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SEC Seeks More Director Review of Fund Ads


Mutual fund directors do a good job monitoring fund advisers on matters required by law but should expand their oversight in several ways, a recent SEC examination of fund directors' practices suggests.

An SEC examination of fund directors' practices indicates that directors could do more to oversee mutual fund advertising and a handful of other fund practices, said Lori Richards, director of the SEC's office of compliance, inspections and examinations. The examinations, conducted randomly by the SEC last year, found that relatively few boards review fund ads, Richard said. The SEC wants fund boards to take a greater role in overseeing advertisements, she said.

"Boards should understand how the fund is placing itself before the public eye," Richards said.

Richards make her remarks during a panel discussion and subsequent interview at the 2000 Mutual Funds and Investment Management Conference in Palm Desert, Calif. recently. The conference was sponsored by the Federal Bar Association of Washington and the Investment Company Institute.

The SEC undertook the review of fund boards after Arthur Levitt, chairman of the SEC, in March 1999 announced a series of initiatives designed to increase fund directors' independence from fund advisers. Examiners from the SEC's compliance office reviewed practices for fund boards at approximately 50 fund complexes between April 1999 and July 1999, Richards said. The examiners checked the practices that boards used for the 12 months before the exams, she said.

About two-thirds of fund boards had general discussions about marketing plans, sales and redemptions, Richards said. But only a small number actually reviewed fund ads, she said. The precise number of fund boards that conducted reviews was not available. The SEC wants all fund boards to review ads, Richards said.

The SEC also would like fund boards to consider compliance as a separate agenda item for board meetings, Richards said. Although boards discuss a variety of topics that include compliance issues, only 19 percent of the boards the SEC reviewed during the sweep discussed compliance as a separate agenda topic, she said.

Fund boards also should review how fund performance was achieved, Richards said. The SEC examiners found that only 38 percent of those boards reviewed whether fund performance was achieved by investing in a manner consistent with the fund's investment objectives, she said.

The compliance office will present the findings from its exams to the SEC commissioners and the SEC's division of investment management, Richards said. It is unclear if the SEC will make a report public or issue guidance based on the examiners' findings, she said.

At the conference, SEC officials provided some insight into how they schedule exams and what factors lead SEC compliance regulators to forward potential problems to the agency's enforcement lawyers for further investigation.

The compliance office gives funds and fund advisers two to three weeks advance notice before most examinations, Richards said. As part of the advance notice, the SEC asks for a computer disk that provides details of trading information that SEC examiners can review prior to the on-site examination, she said.

The SEC gives no advance notice to new fund advisers that have not been examined previously, Richards said. It also does not give notice on so-called cause exams, those on-site inspections that occur after the SEC has had some indication that a fund or fund adviser may be following some questionable practice.

Richards also identified practices that are referred to the enforcement lawyers for investigation. Those practices include:

* Questionable allocations of initial public offerings;

* Apparent inappropriate use of soft dollars;

* Investing inconsistent with a fund's investment strategy;

* Pricing and net asset value problems;

* Unusual personal securities transactions by company insiders such as investing ahead of a fund, known as front running.

Examiners also are more likely to refer for enforcement, problems identified during previous exams that have not been corrected by the time of a subsequent exam, Richards said.