“Securities regulators are examining whether investment banks have been pressuring affiliated mutual funds to buy shares of initial public offerings and stock in companies with which the bank has a relationship, according to people familiar with the matter,” writes Deborah Solomon in today’s Wall Street Jorunal.

“The Securities and Exchange Commission wants to determine if banks have been trying to curry favor with corporate clients by getting affiliated funds to load up on a company’s IPO or its outstanding stock in an effort to drive up the price. While SEC officials say they have no evidence yet this is occurring, they are concerned that the potential for conflict exists.”

“The agency is conducting a broad review into conflicts throughout the mutual-fund industry, including abusive trading practices by fund managers and undisclosed payments made to brokers in exchange for steering investors to certain mutual funds. The SEC and other agencies have found evidence of widespread problems throughout the $7 trillion fund industry.”

“Investment banks were in the cross hairs last year, when regulators cracked down on firms for allegedly misleading investors with faulty research. In April 2003, the SEC and state regulators announced a $1.4 billion settlement with securities firms that included new rules to address allegations that investment banks misled investors by issuing overly optimistic stock research in a bid to win stock-underwriting assignments and other investment-banking business.”

“The latest examination into banks and their funds is an effort by the SEC to get ahead of potential problems before they become widespread. The SEC has been criticized in the past for failing to spot conflicts on Wall Street. To avoid a repeat occurrence, the agency has recently begun to investigate areas that appear ripe for conflicts even when no evidence of wrongdoing exists.”

“The parent companies of most large investment-banking firms also operate mutual funds. Portfolio managers aren’t allowed to buy securities to benefit anyone besides fund investors, and SEC rules limit how much stock a fund company can buy in an IPO or other stock sale if the fund adviser has corporate ties with the underwriter.”

“An SEC official said the review, which began several months ago, was an outgrowth of the current mutual-fund investigation. ‘The SEC initiated a nonpublic examination review of mutual-fund firms affiliated with investment banks to look at their holdings and the investment decision-making process and whether there’s any influence exerted by the firm’s investment-banking side,’ the official said.”

“The SEC’s Office of Compliance Inspections and Examinations hasn’t yet requested documents or subpoenaed information from any banks or their funds, people familiar with the matter said. The agency is still identifying which firms to request information from but plans to soon ask for documents and e-mail messages, along with other information.”

“Among the questions the SEC wants to answer is whether funds have been pressured to buy stock that underperformed the market and hurt the fund’s performance. SEC officials are concerned that investors in bank-affiliated funds may have been harmed if portfolio managers bought certain stock simply to please the investment bank and not because it was the best security for the fund.”