MIAMI - It’s been best of times and the worst of times for the mutual fund industry, as this past year featured a sharp upturn in the stock market along with a wave of impropriety at the nation’s biggest fund shops and increased regulatory scrutiny. That was the sentiment expressed by Penny Alexander, chairman of the National Investment Company Service Association (NICSA), at its annual conference and expo at the Doral Golf Resort and Spa.

Alexander, SVP of human resources at Franklin Templeton Investments, advised her industry peers that this tumultuous period will ultimately be "good for business" and that the industry will "emerge better and stronger." That set the stage for keynote speaker Paul Roye, director of investment management at the SEC, who outlined a series of proposals to address "gross breaches of fiduciary responsibility." He advised that members of the investment community resist the temptation to look the other way and not treat morally questionable practices with a wink and a nod.

"There will be no sympathy for those collusive in looting the investments of 90 million Americans," Roye said. "There will no longer be a ‘beneath-the-radar, anything goes’ mentality."

In that, he was referring to the recent investigation of mutual fund trading and sales practices that has uncovered widespread abuse and clandestine arrangements between funds and brokerages. The industry has been rocked by revelations about misappropriation and inadequate disclosure of fund fees and expenses, inappropriate market timing, illegal late trading and preferential treatment for hedge funds and other large investors.

The Rock Band ‘Gig’ is Off

Roye cited an e-mail exchanged between two undisclosed executives that compared market timers to a rock band that trashes hotel rooms while they’re on tour. In comparison, market timers go from fund to fund looking to harm the retirement savings of individual investors and when they are told to pack their bags, they move on to the next fund. Funds that encourage this type of behavior resemble "a house of cards that are waiting to fall, he said. "The gig is off," he added.

Several key proposals he mentioned were the hard 4 p.m. deadline for fund trades, mandatory redemption fees on shares sold within five days of purchase and requiring each fund to have a chief compliance officer (CCO). These, along with other proposals on the table, will help "reinvigorate the compliance culture," Roye said. Adoptions of the proposed rules will commence sometime in April.

In a later panel discussion, SEC Deputy Director, Division of Investment Management Cynthia Fornelli noted that the Commission has a very active enforcement calendar in the coming months, including breakpoint discount violations in which customers were not given proper rates they were promised. Failure to deliver on breakpoint discounts, Fornelli maintained, was not a case of outright fraud but rather a function of sloppy oversight. With respect to market timing and late trading, she attributed the abuse to complacency and greed.

Back Office to the Forefront

Tom Smith, managing director and CCO at JP Morgan Fleming Asset Management, told conference attendees that it will be a costly endeavor from an operational standpoint to disclose breakpoint discount offerings and that it is time for back-office and compliance teams to voice their concerns. Still, at his firm, they have put a committee in place to review distributors’ activities so that the board of directors will not be blindsided by unethical or illegal behavior.

Terrance O’Malley, a partner at Investment Management Practice and chairman of the law firm LaBoeuf, Lamb, Greene and MacRae, noted that larger firms offering multiple investment products need to do a better job of training employees because it can confusing as to which rule apply to certain products. In discussing the disclosure of material non-public information, he said that management is typically well intentioned when giving out that information because they believe they are being a good service provider.

But, in the end, it comes down to education, O’Malley said.

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