This is what amounts to the wild side of Wall Street in the 1990s. It’s not yet clear bow widespread these new abuses are, but one thing is evident: despite its promises after the 1987 stock-market crash, the securities industry has failed to police itself adequately. Now, after years of waiting for changes from within the industry, Congress and the Securities and Exchange Commission are at least talking tough. New SEC chief Arthur Levitt says he wants to change the agency’s emphasis from protecting the securities industry to protecting the consumer. Some legislators are pushing for criminal prosecutions for rogue brokers-like those at Prudential who lured investors into shaky real-estate partnerships-and their bosses. Or an even more radical notion: changing the way brokers are compensated. The SEC has already hired hundreds of new auditors to crack down on fraud. Last week Levitt escalated his crusade to gain control over bank mutual funds.
No wonder the brewing furor at the mutual funds has alarmed regulators. With millions of investors driven into the funds by low interest rates and self-managed retirement plans like 401(k)s, there are now 4,500 funds on the market. Nearly a quarter of all American households now have mutual funds: every month $20 billion is invested. But with two new funds being created every day, the SEC has fallen behind in supervision. Especially troubling are fund managers who trade heavily in their own private accounts when they’re supposed to be watching over their clients’ investments. That’s not illegal, but discomfort over such potential conflicts of interest led Invesco to fire superstar manager John Kaweske in January and may have pushed Fidelity to tighten its rules on personal trading. Other violations have crossed the line. Earlier this year the former cochairman of Cooper Cos. was convicted of insider trading after he paid a Keystone mutual-fund analyst and others $700,000 for tips about investments that the fund was planning.
The SEC has already made its first move: it will beef tip its staff of mutual-fund examiners next year from a paltry 133 to 300. Funds will now be audited once a year or so, instead of every three or four years. Levitt is pushing Congress to bring bank mutual funds under his wing as well. Too many consumers assume such funds are covered by federal deposit insurance, a perception that banks don’t discourage. He wants them to be forced to make the same disclosures of risk that mutual funds now must make. And while the commission has not yet taken an official stance on personal trading by fund managers, Levitt himself has spoken out against it.
His ideas for cleaning up the retail-brokerage business are even more radical-at least by Wall Street standards. Levitt is keen on periodic retesting of brokers and shifting their compensation away from commission. Paying them more in straight salary-or at least basing their commission on total assets under management instead of how many transactions they generate-would discourage high-pressure sales and abuses, he says. But he acknowledges that most brokerages, obsessed with quarterly profits, resist such changes. “They choose to ignore the potential for abuse,” he says, “and that could destroy them.”
If brokerage houses fail to clean up their act, Congress may step in. Rep. John Dingell is sponsoring “three strikes and you’re out” legislation to collar recidivist stockbrokers and tougher laws to prosecute high-level managers. “Nobody has the right to repeatedly cheat, steal and lie and still stay in business,” says Dingell. But while such threats may be rousing, so far they amount to little more than heated rhetoric. Levitt may wish to cast his SEC in a reformist mold, but the securities industry wields heavy influence on Capitol Hill and has sidestepped such assaults before. While investors have long put their money where their mouths are, it remains to be seen if regulators and legislators will do the same.
