Mutual Fund Morass

Half of American families invest money in mutual funds, so while the recent news about late trading, market timing and other illegal practices by companies that manage such funds may have sounded like a bunch of financial gibberish, the implications could be big for the average investor. Mutual funds, which manage money on behalf of shareholders by buying and selling stocks and bonds, hold $7 trillion in investments for 95 million investors, many of them through a workplace 401(k) or other retirement plan. Because they invest money in a variety of areas and offer differing levels of risk, mutual funds have attracted small, unsophisticated investors; those who can least afford to lose money.

At a Senate subcommittee hearing on the issue Monday, Sen. Peter Fitzgerald, the Illinois Republican who chairs the Financial Management Subcommittee, was right to urge his colleagues and others not to focus on the fancifully named trading practices, but on the larger problems within the mutual fund industry. As Sen. Fitzgerald said, a “wholesale re-examination” of mutual fund management is sorely needed.

Given the growing popularity of mutual funds, Sen. Susan Collins, chair of the Governmental Affairs Committee, asked this week why the Securities and Exchange Commission did not move sooner to investigate problems, such as the recently publicized late trades among funds managed by Putnam Investments, the nation’s fifth-largest mutual fund company. Coincidentally, the head of the New England regional offices of the SEC said he would step down after criticism that his office did not investigate a whistleblower’s accusations of illegal trades at Putnam, which is based in Boston. Putnam’s CEO also announced he was leaving.

The head of the SEC’s enforcement division said he wished his agency had caught the problems earlier. That’s not exactly reassuring to investors worried that their retirement portfolio isn’t as big as it should be due to fund-manager malfeasance.

While the extent of the problem is still being sorted out, there are several steps that should be taken to ensure that mutual funds remain safe havens for the savings of the working class, especially when there is talk of privatizing Social Security by allowing individuals to invest their portion in the stock market.

A good place to start is by looking at who manages the hundreds of mutual funds offered by hundreds of companies. As Sen. Collins noted with exasperation, the chairman of one fund company sits on 113 different mutual fund boards. Also problematic is the fact that fund managers often make decisions that benefit themselves more than those who invest in the fund.

Another area of concern involves fees, with funds charging wildly different amounts. If mutual fund fees were in line with those charged for the management of pension funds, investors would save $10 billion a year, according to New York Attorney General Eliot Spitzer.

At the Senate hearing, the SEC’s enforcement chief spoke of widespread problems, beyond the dozen companies named for wrongdoing so far. Stephen Cutler said 25 percent of brokerage firms that sell mutual funds had permitted customers to engage in late trading – the buying and selling of shares at the closing price after the 4 p.m. closing – that may have been improper. Thirty percent of the fund companies had disclosed information to only certain shareholders, allowing them to place advantageous trades.

This, Mr. Cutler said, left him with a feeling of outrage. It is time for his agency to turn that outrage into action by investigating mutual fund practices and putting a stop to those that are improper.