The Rise and Fall of Portfolio Pumping Among U.S. Mutual Funds

Abstract:     
This study investigates the effect of increased regulatory attention on the propensity of mutual fund managers to engage in illicit trading behavior. A study by Carhart et al. (2002) constituted a quasi-exogenous shock to regulatory enforcement levels because it developed a pumping measure, showed that pumping was prevalent, and prompted regulatory agencies to more vigorously enforce existing securities laws. We exploit this shock in our research design and show that between 1993 and 2001, quarterly mutual fund portfolios are artificially inflated by about 2.2 billion dollars. Portfolio pumping among U.S. mutual funds sharply decreased by about 110 basis points at year-end once the SEC filed fraud charges alleging portfolio pumping against fund managers in June and August of 2001. We further document that cross-sectional variations in pumping activity and the subsequent decreases of pumping vary in accordance with factors predicted by recent theoretical work. In many studies that examine regulatory rule changes, it is assumed that the degree to which existing laws and regulations are enforced before and after the rule change stays constant. Our findings suggest that this assumption is not innocuous since enforcement levels clearly matter in financial markets.

Number of Pages in PDF File: 48

Keywords: mutual funds, delegated portfolio management, portfolio pumping, regulation, Securities and Exchange Commission, SEC

JEL Classification: G23, G28, K22

working papers series