Before September 2003, the SEC did not investigate such practices – despite academic literature and anecdotes detailing such practices – because it felt that it had higher priorities and because it felt that the mutual fund companies had a self-interest in not allowing such practices, according a GAO report . However, as has become apparent, the practice was widespread and harmful to many individual and institutional investors.
The GAO stated that there are three key lessons that can be learned:
- Without independent assessments during examinations of controls over areas such as market timing, the risk increases that such violations will go undetected.
- The SEC can possibly strengthen its capacity to identify and assess evidence of potential risks.
- That mutual fund company compliance staff – who often detected such practices but failed to act – lacked sufficient independence within their companies to correct identified deficiencies.
To solve part of the problem, the SEC has recently adopted a rule that makes it so compliance officers must report directly to a fund company’s board. However, the GAO warned that this may not be enough to solve the problem, since many compliance officers may not have interests aligned directly with mutual fund investors. The GAO also criticises the federal regulator for not having a cohesive plan on how to collect and assess annual compliance reports.
In conclusion, the GAO suggests that the SEC “routinely assess the effectiveness of compliance officers and plan to review compliance reports on an ongoing basis.” The SEC has agreed with the recommendation, according to the GAO.
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