“The Securities and Exchange Commission may be stepping up its own scrutiny of the mutual-fund industry, but it is also hoping that a new cop walking the beat inside the halls of fund companies will go a long way toward preventing future scandals,” writes Tom Lauricella in today’s Wall Street Journal.

“Starting Oct. 5, the SEC for the first time is requiring that funds hire chief compliance officers. The person’s job will be to ensure that a fund company follow the rules — everything from those covering personal trading by portfolio managers and how funds spread their brokerage commissions, to the accuracy of reports to the SEC.”

“To give teeth to this new watchdog, the chief compliance officer will report directly to fund directors, and not to executives of the fund-management company, who conceivably could profit from any wrongdoing. To further insulate the chief compliance officer from being bullied into keeping quiet about improper behavior, only the fund board can fire the compliance officer. Fund boards will even be responsible for overseeing how compliance officers are paid.”

“Fund-advisory companies, which are hired by fund boards to manage investments, have long had compliance officers on their payrolls. But those positions typically have reported to the fund advisers themselves, not to the fund boards. Fund-industry experts are hopeful that the new compliance officers will prove an effective check on misdeeds by investment advisers, but some warn that it won’t be easy.”

” ‘The chief compliance officer is going to be in a very difficult and sensitive position,’ says Tamar Frankel, a law professor at Boston University who specializes in mutual funds. ‘The question is how will the compliance officer mesh with the adviser: if they are too strict nobody will tell them anything and if they are too lax, then they won’t be doing their job.’ “

“The compliance-officer rules, which were made final in December, were proposed more than a year ago — long before evidence of wrongdoing in the trading of mutual-fund shares became public. The initial catalyst was the wave of corporate scandals in 2002 that prompted SEC officials to try to strengthen governance procedures for mutual funds before problems arose in the industry. But when the fund scandal emerged in September, the push to create fund compliance officers gained urgency and SEC officials say it convinced them of the need to further strengthen the independence protections given the position.”

“The fund scandal underscored the lesson that even in a highly regulated industry, the rules mean little if they are not followed. A common theme in the cases brought by state and federal regulators in the last six months is that fund-management companies had policies to protect investors and some had compliance officers on the payroll to enforce them, but that the provisions were still broken, often because top executives overruled lower-ranking ones.”

“In one instance reported by regulators, a compliance official at Invesco Funds Group complained on multiple occasions to Invesco’s president about damage that improper trading had wrought on several funds, but those complaints were brushed aside. At Massachusetts Financial Services, investigators said that executives didn’t tell fund directors about agreements for directing stock- and bond-trading commissions that violated the firm’s own rules. (Last month MFS settled civil charges against it without admitting or denying wrongdoing; Invesco, which is facing civil fraud charges, says it’s cooperating with regulators.)”

” ‘You’ve seen situations where the compliance people in some cases said, “Hey this is wrong,”…and then had the higher-ups blow them off,’ says Paul Roye, head of the SEC’s Investment Management Division. ‘We wanted to vest the compliance officer with the authority to carry out policies and to have a direct pipeline to the board.’ “