Mutual Funds: It Gets Worse

The mess in mutual funds goes from bad to worse, and the big loser is the small investor. Many fund companies have been underinforming and overcharging their customers for years, but the latest news is still shocking. Late trading and market timing, which bolster the profits of a few large, short-term trading investors, invariably dilute the profits of millions of small, long-term investors. In their rush to increase their asset base -- and fees -- mutual-fund managers and owners have clearly turned a blind eye to practices that are either illegal or breach their own bylaws. It is past time for the Securities & Exchange Commission and the funds' own trustees to step up to their responsibilities.

The list of mutual-fund misbehavior is long and growing. Paradoxically, the latest round of misconduct may be easier to clean up than others that have plagued the industry. Allowing big investors to trade in mutual funds after hours is simply against the law. So brokerage houses that do it, and mutual funds that condone it, should be busted. Practicing market timing is not illegal per se, but it often undermines the long-term profits for everyone else. Nearly all mutual funds ban it in their prospectuses. But clearly some managers are making exceptions for those who offer to deposit large amounts of money in the funds in exchange for the privilege. This, too, can be easily corrected by just enforcing the written rules of the funds. Funds also may have to reimburse investors for loses due to dilution and extra capital-gains taxes they pay.

The harder task ahead may come in cleaning up the structure of the industry. High compensation paid to mutual-fund managers regardless of performance, high fees, and excessive costs have seriously eroded investor returns for far too long. Worse, under the infamous 12(b)-1 rule, investors even have to pay a fee for the funds' own marketing and advertising costs. This is absurd.

What should be done? Public and private overseers of mutual funds have to insist that funds publish quarterly figures that clearly show how much investors are paying in fees on their accounts. Perhaps the light of day will generate sharper competitive pressures and lower costs. Investors also deserve to know how well their mutual-fund managers are being compensated. And the SEC must finally abolish the 12(b)-1 rule.

The mutual-fund industry has lost its way. In its search for assets and fees, it has betrayed the multitude of smaller investors to favor a few high rollers willing to break the rules, if not the law. With the economy finally catching fire and the stock market moving higher, Americans need to feel confident that they will be treated fairly and honestly when they invest. There is no time to waste.

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