Mutual Fund Fraud

Mutual Fund Fraud Related Information:

Mutual Funds have long been an area for investment for millions of Americans who wished to make their money work for them, but weren’t able or could not afford to diversify and lower their costs. Through mutual funds, people could join their resources and make their collective funds work towards benefiting everyone. But even this area of investment, which is one of the best investment products available to investors, has now been tainted by Mutual Fund Fraud.

Committing Mutual Fund Fraud

Recently, the Securities and Exchange Commission (SEC) of the US has unearthed many instances of mutual fund fraud, which involves unethical and illegal practices by leading mutual fund companies in the US.

A mutual fund is controlled by its board of directors, who have the sole and final authority to choose investing officers to invest the monies collected by the fund. More than 80% of the mutual funds; have as the chairman of their board of directors, an insider or a relative/acquaintance of the investing officer or firm. Thus it is very easy for them to indulge in unethical practices and actions that hurt the fund, but give the managers huge profit margins.

How Mutual Fund Fraud Works

There are many illegal practices which are being used in mutual fund fraud. These are:

• Preferential Treatment: Many mutual fund managers have tie-ups with certain brokers and brokerage houses, who ‘sell’ these funds to their customers, in exchange for some commission or other payments receivable from the fund. This is known as revenue sharing and is not an illegal practice as such, but has to fully be disclosed to the fund investors. Many mutual funds do not follow the legal rules for the disclosure of such payments, because of increased payments, which are designed to fill their own coffers, while defrauding the mutual fund investors.

• Late Trading: The prices of mutual fund shares are fixed at the time of closing of trading, which is 4.00 pm each day. It is illegal to trade in mutual fund shares after this time. But some companies allow insiders or valuable clients to indulge in late trading and take advantage of events that occur after the markets close, but which are not reflected in the price of the mutual fund share as this is set at the close of the markets at 4.00 pm.
• Timing the Markets: This is another practice that is unethical and is being used to commit mutual fund fraud. People who ‘time’ the markets, indulge in quick buying and selling of the mutual fund shares at stale prices (buying after market closes) and then selling the shares for a profit, on the next day when the market opens. Such practices are carried out by directors of mutual funds, who have insider information, and end up defrauding the long term investors. When short term buying and selling (‘timing’) is allowed, it depletes the value of the entire fund, and thus the value of the shares held by long term investors is also lowered.

Protecting Against Mutual Fund Fraud

The SEC has passed new rules and regulations, which alters the requirements of the board of directors of mutual funds. The chairman now has to be an independent and not an insider, and the board has to be made up of 75% of independents, and not just a ‘majority’. These rules have been passed to protect investors from mutual fund fraud.

Although all mutual funds claim that they disallow and are not engaged in fraudulent activities, such as late trading and timing, the only way for investors to protect themselves is to thoroughly investigate all mutual funds before making their investments.