Details of widespread trade abuses in US mutual funds have emerged in testimony before Congress in Washington in the past two days, shaking the faith of 95 million Americans who regarded the funds as safe and conservative havens for investment.
In evidence to Senate and House committees, the Securities and Exchange Commission (SEC) has disclosed that a quarter of the US's largest brokerage houses helped favoured clients trade mutual funds illegally after hours.
The scandals, said Republican Senator Peter Fitzgerald, involved "serious, wholesale criminal violations". The SEC began investigating fraud in mutual funds in September and several top firms have since been subpoenaed, including Janus Capital Group, Fidelity Investments and Morgan Stanley. Federal regulators say the $7 trillion (€6.1 trillion) industry faces a wave of legal suits for overcharging customers.
The disclosures have created turmoil in the funds industry. Mr Lawrence Lasser, the top executive of Putnam, the fifth-largest US mutual fund firm, was ousted on Monday after disclosures that six of its employees had made $700,000 in timing trades. Timing involves taking advantage of disparities between a fund's share price and the values of securities in its portfolio, and reduces the potential profit of long-term investors.
The head of the SEC's New England regional office, Mr Juan Marcelino, also said he would step down after his office failed to follow up allegations of civil fraud in Putnam. Public pension funds in six states and New York city have been instructed to stop using Putnam as a fund manager.
The National Association of Securities Dealers has disclosed that investors in mutual funds were defrauded of an estimated $86 million of discounts on fund commissions during 2001 and 2002. Mr Stephen Cutler, director of the SEC division of enforcement, told a Senate panel that "as my colleagues and I have gathered evidence of one betrayal after another, the feeling I'm left with is one of outrage".
Over 25 per cent of brokerage firms, it has emerged, allowed clients to place potentially illegal late orders for mutual-fund shares at the 4 p.m. closing price on Wall Street, a practice likened by one analyst to betting on a horse after the race is won. The SEC said one in four brokerages and 10 per cent of funds surveyed even invited outside investors to come in and conduct improper trading.
Mr Eliot Spitzer, the New York State attorney-general who has aggressively forced the pace of the federal inquiry, said a major problem was lax oversight by directors of mutual fund firms.
In another disclosure Massachusetts regulators are likely to charge Prudential Securities of doing nothing to curb market timing activity by its brokers, despite 25,000 warning letters from mutual-fund firms.
