Curbing Mutual-Fund Follies

The solid program that the Securities and Exchange Commission set forth to combat unethical and illegal practices in the mutual-fund industry is welcome, if overdue.

The $7-trillion industry - in which half of all American households invest - is reeling from charges that funds allowed unethical or fraudulent "market timing" and illegal late trading. The first involves rapid buying and selling of fund shares that raises costs and hurts performance. The second involves back-dating orders submitted after the final bell to make it appear as if they arrived during trading hours.

The scandal, resulting from investigations launched by New York Attorney General Elliott Spitzer and the SEC, has already cost some 50 mutual-fund industry employees their jobs - including Putnam Investments chairman Lawrence Lasser and Strong Financial Corp. owner Richard Strong. In the latest move, regulators filed civil fraud charges against Invesco Fund Group, charging it encouraged market timers in violation of company rules.

In response to the revelations, the SEC announced Wednesday a series of proposed reforms to combat the abuses and illegalities:

• It would require buy and sell orders to be in by 4 p.m. Eastern time - although this may be relaxed a bit if funds can devise a way to prove investors placed orders before then.

• It would require funds to hire a compliance officer who reports directly to the board of directors, not fund management.

• It will soon consider new rules requiring funds to disclose their policies on market timing, release of portfolio information, and fund managers' private trades.

• It will consider in February imposing a 2 percent redemption fee when shares are sold within five days of purchase, to discourage market timing.

Many believe, rightly, that regulators should also examine a type of overhead fee (called 12b-1) that can cost investors far more than market-timing.

In its belated but laudable zeal to protect investors, however, the SEC must be careful not to raise mutual funds' costs so that investors lose as much as they would lose from the abuses regulators are trying to prevent.

Still, trust is the most precious commodity the market has. Restoring and protecting that trust must be the No. 1 goal of regulators, industry managers, and Congress as market reforms proceed.