The spate of allegations against mutual fund firms for abusive trading practices could have a dramatic effect on investor confidence, Henry Paulson, chairman and chief executive of Goldman Sachs said Monday.

"The mutual fund scandal in some ways is the most serious one of all because we have 94 million shareholders in mutual funds in the U.S., " Paulson said.

Speaking at a Wall Street Journal/CNBC conference in London, Paulson said that there is no panacea for the wave of corporate scandals that have rocked the financial services industry and that it will take time to rebuild trust.

While drafting more stringent regulations and imposing stiffer penalties is an important first step, Paulson said it is not enough to persuade investors that such egregious behavior has been stamped out.. "I think we all know you can’t legislate integrity," he said. Paulson stressed the importance of enhanced disclosure and transparency as part of the healing process.

Another consequence of the widening fund probe is its inhibiting influence on investment managers, who have become much more risk averse due to the intense regulatory process, he noted. Paulson also argued that executive pay needs to be better aligned with performance and that fund executives need to do a better job protecting shareholder interests.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.