New Report Urges SEC To Improve Fund Oversight

by Glen Shapiro, LawAndTax-News.com, New York

22 September 2005

Congressmen Paul E. Kanjorski (D-PA), the most senior Democrat on the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, and Barney Frank (D-MA), the Ranking Democratic Member of the House Financial Services Committee, on Monday released a report by the Government Accountability Office (GAO) which states the need for the Securities and Exchange Commission (SEC) to improve oversight of the mutual fund industry.

According to Kanjorski and Frank, the report raises "very troubling issues about the adequacy of the SEC’s inspections of both mutual funds and sales of mutual funds by broker-dealers".

In releasing the report, both Congressmen called upon the Commission to improve its oversight of the mutual fund industry and better protect American investors.

“State regulators, rather than the experts at the SEC, were the first to uncover abuses in the mutual fund industry in 2003. The SEC has fortunately taken important actions since then to better protect investors,” noted Congressman Kanjorski. “This GAO report, however, confirms my long-held suspicions: more can be done and more should be done to protect American investors, especially when nearly half of all U.S. households now own mutual funds.”

The GAO report, entitled 'SEC’s Revised Examination Approach Offers Potential Benefits, but Significant Oversight Challenges Remain', was requested in the wake of a series of abuses by mutual funds that were not identified by the SEC.

Conclusions reached by the report included that:

• The SEC has shifted resources from routine exams of funds to “targeted” exams on specific risks, with comprehensive exams to be conducted only on funds considered to be “high risk.” Funds considered to be lower risk may not be examined for 10 years or more;
• Planning for inspections, supervisory review, and quality control generally were found to be weak. The SEC has no mechanism for tracking results to spot general problems; and
• SEC exams of broker-dealers, which are intended to assess the quality of the self-regulatory organization (SRO) exams, are not conducted in a way that allows meaningful assessment of those exams. Further, because the SEC does not track the scope of work done in its exams, it cannot determine the extent to which broker-dealer exams actually cover mutual fund sales practices.

In addition, the GAO report concluded that mutual funds now hold roughly $8 trillion in assets, or almost twice the $4.5 trillion in insured deposits held by commercial banks, but the SEC has significantly fewer examiners relative to the number of investment advisors and fund complexes it regulates.

The study also observed that these resources may be further strained as the SEC undertakes regulation of the hedge fund industry, which will increase the number of registered advisers by an estimated 8 to 15 percent.

The GAO report made four specific recommendations to the SEC to better protect investors. Both Congressmen have urged the new leadership at the SEC to implement these prudent reforms expeditiously.

The first two recommendations are designed to help ensure that the Commission is using its limited resources effectively to oversee mutual funds and broker-dealers selling mutual funds. The additional reforms are aimed at improving the quality of mutual fund examinations and to enhance the oversight of SROs, primarily the NASD and the New York Stock Exchange, conducting exams of broker-dealers selling mutual funds.

“The GAO has proposed a set of common-sense, practical recommendations that represent important steps toward improving the quality of SEC examinations of mutual funds and broker-dealers,” concluded Congressman Kanjorski. “This is an area where we will need to pay close attention in the future to ensure that the SEC’s examinations can identify the true risks of the funds it oversees.”

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