Securities reform to have real impact

By DAVID MOON, Moon Capital Management
November 30, 2003

After weeks of claiming a victim or two every day, the mutual fund scandal has its first fatality. Because it allowed certain institutional investors to 'late trade' various mutual funds, Security Trust Co. will be dissolved by March 31, 2004. Two of its executives face criminal charges.

This is the kind of securities reform that will have a real impact.

Security Trust Co. (STC), a Phoenix-based company, processes mutual fund orders on behalf of 2,300 different retirement plans across the country. By allowing some institutions to make mutual fund purchase and sale decisions after the 4:00 PM market close, STC allowed favored investors to reap profits that should have been allocated only to the folks who owned the funds when the markets closed.

These late trading profits came directly out of the pockets of the shareholders of those funds. If you feel some sense of comfort because you have never heard of Security Trust, think again. Their clients are all over the country, including in east Tennessee. It is possible you are a Security Trust client and don't know it.

However, your retirement plan doesn't have to use STC for you to be a part of this scandal. Any shareholder of a mutual fund in which STC facilitated late trading was damaged. It doesn't matter if the fund company had any idea STC was helping some evil hedge fund manager abscond with mutual fund shareholders' money. (STC even had a formal agreement to receive a fixed split of these ill-gotten gains.) Millions of investors suffered a diminution of their investment returns as a result of these illicit (and likely illegal) actions. Sadly, few investors even realize it.

The big question is how to prevent - or more quickly expose - these types of activities in the future. Not since the 1960s have investors had any widespread reason to question their unfailing faith in the mutual fund system. For forty years the industry has grown to become among the most powerful forces on Wall Street. But it is clear that the regulation of the system is broken. Last week, the US House of Representatives passed a bill making it a crime for a mutual fund executive to "time" his own mutual funds. But the ideal solution doesn't involve more rules; after all, what many of these people did was already illegal. Many fund company executives were behaving in a manner exactly contrary to their stated public missions.

Giving the Securities and Exchange Commission a bunch more rules to enforce won't solve this problem. Nor will it prevent other similar problems.

If the city of Knoxville has a problem with too many people speeding through town, passing a bunch of new lower speed limits won't fix anything. But if you put more police cars on the roads, write more tickets and put the deserving speeders in jail, watch the cars slow down.

That's what we see happening with STC ' and this type of reform will work.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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