohibit sending trade orders after the deadline. However, some retirement plans are allowed to back trades after 4 p.m. and still get that day's price, as long as the plan's participants placed their orders before 4 p.m. Some funds and investors have complained this would impose an unfair hardship on retirement-plan participants.

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