SEC examiners have begun informally questioning mutual fund companies on what their funds spend and receive for executing securities trades.

A group of SEC examiners began visiting mutual fund companies in the past two months to discuss the so-called "best execution" of securities trades, Gene Gohlke, associate director of the SEC's inspection division, said last week. The review is expected to continue for several months, Gohlke said. He declined to identify the number of firms expected to be questioned. As a matter of policy, the SEC does not name the firms it is examining.

The review is part of a fact-finding effort by the SEC and was prompted in part by the agency's report last year on the securities industry's soft-dollar practices, Gohlke said. The SEC could revise its examination procedures as a result of the current review, Gohlke said.

Mutual fund companies seek the best execution of their securities trades for their funds. Best execution, however, is not precisely defined.

Federal securities laws, for example, permit funds to pay broker/dealers more than the lowest possible commission in certain circumstances. Funds can receive services such as research in return for directing fund securities transactions to a particular broker/dealer, a phenomenon which can increase execution costs but presumably provides funds with a separate benefit. Funds also can send transactions to a broker/dealer which sells fund shares. Sales ultimately should reduce fund expenses by increasing assets.

"It's hard to define and even harder to measure," Gohlke said of best execution.

An execution charge of approximately six cents a share is common among the Wall Street broker/dealers serving mutual funds, said Gohlke and industry executives. Gohlke said the SEC is looking into whether funds should be trying to negotiate lower commission rates, place trades with lower-cost broker/dealers or use electronic trading systems - known as electronic communications networks, or E.C.N.s - in an effort to reduce execution costs.

On E.C.N.s, investors who want to buy and sell a particular security are matched. The execution cost is lower than that which large broker/dealers charge.

At an industry conference last month, fund executives said that low cost execution does not necessarily save a fund money. For example, while E.C.N.s may reduce commission costs, such systems may not be as efficient as large broker/dealers in getting the best available price for a security, executives said. In addition, they questioned whether smaller, lower-cost broker/dealers have the capacity to gradually make a big sale or purchase without affecting market prices in a manner which hurts a fund.

"It's an art to achieve best execution," said Stuart Strachan, senior counsel at Capital Research and Management. He spoke at the Investment Company Institute/Federal Bar Association Mutual Funds and Investment Management Conference last month. "It is a complex task to move huge blocks of securities without having an effect on the market."

Gohlke said the point was valid and that a failure to get the best price for a security can wipe out the benefit of decreased commission costs. Nevertheless, the SEC wants to learn more about what factors fund companies consider in deciding where to send their trades and what funds receive in return, Gohlke said. As part of its review, the SEC also will look at trade executions which are directed to particular broker/dealers as part of an effort to sell funds, Gohlke said.

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