WASHINGTON – The crusade against mutual fund firms for ripping off customers took a major step forward Monday as New York’s top regulator fired a shot across the bow.

Attorney General Eliot Spitzer continued to thunder away at the fund industry Monday for engaging in abusive trading practices at a hearing before the Senate Subcommittee on Financial Management.

Spitzer promised stiff penalties for firms found guilty of late trading, market timing and self-dealing, or what Stephen Cutler, director of enforcement at the SEC, calls the "unholy trinity."

Meanwhile, the Securities and Exchange Commission told lawmakers Monday that more than 25% of brokerage firms and at least 10% of the leading fund companies have allowed late trading. Earlier, the SEC has said that at least 50% of fund companies have engaged in market timing.

Spitzer called for complete disgorgement of losses, along with any fees retained as a result of neglecting fiduciary duties. "The number will be big, it will impose pain, and it should," he said.

‘Cesspool’

In terms of defining criminal behavior, Spitzer said that if a firm knowingly permitted timing and accepted payment for it, it will be charged. The mutual fund industry "is a cesspool," Spitzer said. Sen. Peter Fitzgerald, chairman of subcommittee hosting yesterday’s hearings, called it "the world’s largest skimming operation."

Another sticking point for Spitzer was funds not delivering their promise of economies of scale by charging excessive fees. He noted that mutual fund assets grew 60 times between 1980 and 2000, while fund fees expanded 90 times during that period. Further, shareholders pay 25 basis points more than institutional investors. If the fund industry were to waive this surcharge, as Spitzer sees it, it would result in a staggering savings to investors of more than $10 billion a year, Spitzer said.

Despite the overwhelming evidence of impropriety, Spitzer stopped short of recommending investors dump shares. "That would be a mistake," he said.

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