The Securities and Exchange Commission's expansion of mutual-fund oversight may leave some funds unexamined for a decade due to limited...

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The Securities and Exchange Commission’s expansion of mutual-fund oversight may leave some funds unexamined for a decade due to limited agency resources, a government report issued yesterday said.

The SEC, which used to conduct routine examinations of all funds over a roughly five-year period, is now targeting specific practices, including market timing, based on tips or other information, a report by the Government Accountability Office (GAO) said. Only funds considered at “higher risk” will still receive routine SEC inspections, according to the report.

The new focus raises “significant challenges,” said the GAO, the investigative arm of Congress. “The tradeoffs may limit SEC’s capacity to examine funds considered lower risk within a 10-year period,” the report said. “This outcome could limit SEC’s capacity to accurately identify which mutual funds pose relatively higher or lower risk and effectively target higher-risk funds.”

The SEC revised its system of examinations in response to mutual-fund abuses, such as market timing, that came to light in 2003. While market timing isn’t illegal, regulators say many fund companies allowed favored investors to trade in and out of their funds, reaping quick profits at the expense of other shareholders.

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Putnam Investments, a unit of March & McLennan, and Alliance Capital Management are among companies that settled regulatory lawsuits for market-timing arrangements with certain investors.

SEC spokesman John Nester said yesterday that the agency is “seeking to maximize the efficiencies and benefits of our examination oversight.” The SEC has about 495 staffers set aside for examination oversight of mutual funds and investment advisers.

In addition to revamping its examination program, the SEC tightened its regulation of mutual funds, which hold the savings of about half of U.S. households. In its report, the GAO recommended that the SEC periodically review how it allocates the time of its examiners.

In a written response included in the report, SEC Director of Compliance Inspections and Examinations Lori Richards defended the shift away from random examinations of all mutual funds.

“Given the size and growth of the industry, it is not possible for the SEC to conduct comprehensive, timely, routine examinations of every registrant,” Richards wrote. She said the agency developed a risk-mapping program and opened its Office of Risk Assessment to focus limited resources “on the highest-risk activities and firms, and on identifying emerging compliance risks.”

The GAO warned in its report that the agency may become even more overtaxed in the near future as a result of its increased responsibilities in supervising hedge funds.