PALM DESERT, Calif. - A culture of compliance and dedication to long-time shareholders has to be priority No. 1 for mutual funds. That was the consensus of a number of high-profile industry professionals at the annual Investment Company Institute Mutual Funds and Investment Conference last week.
With funds under siege for widespread trading abuses, there is a sense of urgency for the industry to get its house in order. But the industry's chief regulator is not entirely convinced that fund firms have embraced the burden of accountability.
"The fund industry has nowhere to hide and must shoulder the blame," said Paul Roye, director of the SEC's division of investment management, in his keynote address. He accused industry insiders of "turning a blind eye" to harmful activity such as market timing, late trading and self-dealing, behavior that has resulted in long-term damage to the industry.
While there were a number of contributing factors to what went wrong, Roye noted, the bottom line is that too many fund executives lost sight of their fiduciary obligation and the principle that shareholder interests come first. He urged the fund community to put an end to the finger pointing. Quoting famed author Sir Josiah Stamp, Roye added, "It is easy to dodge our responsibilities, but we cannot dodge the consequences of dodging our responsibilities."
Following his remarks, a panel discussed the root causes of the trading scandal and effective action steps to remedy them. Jack Cogan, deputy chairman of Pioneer Global Asset Management, pinned the wave of transgressions to "an erosion of fiduciary responsibility" fueled by "complacency and a lack of skeptical inquisitiveness."
While acknowledging there is no panacea, Cogan recommended swift punishment for those responsible for bilking investor returns and anyone complicit with their ill-conceived scams. He also suggested that stronger oversight is a big part of the equation, noting the importance of the new SEC compliance rule requiring funds to designate a chief compliance officer -- who will report directly to the board of trustees. Additionally, he called for the Commission to implement a more robust inspection process.
John Hill, an independent chairman at Putnam, doesn't think the current spate of rule proposals, while well-intentioned, would have prevented the abuse had they been already in place. While he supports the independent director rule and disclosing portfolio manager compensation, Hill said that none of the issues being tackled by regulators and Congress are related to the charges that ignited the scandal in the first place.
He believes that since the settlements with regulators have been huge, disciplinary actions have been taken and the companies have promised restitution, further regulatory proposals and legislation from Congress are unnecessary.
In his opinion, the most important issue regulators should focus on is bringing clarity to the trustees' responsibility -- not by merely holding further discussions to improve transparency, but abolishing the use of soft dollars to pay brokerage commissions, revenue-sharing agreements and charging 12b-1 fees. That would bring about "dramatic reform" and "make life easier on fund boards," he said.
Hill's criticism extended to New York Attorney General Eliot Spitzer as well for including a fee revision as part of the Alliance Capital settlement. In doing so, he charged, Spitzer ignored the '40 Act and "threw out due process." Further, he was appalled at how Bank of America was forced to cleanse its board, while the board members themselves were kept in the dark.
Another panelist, former ICI President David Silver, had more scathing criticism, taking the SEC to task on its approach to the securities industry. He urged the SEC to take a more holistic approach to the problem, similar to what regulators in the UK have done. Rather than singling out individual lines of business, Silver thinks the SEC should treat the problem as a company-wide issue. Silver chimed in that the problems are "a mile wide but only two inches deep." In his opinion, there is conflict because unregulated companies are parents to regulated companies in the fund industry.
Having served as a member of the SEC and ICI in his long career in the securities business, Silver said that the Commission is "remarkably unchanged" since 1960, when he last served on its staff. Meanwhile, the securities industry has changed dramatically, with most firms becoming full-service operations. Silver also defended industry tactics in dealing with rapid trading, noting that there were six cases in the last decade in which market timers sued mutual fund firms for restricting their trading activity.
But Jason Sweig, a columnist for Money magazine, swung back at the ICI, expressing contempt for the industry's "remaining smugness" even after numerous top-level executives have been charged with securities fraud, some even led away in cuffs. He attributed the downfall of funds to management "deliberately putting their cash flow before their shareholders." In essence, they had become "fee-generation machines," he charged. It was the "quiet daily risks" managers took that forged a culture of greed, where taking away a nickel here and a nickel there was acceptable.
Sweig also pointed out that lower-level employees were the ones spotting instances of abuse, but when complaints were passed up the chain of command, the corner-office folks turned a blind eye. His solution to the problem was simple: "Start handing out pink slips."
With that, Sweig expressed a very evident truth that has emerged from this whole mess. Achieving a culture of compliance and fiduciary responsibility starts at the top. And fund directors, as overseers of fund management, will now have to play a more active role in ensuring the right culture has been created. Given their heightened profile, you may see many directors asking for higher pay or perhaps considering resigning altogether.
Copyright 2004 Thomson Media Inc. All Rights Reserved.