SEC warns brokers to clean up their act

US Securities and Exchange Commission chairman William Donaldson urged the brokerage industry to clean house or risk prosecution as regulators probe cheating in the 6.9-trillion-dollar mutual fund industry.

"If there is more wrongdoing, we will find it and will punish the perpetrators," Donaldson said in prepared remarks Friday to an annual meeting of the Securities Industry Association.

The SEC will meet in coming weeks to consider new rules to clean up "a laundry list of industry wrongdoing," Donaldson said.

But, he added: "You need to consider what you as an industry can do to regain the trust and loyalty of America's investors."

Likely measures include setting a strict 4pm deadline for orders to buy and sell mutual funds, a move aimed at eliminating illegal late trading in which investors place orders after the market close but get that day's price.

To thwart market timing -- in which insiders seek to profit from short-term fluctuations in share prices, often at the expense of general investors -- Donaldson said the SEC might require mutual funds to impose a 2 percent penalty on short-term traders.

The watchdog also could require each fund to designate a chief compliance officer to ensure questionable practices are quashed.

Regulators have been trawling the mutual fund industry for violations amid allegations that some allowed late trading and market timing.

Brokers also have been snagged in the SEC's driftnet. Earlier this week, the agency charged five former brokers and a former branch manager at Prudential Securities with having lied about their own and their clients' identities in thousands of market timing transactions.

Donaldson said he worried that the securities industry was not being open enough with investors about revenue-sharing arrangements between mutual fund companies and the brokerage firms that offer their products to investors.

Such deals may increase cost to investors and create conflicts of interest, he said.

"I have been distressed by the conduct we have seen from key participants in our nation's securities markets," Donaldson said.

"I am left with the conclusion that these occurrences represent a fundamental betrayal of our nation's investors, and are symptomatic of a disease that has afflicted far too many in the industry," he said.

Citing recent SEC surveys, he said late trading appeared to be a problem at about one-fourth of US brokerages and that almost 70 percent seemed to engage in market timing.