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Congress Probes Mutual Fund Fraud - 2003-11-03

A U.S. Congressional panel Monday heard evidence of massive fraud in the management of mutual funds, which millions of Americans use to indirectly invest in publicly traded companies. The scale of the abuse appears to be far greater than had been thought.

A government regulator told the Senate Government Affairs Committee that mutual funds routinely violate securities laws.

Stephen Cutler of the Securities and Exchange Commission said 25 percent of the biggest brokerage firms have admitted to trading violations. The most common abuses are late trading and market timing - practices that allow traders to get better prices than the public at large.

Elliot Spitzer, the energetic attorney general of the state of New York, is demanding that guilty firms refund all fees charged to investors during the period in which fraud occurred. "There is absolutely no room for the receipt during the period of time in which funds are violating a clear [financial] duty. This number will be big, it will impose pain, and it should," he said.

Ninety-five million Americans in 54 million households own shares in mutual funds, an industry that holds $7 trillion in assets. Mutual funds pool the investments of many, and then buy large holdings in dozens, or even hundreds of companies. There are thousands of mutual funds.

John Bogle, the 74-year-old Philadelphia financier, has long campaigned against the excessive fees charged by fund managers. Mr. Bogle told the committee that the drive to draw in more investors and boost profits caused mutual funds to become reckless. However, he sees a certain benefit to the current scandals. "They call attention to the profound conflicts of interest that exist between fund managers and fund shareholders. Conflicts that arise from an inherently flawed governance structure, in which fund owners, in practice, have little, if any, voice. The trading scandals are just the small tip of an enormous iceberg of conflict," he said.

Mr. Spitzer agrees that the mutual fund industry charges excessive fees and has an ownership structure, in which it is accountable to neither shareholders nor government regulators. "There is no question at all that the boards of directors of the mutual funds have been inert," he said. "They have been passive. They have failed. They have utterly failed the investor. They have misunderstood their role. They have not been responsive to the appropriate parties. This must change."

The disclosures of fraud in mutual funds is the latest in a series of scandals that have exposed widespread fraud in corporate accounting and other management abuses that have badly tarnished the American model of corporate governance.