Mutual Funds: Does Washington Need More Cops On The Beat?

Mutual funds have been riding the crest of spectacular growth. Lured by the prospect of dazzling yields, investors have forsaken the security of federally insured deposits and pumped a staggering $2.1 trillion into funds. Three recent controversies, however, threaten not only to undermine public confidence in the mutual-fund industry but also to embolden Congress to impose regulations whose cost would ultimately be borne by investors.

To discourage an overreaction by lawmakers, the Securities & Exchange Commission wants to expand its monitoring of the funds. But that move is likely to founder in Congress, which is reluctant to give SEC Chairman Arthur Levitt Jr. a bigger budget. That gives the industry an opportunity to clean up its own act. Indeed, the funds are eager to take advantage of the chance because they know the price of doing nothing could be investor flight and congressional meddling.

SCARE STORIES. The trouble began in January when Denver-based Invesco Fund Group Inc. fired a star portfolio manager for allegedly failing to report personal trades. That set off a firestorm by bringing to light a common but little known industry practice of letting managers trade for their own accounts. Next came reports of major derivative-trading losses, triggering scare stories about the safety of funds heavily involved in these financial instruments. Then, in June, Fidelity Investments, the largest mutual fund manager, admitted that it reported day-old prices for some funds.

The biggest headache for now involves derivatives, which are based on movements in stock, bond, and currency prices. Many funds plunged in value this year as an unexpected hike in interest rates hit derivatives hard. Levitt promptly told the industry to produce a plan to dump the riskiest securities.

Some members of Congress are alarmed about the use of derivatives because they pose huge risks in money-market funds--which investors consider as stable as bank accounts. The potential for shaken public confidence has spurred the SEC to consider restricting derivatives. "We're nervous, but not panic-stricken," says SEC Commissioner Richard Y. Roberts.

The industry, keenly aware of its need to preserve public faith, is rushing to fix its problems. It has adopted new restrictions on personal trading, taken steps to improve daily price reporting, and is working on new derivative rules.

Still, that's just a start. The SEC wants more accountability. For example, by the time regulators receive semiannual reports, the information is outdated. But the SEC won't seek these changes soon because it doesn't have the staff to process loads of new data. Why? Its resources haven't kept pace with the industry's growth. There are just 180 examiners for 5,000 funds, and plans to hire 100 more examiners by 1996 mean funds would be examined only every two or three years.

To grow, the SEC wants to keep all industry fees it collects, a change approved by the House. But the Senate wants to keep spending most of the corporate fees elsewhere. If the SEC's budget restraints persist, Representative Edward J. Markey (D-Mass.), head of an SEC oversight subcommittee, is threatening to push a bill that could establish a mutual-fund self-regulatory agency.

To be sure, the industry's admirable record until now lends scant support for overhauling a regulatory system that has worked since 1940. But without better oversight, a new bureaucracy is just what the funds may get. The alternative is worse--shrinking assets in an industry that of late has known only expansion.

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