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Portfolio > Mutual Funds

Funds Face Rising Disclosure Demands

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Mutual funds are facing increasing demands for a significant upgrade in the quality of information presented to investors and in their ethical behavior.

And the demands are intensifying following New York Attorney General Elliott Spitzers investigation of alleged manipulations of mutual fund trading.

William H. Donaldson, chairman of the Securities and Exchange Commission, sent a letter to Matthew W. Fink, president of the Investment Company Institute, Washington, promising “a vigorous and broad-based investigation into these types of abuses.”

And Donaldson asks Fink to urge ICI members promptly to seek assurances from broker-dealers and other intermediaries that they are following all relevant rules and regulations.

“I also urge you to remind your members of their obligations with respect to market timing activity and request that they review their market timing policies and procedures, as well as their fair valuation procedures, for sufficiency in addressing concerns in this area,” Donaldson says.

Fink relayed the message to his members, noting, “I am sure you appreciate the vital importance of these issues in maintaining the confidence of mutual fund investors.”

Donaldson, for his part, issued a separate statement to the public following news of the New York investigation, saying it “further illustrates the importance of the SECs ongoing review of both hedge funds and mutual funds, and the SECs upcoming recommendations regarding improvements and increased disclosure requirements for both.”

But if the SEC is putting pressure on the mutual fund industry, Congress is putting pressure on the SEC.

The House Financial Services Committee has taken a leading role in the drive to upgrade mutual fund disclosure, approving H.R. 2420, the Mutual Fund Integrity and Fee Transparency Act.

But in a separate letter to Donaldson, two leading members of the committee say the SEC should not wait for Congress to finish its work on H.R. 2420.

Rep. Mike Oxley, R-Ohio, who chairs the full committee, and Rep. Richard Baker, who chairs the Subcommittee on Capital Markets, sent a joint letter to Donaldson urging him to use the SECs existing regulatory authority to implement reforms that do not require legislative action.

These include improving mutual fund fee and expense disclosures, improving governance by boards of directors and requiring funds to have a chief compliance officer.

But some believe the reforms contained in H.R. 2420 do not go far enough. John C. Bogle, founder of the Vanguard Group of funds and president of the Bogle Financial Markets Research Center, says it is impossible to believe mutual funds are managed in the interests of shareholders rather than the interests of directors, officers, investment advisors, underwriters or brokers.

“I believe that this industry has not adequately measured up to its responsibilities to mutual fund investors,” Bogle says in recent testimony to the Financial Services Committee.

First, Bogle says, the Investment Company Act of 1940 should be amended to establish an express fiduciary duty on the part of fund managers to place the interests of fund shareholders ahead of the interests of fund managers and underwriters.

Second, Bogle says, funds should disclose costs to investors in terms of dollars rather than a percentage of the investment. This, he says, would help investors become aware of the “truly punishing penalty of high expenses.”

Bogle also calls for more complete disclosure of where the expense money goes, including salaries of senior officers, marketing, advertising, operations and administration.

Once this information is disclosed, he says, the behavior of fund managers will change.

“It will lead to substantial reduction in costs and will therefore materially enhance the returns that shareholders receive,” Bogle says.

Paul. G. Haaga Jr., the current chairman of ICIs board of governors, says many aspects of H.R. 2420 would indeed benefit investors, including enhanced independence of fund boards, independent audit committees and additional disclosure in certain areas.

But Haaga says ICI does not agree that funds should disclose the estimated dollar amount of operating expenses borne by each shareholder.

“We question both the practicability and the necessity of this requirement,” he says.

Mutual fund investors, he says, already receive significant disclosure about fund fees and expenses.

Moreover, the SEC has proposed a rule that would further enhance disclosure by requiring funds to disclose the costs in dollars of a $10,000 investment in the fund, he adds.

“The Institute believes that the SEC should proceed with its proposal and that Congress should study the effectiveness of the new fee disclosure initiative in development before mandating yet another related and costly disclosure requirement,” Haaga says.

Paul Roye, director of the SECs division of investment management, says the SEC supports the goals of H.R. 2420, particularly enhanced disclosure and increased independence of fund directors.

But he urges Congress to preserve the SECs flexibility to determine appropriate standards through the notice and comment rulemaking process.

Reproduced from National Underwriter Life & Health/Financial Services Edition, September 26, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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