SEC draws bond funds into probe

THE Securities and Exchange Commission is stepping up its pressure on the US mutual funds industry, broadening its investigation of alleged trading abuse into other areas such as bond funds.

Investigators say the mutual fund business has enriched insiders at the expense of investors, and have already charged several high-profile companies. But so far, their spotlight has focused largely on equity funds.

Sources at the SEC now say the watchdog is looking at more than a dozen companies over out-of-date pricing - where investments were only given a price from time to time rather than every day.

It is unclear whether either of the two British-owned mutual fund companies known to be under investigation - Invesco Funds Group, owned by FTSE 100 fund manager Amvescap, and Pilgrim Baxter, owned by financial services-group Old Mutual - are part of this wider inquiry.

However, a week ago Colorado state regulators said they were investigating Invesco for abuses that went beyond the 'market timing' and 'late trading' that were the focus of investigation by the SEC and New York Attorney General Eliot Spitzer.

Colorado did not specify what the new alleged abuses were. Invesco Funds Group is based in the state.

Out-of-date pricing can most easily happen in funds with investments that are hard to value because they are not frequently traded.

As a result, there is less pressure to value the securities every day, allowing select investors to trade at favourable prices.

Investment insiders say high yield bonds, often called junk bonds, are particularly vulnerable to this problem.

They are rated below investment grade and pay much higher yields than ordinary bonds to compensate for the higher risk.

Experts say some junk bonds in high-yield funds are sometimes not be traded for weeks, and that some funds failed to keep revaluing them in line with market movements.

This allows arbitrageurs to step in a buy and sell at very favourable prices - a practice sometimes known as 'stale price arbitrage'.

Last month, Stephen Cutler, the SEC head of enforcement, told Congress that the agency was examining mispricing by funds.

Cutler said that at least two funds had 'dramatically' written down their net asset values in ways that had made the regulators suspicious.