Recommendations deal with advisers' business ethics


When Denver's Invesco Trust Co., sub-investment adviser of Invesco Industrial Income Fund and Invesco Strategic Health Sciences Portfolio, terminated John J. Kaweske last January, it did more than end the services of the high-performing funds' co-portfolio manager.

It rang alarm bells in mutual fund management offices from coast to coast -- and it may have caused you to raise at least one eyebrow.

Invesco said that Kaweske was terminated for failing to comply with its code of conduct in respect to his personal securities transactions in 1993: for not getting the firm's approvals prior to engaging in such transactions, for not providing brokers' confirmation statements to its compliance office afterwards for comparison purposes, or both.

They "had absolutely no impact on investors in the funds," Dan J. Hesser, chairman of Invesco Trust's parent company, said at the time.

If Health Sciences, which Kaweske had managed or co-managed since 1985, had been the worst-performing health care fund in 1993, it was due to overweighting in small company stocks; Industrial Income had beaten the equity income group's average and Standard & Poor's 500.

What alarmed industry executives was how investors might react to news of the violation of a code of ethics, which the Securities and Exchange Commission requires fund directors to adopt under a rule (17j-1) that addresses potential conflicts of interest.

They had built the industry on a foundation of public trust through both self-regulation and compliance with the Investment Company Act of 1940, which had been enacted to protect investors.

Thus, as word of Kaweske's firing spread, they were worried about how many people would wonder -- despite the industry's record -- whether fund personnel placed shareholders' interests ahead of their own.

Within a few days, Chairman Edward J. Markey (D-MA) of the House Subcommittee on Telecommunications and Finance asked SEC Chairman Arthur Levitt for a study of fund complexes' policies and procedures regarding managers trading for their own accounts, the possible need for new fund procedures or legislation, and related matters.

By mid-February, the Investment Company Institute reflected the industry's concern by announcing the appointment of a "blue-ribbon" group to conduct its own study of investment company standards and practices dealing with personal investing by industry personnel and recommend any changes needed.

Chaired by ICI Chairman Ronald P. Lynch, managing partner of Lord, Abbett & Co., the Advisory Group on Personal Investing was asked to report to the SEC, Congress, and the public in May.

A few days ago, it issued its report, which included some tough proposals. Lynch expects the ICI board to vote on them in June. Then it will be up to fund companies -- some of which already have some similar policies -- to adopt them, too, and enforce them.

It will be up to fund directors -- especially independent directors -- to oversee compliance and up to the SEC to help ensure it.

The major recommendations, which are intended to prevent and detect abusive practices and preserve investor confidence, include:

* No purchases of securities in an initial public offering and limits on the acquisition of securities in private placements, either of which could provide "the opportunity for lucrative side deals."

* No profiting from short-term (up to 60 days) trades.

* No transaction in a security while any fund within a fund family has a "buy" or "sell" order pending in that same security until the order is executed or withdrawn.

* No buying or selling by a portfolio manager of any security within seven days before or after his or her fund trades in it.

* Preclearance of personal investments and transactions reports.

* Disclosure to fund shareholders, probably in prospectuses, about personal investing activities, restrictions, and procedures.

Markey was "pleased" with the report. Barry Barbash, director of SEC's Division of Investment Management (DIM), called it "an admirable initiative" and said the group "acted very responsibly."

The panel did not recommend a total ban on personal investing, as some people had urged, because members felt this would be unfair and make it difficult to attract and retain good portfolio managers.

The ICI study didn't try to discern the patterns of managers' securities transactions -- such as comparisons of short-term trades and long-term investments (including their own funds and retirement plans) -- and it's not certain whether the SEC study will provide such data.

Michael Parker, DIM's assistant director, who's in charge of fund inspections, has the impression that the tendency to trade is greater among managers who trade actively for their funds and among those who have a background in securities, instead of other fields.

In view of the ICI group's call for vigorous SEC oversight and enforcement and SEC's limited funds, he indicated resources would be shifted so that SEC examiners, who look for violations of ethics codes and evaluate funds' control systems, could focus on "the more likely situations:" fund complexes where there's active trading.

Whether and how the SEC study's recommendations may go beyond those of the industry group remains to be seen. Markey expects it to be ready in time for a subcommittee hearing in June.

"We then will be in a position to judge whether voluntary compliance with industry standards is likely to curb abuses," he said.

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