Mutual Fund Trading Abuses: SEC Consistently Applied Procedures in Setting Penalties, but Could Strengthen Certain Internal Controls
Highlights
The Securities and Exchange Commission (SEC) and other regulators have recently identified two significant types of trading abuses--market timing and late trading--in the mutual fund industry. The more widespread abuse was market timing, which involved situations where investment advisers (firms that may manage mutual funds) entered into undisclosed arrangements with favored customers who were permitted to trade frequently in contravention of stated trading limits. These arrangements harmed long-term mutual fund shareholders by increasing transaction costs and lowering fund returns. Late trading, a significant but less widespread abuse, occurs when investors place trades after the mutual fund has calculated the price of its shares, usually at the 4:00 p.m. Eastern Time close of financial markets, but receive that day's fund share price. Investors who late trade have an opportunity to profit, which is not available to other investors. To assess SEC's efforts to impose penalties on violators, this report (1) discusses SEC's civil penalties in settled trading abuse cases, (2) provides information on related criminal enforcement actions, and (3) evaluates SEC's criminal referral procedures.
Recommendations
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| United States Securities and Exchange Commission | To strengthen SEC's management procedures and better ensure that agency responsibilities are being met, the SEC Chairman should ensure that the agency document informal referrals to criminal authorities for potential criminal prosecutions and the reasons for such referrals. |
Closed – Implemented
SEC implemented a new computer system to manage investigations, which includes a field for noting referrals.
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| United States Securities and Exchange Commission | To strengthen SEC's management procedures and better ensure that agency responsibilities are being met, the SEC Chairman should ensure that the agency request that departing employees provide the name of their next employer as part of exit procedures and establish procedures to review the departing employees' related work products if a potential conflict of interest is determined to exist. |
Closed – Implemented
SEC developed questions to be included in its employee exit questionnaire which request information on employees' future employers.
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