Regulation Row

The mutual fund industry wants the SEC to rein in

The row between the Investment Company Institute (ICI) and the Securities and Exchange Commission over the regulation of folios as mutual funds continued last week at the ICI's annual meeting in Washington.

Matthew Fink, president of the ICI, told representatives of the mutual fund world that the $7 trillion industry with its 8,000 funds is strong, but that new competitors like folios and hedge funds create "serious and unnecessary risks" to investors and the industry. "If parallel industries are allowed to develop--one regulated, one unregulated--the only direction we are destined to move in is a 'race to the bottom,' as competitive forces pressure all firms to minimize regulatory costs," he told the thousands of attendees.

Fink reminded attendees that the ICI "argued successfully" that variable annuities be viewed as mutual funds. And he said that if hedge funds "want to enjoy the privilege of publicly offering their shares, they must be subject to corresponding regulatory responsibilities."

As for folios, Fink said that the "synthetic fund-like products" pose many of the precise risks that the 1940 Investment Company Act was designed to protect against: self dealing; excessive fee arrangements; deviation from stated investment objectives, and abuse in disclosure and advertising. He said the relevant policy issue could be summed up by a phrase used by former SEC director Sy Mendelsohn, "If it walks like a duck and quacks like a duck, it's a duck."

But Paul Roye, director of the SEC's Division of Investment Management, countered that the Web-based baskets of securities known as folios could really be chickens. "I'm not persuaded that products that compete with mutual funds should be regulated like them," he said. He added that the SEC continues to investigate "how these products operate," and that folios' regulation as mutual funds hinges on whether the SEC finds that these Web baskets are investment companies within the meaning of the Investment Company Act.

John Baker, a securities lawyer with Stradley, Ronon, Stevens & Young in Washington, says that a lot of people think the debate between the ICI and the SEC centers on two questions: "Will the folios be regulated as investment companies? And will the folio companies have to register as investment advisors? The folio companies currently are registered as broker/dealers, not investment advisors."

Roye told the assembled attendees that the SEC is also monitoring mutual funds that are using hedge-fund-type strategies, such as short selling, the aggressive use of leverage, and derivatives.

And exchange-traded funds (ETFs) are on the SEC's radar, too. During the fourth quarter of 2000, $26.8 billion flowed into ETFs, a figure which nearly equaled the $29.6 billion that flowed into mutual funds. Each of the ETFs approved so far have been based on an equity securities index, Roye said. But the SEC currently has an application pending for a bond index ETF, and there's interest in structuring an actively managed ETF. He says an actively managed ETF would raise many issues, including how "to achieve enough transparency of the fund's portfolio to permit the arbitrage discipline to function so as to keep the market price of shares close to the fund's net asset value."

Roye said the SEC will soon publish a concept release regarding actively managed ETFs and generate a comment period to get a better understanding of the issues surrounding actively managed ETFs.

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