The public backlash against regulatory compliance costs in the wake of mutual fund scandals and SEC sweep exams has begun, with leaders in the industry trying to quantify the effect.
The mutual fund industry could become more concentrated and less competitive over time, according to Paul Schott Stevens, president of the Investment Company Institute, due to escalating compliance costs.
“Some of our smaller members tell us that compliance costs have reached 10% of gross revenues,” and some small mutual fund firms are withdrawing from the business while others will be deterred from entering, Stevens said during a mid-March panel on the economics of the mutual fund industry sponsored by the American Enterprise Institute in Washington.
Bob Pozen, the chairman of Boston-based MFS Investment Management, a firm that manages more than $160 billion in assets and founded the nation’s first mutual fund, focused on his own company. Pozen estimates that compliance costs are worth between two to five basis points of the fund’s investment returns or yields.
“People [at fund companies] spend millions and millions of dollars on e-mail searches,” Pozen said, noting the SEC can come in during a sweep and order up every e-mail that mentions municipal bonds. Also, companies are spending money on long-term warehouse storage for record retention requirements. “Compliance officers have the run of the farm,” at companies, he complained, suggesting it was only his imposing Yale law degree that kept some requests from compliance folks at bay.
“At MFS, we have 40 or 50 people in the compliance department, ” he said. It is “ clearly the biggest growth area,” of the company, he remarked drily.
Also, as regulatory costs have risen, noted Pozen, some of the “fringe” players in the business that were initially attracted to mutual funds in the late 1990s–banks, insurers, even Caterpillar, Inc., the large construction equipment company–found that the mutual fund grass was not always greener, and that costs of compliance were high.
“I think you will continue to see these [fringe/small players] exit the business of mutual funds,” said Pozen, who is also a former vice chair of Fidelity Investments and has served on President Bush’s Commission to Strengthen Social Security.
Increased regulation of mutual funds could drive investors toward less regulated products, such as hedge funds, unit investment trusts, and separate accounts, says ICI’s Stevens. These products, as fellow panel member Pozen’s data showed, grew at a robust pace from 2000 to 2005.