PERSONAL TRADING RULES
I was delighted the Association for Investment Management and Research wrote to Pensions & Investments (Letters to the Editor, May 4) regarding my recommendations (Others' Views, April 6) for ending personal trading abuses by mutual fund money managers. I was disappointed the Investment Company Institute did not step forward to publicly state its position. Both of these organizations have consistently opposed any further regulation of personal trading by money managers. AIMR is, as its president points out in his letter, an association of investment industry insiders. The ICI is a mutual fund trade group and lobbyist for the mutual fund industry. While both organizations may from time to time make recommendations to the SEC that benefit investors, neither is an "investor advocate." Investors must keep this fact in mind in analyzing their conclusions.
Mr. Bowman's letter is misleading where he describes AIMR as an investment professional organization that also acts as an "investor advocate." You can't be both -- that is an obvious conflict of interest. The objective of his letter seems to be to defend the ethics of mutual fund professionals and to deny that the industry has any problems in this area. That is consistent with his organization's agenda but is hardly what an investor advocate would be concerned with.
Bowman's statement that an AIMR task force consisting of industry insiders concluded the industry did not need to be further regulated is hardly persuasive. The ICI study he refers to involved the ICI members supplying data regarding personal trading by mutual fund employees on the basis that it would be reported to the SEC in an aggregate fashion only, without identifying the specific mutual fund complexes or companies. As recent revelations regarding the tobacco companies have made abundantly clear, the most sensitive data regarding personal trading violations and investigations would obviously have been withheld from such an industry survey on the basis that such information was subject to the attorney-client privilege. This type of sensitive information mutual fund complexes would not share with even the ICI, which represents all its members. Therefore, the industry's data is no more reliable than the data companies in any industry share with the general public or their regulators.
Nevertheless, even the ICI and AIMR concluded that mutual fund complexes should strengthen their internal codes of ethics beyond what is required by the federal securities laws in order to ensure investors are not harmed by personal trading activity. Curiously, neither organization recommended securities laws themselves be changed to require such strengthened codes. The apparent reason these industry groups have not supported strengthening the laws in this area, even while they recognize that the existing laws do not adequately protect investors, is because some of their membership want to be able to continue personal trading which is harmful to investors and would not be permitted if the laws were strengthened. Mr. Bowman mentions that most mutual fund managers strengthened their internal codes of ethics following ICI and AIMR recommendations. Don't investors have the right to know which ones did not?
Under current law investors are not permitted to see the codes of ethics their managers have adopted and compare one manager's ethical standards against another's.
Despite any reassurances from the mutual fund industry you may have heard, money managers trading for personal profit is commonplace. How does personal trading by money managers benefit investors? It doesn't. It is tremendously harmful to investors and undermines the fiduciary relationship between manager and client. Violations of internal codes are rampant in some mutual fund organizations and violators are rarely meaningfully punished. Few investment management insiders have ever conducted internal investigations of massive trading violations to even begin to understand the complexity of the issues involved and the harm to investors that can result from such activity. Even the SEC is struggling with how to ensure that today's large global money management firms, trading from offices around the world in different time zones, can ever adequately enforce a code of ethics that would protect clients.
As I have said before, today mutual fund managers and mutual fund board of directors selected by the managers are the only parties involved in determining the rules by which money manager personal trading will be governed. Enforcement of the rules is weak due to the conflicting loyalties of internal compliance personnel. Here again are my recommendations for what is needed to protect investors from money managers personally profiting at their expense:
1. The SEC should establish clear minimum personal trading standards every money manager would be required to follow.
2. Mutual funds should be required to provide to investors, upon request, a copy of the codes of ethics their boards adopt so investors can compare manager ethics.
3. Funds should be required to disclose to investors any violations of their codes by managers and any action taken to address these violations. This would enable investors to determine whether managers are seriously punishing violators.
4. Disclosure of the risks related to manager personal trading should be required in mutual fund prospectuses.
These recommendations would ensure that managers would become publicly accountable for ethical standards they adopt. There would be no more secrets, and managers who did not follow the highest ethical standards would be forced to publicly defend their actions. It is impossible for me to understand why an "investor advocate" would ever oppose these recommendations. Perhaps AIMR or the ICI can articulate how investors would be harmed if these recommendations became law.
My final recommendation is the SEC unambiguously state whomever is responsible for monitoring personal trading within a mutual fund company has a paramount duty to protect the shareholders of the fund. Money managers should be specifically precluded from asserting the attorney-client privilege to prevent disclosure of violations. Mr. Bowman again misses the point when he states "the codes of ethics of many mutual funds require the fund's compliance officer to report to the fund's board any material violations." The point is that there is no such legal requirement and many managers do not have such a provision in their codes.
Furthermore, such a provision does not preclude a manager from asserting the attorney-client privilege to prevent disclosure of internal violations. Mr. Bowman's bold assertion that "when in-house counsel is responsible for monitoring personal trading of the fund manager, the counsel's duty is to the fund and its shareholders" is unsupported in case law. There is no precedent for such a statement at this time; hopefully one will emerge in the near future.
Edward A. H. Siedle
Lighthouse Point, Fla.
P&I's Feb. 23 editorial, "Outsourcing rival," states "outsourcing is no panacea. Its track record compared with traditional corporate pension management is too new to judge."
I certainly agree with the first statement, and have another view about the second. At Russell, we have been providing outsourcing -- or strategic relationships, as we prefer to call them -- since we entered the investment management business in 1980. Many of our first clients were strategic relationships and remain so today. We now have strategic relationships with about 100 organizations and $9 billion in assets. Still it's no panacea, as most of our clients continue to use other managers as well.
Why do strategic relationships make sense for some plan sponsors but not for others? Strategic relationships are most appropriate for plans whose need or preference is to concentrate on their core business. Our firm is a manager of managers. We select and manage well-diversified portfolios of outside managers in all major asset classes. Plan sponsors get access to top investment talent, in portfolios that are structured to control style and other key factor risks. So plans get the convenience of having to manage only a single relationship, without having to put all of their eggs in the basket of a single organization.
It's a compelling solution. But what about plans that have investment expertise internally or existing relationships with providers that they want to continue? Those conditions are true of the majority of our client base. To us, these are not "outsourcing rivals"; they are plans who may choose to expand their relationship with us at some time in the future, if we do well and it meets their needs to do so. The objective of the strategic relationship is simply to fill in where the plan sponsor needs help and let them focus on the areas where they excel.
That's what we've been doing for the last 18 years. Which brings me back to the other point about the lack of a track record for outsourcing: We'd be happy to share performance actually received by our clients with any plan sponsor that would like to compare our results with that of traditional corporate pension management.
Kelly L. Haughton
Frank Russell Trust Co.