Galvin slams fund industry in testimony

In testimony before the Senate Governmental Affairs subcommittee on financial management, Galvin said the mutual fund industry is "putting its own interest ahead of their customers." Fund officials are delivering "deceit and underperformance," Galvin said, as they "quietly tolerate known market abuses while they parse words trying to describe clearly unethical practices as not illegal."

Galvin endorsed legislation introduced by US Representative Richard H. Baker, a Republican of Louisiana, called the Mutual Funds Integrity and Fee Transparency Act.

US Senator Peter J. Fitzgerald, an Illinois Republican and chairman of the Senate subcommittee conducting the hearing, said "it is time for a wholesale reexamination of how mutual funds are organized and managed."

He referred to the mutual fund industry as "the world's largest skimming operation," and said market timing and late trading "transformed this once sleeping industry into a monster." He advocated across-the-board "disclosures" of broker compensation fees, and recommended "at least 75 percent of funds' directors become independent" of the investment managers.

US Senator Susan M. Collins, Republican of Maine and chairwoman of the Senate Governmental Affairs Committee, said there is an increasing record that "officials benefited personally from market-timing" trading activities.

Galvin said that with one-half of all American households owning a total of $7 trillion in mutual funds, investors are placing their trust in mutual fund managers and expect to be "treated fairly." But he said he has discovered a "common theme" of fund managers taking steps to allow investors to be cheated. He said the federal government needs "aggressive enforcers," and Congress should be able to "convert investor outrage to a call for action."

The Baker bill requires disclosure and review by the board of directors on all soft-money commissions -- a controversial practice in which funds compensate research and services with commissions on stock trades. But Galvin said such commissions "should be banned." Critics say soft dollars result in inflated commission charges that are unfair to investors.

The bill also would require mutual funds to make quarterly disclosure statements of operating expenses and how they calculate and award commissions for portfolio managers. The legislation would require disclosure of payments outside the company intended to facilitate the company's shares, and information on discounts on front-end sales loads for which investors may be eligible.

Mutual fund boards would be required to supervise investment advisers, and audit procedures would be strengthened.

Spitzer said an estimated $10 billion could be channeled back to American consumers by setting the management rates for mutual funds at the same lower level as those for pension funds. That would total $6,000 over a 10-year period for an individual who held $100,000 in mutual funds.

"The rules are clear," Spitzer said. "The problem has been a failure of compliance; conduct that was not caught should have been caught, and will now be aggressively prosecuted." He said the penalty now should be "big; it will impose pain, and it should."

Much of the problem has been in overlapping boards of directors and in hidden compensation for fund managers that works to the detriment of individual investors.

There's "no question at all that boards of directors have been inert and they have been passive and they have failed," Spitzer said. "They have not been responsive to the appropriate parties."

(States News Service reporters Myron Struck, Nathan Santamaria, and Carolyn Polinsky contributed to this report.)