[Congressional Record Volume 149, Number 174 (Tuesday, November 25, 2003)]
[Senate]
[Pages S15983-S15985]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. DASCHLE (for Mr. Kerry (for himself and Mr. Kennedy)):
  S. 1958. A bill to prevent the practice of late trading by mutual 
funds, and for other purposes; to the Committee on Banking, Housing, 
and Urban Affairs.
  (At the request of Mr. Daschle, the following statement was ordered 
to be printed in the Record.)
 Mr. KERRY. Mr. President, as the world's largest economy, I 
believe the United States must have the fairest, most transparent and 
efficient financial markets in the world. Our financial services 
companies must live up to the highest standards of accountability. This 
is critical to ensure that the United States remains strong, 
competitive and safe in the global economy. Unfortunately, recent 
reports of late trading and market timing have brought into question 
whether mutual fund companies have lived up to the highest standards of 
accountability. They have also shown that the Bush Administration 
failed to provide effective oversight and examination of mutual fund 
companies, while poorly enforcing our securities laws. The inaction of 
the Bush Administration has dangerously eroded the trust and confidence 
of the American people in mutual funds and may have allowed mutual fund 
companies and big investors to engage in fraudulent behavior against 
individuals and pension funds.
  New York and Massachusetts regulators have uncovered a scheme in 
which some of America's top mutual fund companies let big investors 
profit illegally at the expense of small investors with so-called 
``late trades'' and ``market timing.'' The scam appears to be 
widespread. Today, roughly half of all American households own mutual 
funds either directly or through a retirement account or pension fund. 
It's been reported that as much as one quarter of mutual fund companies 
may be involved in late trading and market timing and that such schemes 
may cost investors as much as $5 billion annually.
  In a late trade, big investors purchase mutual fund shares after the 
close of the market but at the closing price, allowing them to take 
advantage of late-breaking financial news. A mutual fund manager might 
allow a big investor to buy shares in a technology fund at the 4 p.m. 
close price after learning at 5 p.m. that a major technology company 
has reported unexpectedly strong earnings. The investor is almost 
guaranteed a profit when the market opens the following day and share 
prices climb. In return for this illegal access, the big investor might 
pledge to continue to invest in the fund.
  Market timing exploits the unique way that mutual funds set their 
prices. While it is not illegal, most mutual fund companies assure 
investors that they discourage such practices and that they are working 
to prevent fund timing. Under a market timing trade, big investors 
trade in and out of certain mutual funds in order to exploit the 
inefficient way mutual funds price their shares and ensure a profit.
  In 2002, individuals who invested in mutual funds paid approximately 
$70 billion in advisory and management

[[Page S15984]]

fees, an average of more than $700 per investor. There is a significant 
disparity between the rate of advisory fees charged to mutual fund 
investors and the rate paid by institutional investors, even though 
they provide the similar services. Currently, mutual fund managers are 
under no obligation to negotiate advisory and management fees that are 
in the best interest of their shareholders. In some instances, mutual 
fund managers has a financial relationship with the contractor which 
receives a no-bid contract from the same mutual fund.
  In a September 2003 complaint, New York Attorney General Spitzer 
alleged that Canary Capital Partners, a New Jersey hedge fund, engaged 
in illegal and unethical trading in mutual funds, such as late trading 
and market timing. After the New York State complaint, the SEC ordered 
a preliminary investigation, which found that half of the 88 mutual 
fund companies and brokerage firms had arrangements to make market-
timing trades. These arrangements occurred even though about half of 
the fund companies have policies specifically barring market timing. 
Other investigations of mutual fund companies have begun, and it 
appears as though many mutual fund companies have been involved 
directly or indirectly in late trading and market-timing schemes.
  I am very concerned that the actions of the SEC in response to the 
State investigations of late trading and market timing have been 
inadequate and show a bias in favor of mutual fund companies at the 
expense of small investors.

  For example, earlier this year the SEC conducted a four-month 
investigation of Putnam Investments' record keeping, internal controls, 
and ability to comply with Federal securities laws. During that review, 
a Putnam employee informed the SEC that the company had failed to stop 
improper market-timing trades. Despite the tip, SEC examiners did not 
identify any problems with market timing in its report on Putnam. The 
Putnam employee, after being rejected by the SEC, brought the same 
information to the Massachusetts Secretary of State's office, which 
began an investigation. Only after the Commonwealth of Massachusetts 
began an investigation did the SEC begin its own investigation of 
market timing at Putnam. In October, both the Commonwealth of 
Massachusetts and the SEC charged Putnam with securities fraud, only 
months after the SEC gave Putnam a clean bill of health. Only a few 
weeks later, Putnam reached a partial settlement of the securities 
fraud charges with the SEC which did not include the Commonwealth of 
Massachusetts. Under the settlement, Putnam agrees to make restitution 
only for losses to investors attributable to excessive short-term and 
market-timing trading by its employees and to make structural reforms. 
Under the agreement, Putnam neither admitted nor denied wrongdoing and 
the SEC still has not investigated whether outside investors were 
engaged in market-timing activities. New York Attorney General Eliot 
Spitzer said that Putnam's agreement with the SEC does not address 
crucial issues involving restitution to fund holders, fees and 
penalties. William Galvin, the Massachusetts Secretary of State said 
that the agreement clearly demonstrates that the SEC is more interested 
in protecting the mutual fund industry than the average investor.
  These actions by the SEC highlight a fundamental problem in the Bush 
Administration's hands-off approach to regulating financial markets and 
the danger it poses to small investors and the national economy.
  Compounding this danger and lack of responsible leadership, President 
Bush has repeatedly nominated individuals to important economic 
positions notable for their corporate sympathies. The President 
selected a lobbyist for financial deregulation as the chief regulator 
of the federal mortgage lender Freddie Mac. His first SEC chairman was 
an accounting industry who was forced to resign in a storm of public 
outrage over his lenient treatment of his former business.
  Even after the accounting scandals that felled Enron and WorldCom, it 
was last year's Democratic Senate that pushed to enact an historic 
corporate reform law and the President who joined the effort only once 
its passage was all but ensured. It was state attorneys general who 
exposed dubious conflicts of interest at brokerage houses. And when 
energy companies gauged ratepayers in the West through questionable 
trades, the Administration sat on its hands for months.
  The message from the White House to the regulatory agencies, in 
actions if not words, is don't ask and don't tell when it comes to 
protecting investors and consumers.
  Justice demands that we fully prosecute Wall Street insiders that 
steal from Americans saving for retirement, education or simply a 
brighter future. And we can only hope to revive our economy if we 
restore investor confidence in the markets so that capital flows to 
business growth and job creation.
  To stop the erosion of trust in our financial markets and to help 
restore the American investor's faith in the mutual fund industry, I am 
introducing the Mutual Fund Investor Protection Act to update federal 
securities laws to curb late-trading and market-timing abuses and 
institute new limits on mutual fund fees paid by investors.
  The actions by the SEC show that it is incapable of protecting 
investors from securities fraud by mutual fund companies and will not 
prosecute this type of fraud to the full extent of the law. Therefore, 
we must take the day-to-day oversight of mutual funds away from the SEC 
and develop a new Mutual Fund Oversight Board to provide oversight, 
examination and enforcement of mutual funds. This new board will be 
similar to the Public Company Accounting Oversight Board developed in 
the Sarbanes-Oxley Act. It will be charged with identifying potential 
problems in the mutual fund industry and ensuring that fund boards are 
actively addressing these problems--before they spread. It would 
promulgate guidance regarding current regulatory issues and best 
practices regarding how to deal with them, and it would examine mutual 
funds to ensure that they are taking necessary steps to protect 
shareholders. The Board itself would determine how to provide an 
adequate and reliable source of funding for its investigations.

  I believe that every investor has the right to know how much their 
mutual fund takes away from their investment to pay for advisory, 
management, and investment service fees. Under this legislation, each 
investor will receive in their statement a regular accounting as to 
what types of fees they are paying to invest in their mutual fund. This 
will help investors shop around and find the mutual funds that have the 
lowest fees. Mutual funds will have to respond to the changing 
marketplace and only charge fees that are absolutely necessary to the 
management of the fund. Also, this legislation requires mutual fund 
managers to negotiate fee contracts that are reasonable and in their 
investors' best interest and to report on any significant or material 
business or professional relationship with companies that the mutual 
fund provides contracts. Finally, the bill requires each mutual fund to 
hire a compliance officer to ensure that the mutual fund complies with 
all relevant laws and makes sure that they provide any information on 
scams to the independent mutual fund directors to stop abuse. Taken 
together, these provisions will help investors by making it much more 
difficult for mutual funds to charge unreasonable and unnecessary fees.
  Today, mutual funds are valued once a day, called the Net Asset Value 
or NAV, usually at 4 p.m. EST, when the New York market closes. The 
bill will require that all mutual fund companies receive an order prior 
to the time the fund sets a share price or NAV for an investor to 
receive that day's price. This will make it much more difficult for big 
investors to use brokers to send in trades after the 4 p.m. deadline.
  We should include late-trading laws as an offense under the Racketeer 
Influenced and Corrupt Organization (RICO) provisions of the criminal 
code. First used to prosecute the Mob, RICO should now be used to stop 
and punish organized crime on Wall Street. This will help limit mutual 
fund employees and big investors from attempting to defraud small 
investors. It will also help investors who lose money due to late-
trading schemes to recover treble damages, costs and attorneys' fees.
  The SEC recently found that many mutual fund companies and brokerage

[[Page S15985]]

firms had arrangements with big investors allowing them to make market-
timing trades even though these fund companies have policies 
specifically barring market timing. My legislation bars mutual fund 
employees from engaging in market timing trades. It requires each 
mutual fund prospectus to explicitly disclose market-timing policies 
and procedures to stop abuse. Then, it increases penalties for mutual 
funds which do not follow their own policies and procedures to limit 
abuse.
  In order to help stop mutual fund abuse, this legislation increases 
the penalties and jail time for current securities laws including: 
defrauding the offer or sale of securities, failing to keep current and 
appropriate records of brokerage transactions, and not selling or 
redeeming fund shares at a price based on current Net Asset Value 
(NAV). These changes will make criminals think twice before committing 
violations of securities laws. The proceeds of the additional fines 
collected by this legislation will be put into a fund to assist the 
victims of their crimes.
  Today, individual mutual funds are effectively dominated by their 
advisers. My legislation strengthens the influence of independent 
directors on fund boards by requiring that independent directors 
comprise at least three-quarters of the board. It will also require 
mutual funds to have an independent chairman with the authority and 
ability to demand and receive all information from the fund advisory 
and management companies. This will increase the voice investors have 
in fund management and limit mutual fund abuses.
  By developing a new structure to provide appropriate oversight and 
enforcement mechanisms to fight abuse in the mutual fund industry, this 
legislation restores the confidence of investors in mutual funds. 
Ultimately, investor confidence will increase investment and enhance 
economic growth. I ask all my colleagues to support this 
legislation.
                                 ______