The frauds plaguing the mutual fund industry were not foreseeable.
The frauds were not only foreseeable, but they were, in significant
respects, widely known. Articles about arbitrageurs exploiting stale fund prices
had been published for years, including two that I wrote that were cited by New
York State Attorney General Eliot Spitzer in his complaint against Canary
Capital [a New Jersey-based hedge fund], yet the SEC never took any steps to
address this widespread and well-known problem. The SEC chairman has admitted
that the SEC was not even inspecting for late trading or market timing. It is
eminently foreseeable that when regulators ignore potential abuses, those abuses
will occur.
Now that the trading abuses have been identified, regulators can eliminate
them.
As noted above, many of the trading abuses were common knowledge before
Eliot Spitzer filed his first complaint, yet the SEC had not taken adequate
steps to address them. Thus, there unfortunately is no historical basis for
assuming that the SEC will ensure that these and other abuses are eliminated,
although the SEC has vigorously prosecuted a number of wrongdoers in connection
with the current scandal. For example, the SEC continues to ignore sales abuses
that exist, in part, because of the lax SEC standards under which brokers
operate. Legislation and constant vigilance by investors, state regulators and
Congress are necessary to ensure that the SEC fulfills its responsibilities to
the investing public.
The SEC comes down hard on violators.
Sometimes the SEC comes down hard on violators, but sometimes it is
inexplicably soft on them. For example, when the SEC settled with the
independent directors of the Heartland Funds [the Milwaukee-based mutual fund
company], the SEC let them off with only a cease and desist order, the lowest
possible form of penalty, and even permitted them to retain directors’ fees
earned while the case was pending. These directors oversaw the worse case of
mispricing in the history of the industry, in which some investors lost 70
percent of their retirement funds in one day. This pattern has continued through
the current fund scandal, where not one independent fund director has been
charged with any wrongdoing by any regulator—state or federal.
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