For years, the $7 trillion mutual fund industry had escaped major reform. But that was then, and this is now.

In response to the recent spate of mutual fund scandals, new regulations have flooded the industry over the past year. One proposed solution is so complicated that, despite the desire to enforce a "hard close," the specifics elude even regulators. But the industry has changed, and experts contend that investors should be better off.

Not since the late 1960s, when Bernard Cornfeld and fugitive financier Robert Vesco swindled investors of $500 million in the Investors Overseas Services scandal, have so many been highlighted for so many infractions.

"In my 30-year career span, mutual funds have been relatively free of skullduggery," said Peter F. Bauer, CFA, CPA, and president of Oakbrook Financial Group Inc., in Oak Brook, Ill. "But this is very much over, with mutual funds getting back to basics and operating in the clean way that the vast number always have."

Part of what kept fund managers on the straight and narrow was an already extensive body of regulations and oversight. But the desire to stay clean was supported by the immense demand for their products and "comfortable" profits.

Increasing competition shifted one of the two factors. "The changes in the world might have triggered these incidents," said Bauer. "Competition for assets to manage hits mutual funds from investors seeking more direct participation, like separate accounts and private stocks and bonds."

So some fund managers turned to both illegal and too-creative strategies.

Market timing, allowing late day trading, and inconsistent methods of valuing holdings became top-down practices at a handful of funds. "Some of these were innocent mistakes or the result of poorly trained employees," Bauer explained. "But there were clear problems at funds where the orders came from the top executives, who have now left firms like Strong Mutual Funds and Putnam."

Funds have been deluged with new requirements to inhibit specific infractions, as well as to set a different context in a broader sense. The process started in mid-2003 and will continue into the future, with already enacted rules through early 2006, when funds must have finished the transition to fully independent directors.

"I think members are continuing to work with implementing the staggering number of regulations," said Amy Lancellotte, senior counsel at the Investment Company Institute, in Washington, an association of U.S.-based mutual funds. "Funds are bearing the additional costs and tasks, in addition to continuing to respond to document requests from the SEC."

The omnibus change in rules on compliance methods and personnel may be the most significant. The new requirements for firms to document all compliance procedures, as well as have a chief compliance officer personally responsible for the implementation of the policies, involve the entire operations of the firm. "The new compliance rules were one of the largest initiatives to implement," said Lancellotte. "The impact is global in scope and required significant changes in communications between the CCO and the board."

The new procedures require that every employee be aware of policy, which experts hope will remove errors and improve the general level of compliance. But increased accountability in the executive suite is believed to be the strongest wall of defense against future problems.

"The SEC is taking the stance that management is responsible first, and then lower-level employees," Bauer said. "I've had a number of fund executives tell me they're not willing to take that kind of risk."

Anticipating problem funds may be easier due to the changes. The compliance procedures and chief compliance officer's name are readily available to all who ask. Bauer's firm uses mutual funds for smaller clients, and the due diligence process includes new questions. "This has affected the way we look at new funds," said Bauer. "In addition to performance and risk parameters, we go deep into the fund's regulatory record. With so many good fund families out there, we certainly don't have to do business with those that have had problems."

Advisors must deal with disclosures regarding the fund's end-of-day close as well. Despite the SEC's desire to enact the 4 p.m. "hard close," attempting to shut down after-hours trading, the issue is as yet unresolved. "The SEC can't find the answer to the question of which time zone holds the closing time," said Tom Roseen, senior research analyst at Denver-based Lipper. "Using 4 p.m. on the East Coast puts a terrible burden on the West Coast brokers and intermediaries having to close, as their days are half over."

As a compromise, the SEC requires full disclosure. Funds must come up with a policy of cutting off daily trading, and a good, solid way to apply whatever methods they choose. "Funds walk a fine line in disclosing their trading close," said Roseen. "The language must have enough details for shareholders to understand, but not enough for arbitrageurs to figure it out and front-run the trades."

Funds must comply with similar requirements to assign prices to holdings. The law says that the fund must decide on a method of fair value pricing, explain the circumstances in which fair value rather than market pricing would be use, and detail what actions the fund takes to establish the prices.

Research indicated, however, that regulated closing times and fair value pricing are not going to stop market timing. "The market will probably also see added friction costs like the proposed 2 percent redemption fee," Lancellotte said. "Policies with smaller affects like limits on round-trip trading might be coming as well."

The SEC is working diligently to standardize closing time. The solution may lie in technology. Several companies offer methods of time-stamping trades, such as Surety and Authentidate. "Lots of sectors like the retirement plan market are concerned about the impact of the hard close," Lancellotte said.

So fund companies continue to deal with more regulation, more competition and lower profit margins. More may develop additional product lines as ways to capture assets. But funds operating in the new and improved regulatory environment are here to stay. "Mutual funds are a large part of almost every American's pension plan," said Bauer. "That huge bucket of assets ensures that we'll have a mutual fund industry for some time."

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