Originally created 01/15/04

SEC proposes required ethics codes for investment advisers



WASHINGTON -- Responding to the mutual fund industry scandal, federal regulators on Wednesday proposed requiring investment firms that advise funds to adopt ethics codes for officials and employees that would set standards of conduct and require reporting of personal trades.

The Securities and Exchange Commission also was moving to ensure that fund investors get more information about arrangements in which brokerage firms steer clients toward certain funds in exchange for payments from those fund companies. The SEC is investigating numerous cases in which the brokerages may have failed to fully disclose the deals to investors.

At a public meeting, the SEC commissioners voted 5-0 to propose the ethics codes for investment advisers, which would require employees of investment advisory firms to report their personal trading - including trading in any mutual funds managed by their firms.

Investment advisers are required by law to protect the interests of their clients, the mutual funds they manage, in what is called a fiduciary relationship.

"It is extremely troubling that so many of the recent scandals in the mutual fund industry have involved a breach of the fiduciary relationship between investment advisers and their advised funds," SEC Chairman William Donaldson said before the vote. "Advisers owe their clients more than mere honesty and good faith. What we are seeing leads me to believe that all too many advisers have been delivering much less."

In one of the biggest mutual fund cases, investment adviser Alliance Capital Management last month agreed to a $600 million penalty to resolve regulators' allegations of improper fund trading and violating its fiduciary duty.

The SEC's probes into payments to brokerage firms for pushing certain funds consist of eight inquiries involving brokerages and 12 involving mutual fund companies, some of which are linked as single cases, SEC Enforcement Director Stephen Cutler told reporters Tuesday.

The inquiries, which include the role of mutual fund board directors, are part of the widening investigation of practices in the scandal-tainted mutual fund industry by federal and state regulators.

At the same time, the SEC's "sweep" inspection of brokerages that sell mutual funds has found that 14 of 15 received cash from funds' investment advisers and two-thirds accepted payments in the form of commissions on fund trades, a practice known as revenue sharing. In return for the payments, 13 of the 15 brokerage firms appear to have favored the affected funds by giving them greater visibility on their Web sites and in promotional materials sent to customers, SEC officials said.

Brokerage houses sell some 80 percent of all mutual fund shares and collect billions of dollars in fees for those sales.

The SEC's action Wednesday built on its tentative adoption last month of a rule imposing a "hard cutoff" of 4 p.m. Eastern time for pricing of fund shares to stem illegal after-hours trading. The agency also was proposing requirements that board chairmen of fund companies be wholly independent from the companies managing the funds, and that three-quarters of the directors on a fund company board also be independent - an increase from the current requirement of 50 percent.

The proposals could be adopted formally after the SEC gathers public comment.

Similar concerns about individual investors prompted the House in November to overwhelmingly pass legislation requiring, among other things, mutual fund companies to disclose more information about fees and operations. The Senate is expected to act on its own version of such proposals early this year.

Cutler said the SEC is examining the practice of buying and selling "shelf space," in which mutual fund companies buy space on a broker's list of recommended purchases, and to what extent investors are adequately informed of the potential conflicts in such arrangements - and whether mutual fund board directors are told about them.

On the Net:

Securities and Exchange Commission: http://www.sec.gov

The House-passed bill, H.R. 2420, is available at http://thomas.loc.gov