Financial industry analysts are anticipating a wave of new regulations to come out of this financial crisis, but with any luck, mutual funds will escape a direct hit.
"Consumers, regulators and institutions all seem to agree that there is shared blame for the current problems and that it will be important to act with a combination of speed and caution," said Eva Weber, an analyst at the Aite Group.
"Congress is sympathetic to consumer pain, and well aware of consumer anger against the market participants and financial institutions that created these problems, and the regulators who were supposed to be watching them," said Weber, author of a recent report, "What's Next? Legislative and Regulatory Responses to the Financial Crisis."
"Sweeping changes that favor consumers seem likely. The only real question is how far the pendulum will swing toward consumers," she said.
Weber said regulators are scrambling to identify and fix a variety of problems with mortgages, ratings agencies and bankruptcy protection rules.
"The theme of the Republicans for the last few years was less regulation," said Geoffrey Bobroff, head of Bobroff Consulting. "Clearly the new theme will be more regulation. My sense is that the areas that will see the most regulation will not be traditional mutual funds but hedge funds and hedge fund advisors."
Theoretically, hedge funds are only sold to sophisticated investors and aren't required to be nearly as transparent as other investments, Bobroff said. But as more institutional investors and pension funds invest in hedge funds, regulators may want to step in, particularly at a time like now when people want their money back and many hedge funds are closing their doors.
Mutual funds have largely escaped the problems facing mortgage brokers, ratings agencies and investment banks, although some funds, most notably Reserve Funds' Primary Fund, were invested in questionable investment vehicles.
"This market crisis is very unfortunate, but it doesn't change anything about mutual funds," said Paul Haaga, vice chairman of Capital Research and Management, at a conference in October. "Mutual funds will continue to be a very dominant part of the savings and investment landscape."
While mutual funds will largely escape stiff regulatory reactions in the coming year, many experts expect the Securities and Exchange Commission to look at revising 12b-1 fees and implementing XBRL data tagging.
One area of particular concern is money market mutual funds. The normally boring funds got a huge amount of attention in September after the Primary Fund broke the buck. For a short time, money market funds and other cash instruments didn't seem safe, causing panicky investors to stash their money in Treasuries.
Money market funds quickly recovered their status as a safer place than equity or bond funds, and investors came back in droves. Fidelity Cash Reserves, a $130.7 billion money market fund, is now the biggest mutual fund in the nation.
If money market funds are to face any changes in 2009, raising the $1 net asset value so that fluctuations in its price do not seem so pronounced, seems to be a logical move, industry experts say.
"The SEC was very reluctant to give anybody a pass on meeting daily redemptions," Bobroff said. "I can see a benefit to going to $10, taking away the implied guarantee and letting the net value float."
"We would be better off without a $1 NAV," Haaga said. "We invented the $1 number to compete with banks. It probably misled people all along. When a number hasn't changed for a long time, you need to look at that. I think we should let the NAVs float."
Bobroff said it would also make sense to create different money market funds that invest in various types of debt, so a big movement in one area won't affect other areas.
"The dramatic nature of the current crisis has produced surprising levels of cooperation and agreement among lawmakers, regulators and industry players," Weber said. "Across both sides of the aisle, politicians are stepping up to help solve the massive problems the country faces."
Weber said regulators are scrambling to identify problems, plug holes and define their own roles as defenders of the public good. As they gain more confidence, regulators will step forward with stronger controls to measure and manage risk carried by institutions, she said. They will place operational controls on institutions and try to shift the balance back toward the consumer, with a focus on providing better consumer protections.
However, "until we get a new chair of the SEC, it's very hard to predict what will happen," Bobroff quantified.
"Clearly there is a risk" that regulators and legislators will overdo it, he said, although there's much more danger in legislative overreaction than in regulatory overreaction.
"Regulations can be modified in the future; they can be ameliorated over time," he said. "I hope the new chair of the SEC will convince Congress to let [the SEC] deal with these issues in a regulatory landscape. I would rather have regulators deal with it than put it into the statute."
"Markets will overcorrect, and regulators and regulations will overcorrect, as well," Haaga said. "We will see more regulation than is good for the market."
Weber said she doesn't think it's very likely for regulators to overdo it and end up hurting the market.
"The chances are relatively low," she said. "They will take great care in not jumping in too quickly. Sarbanes-Oxley was a good lesson in that regard."
Legislators and regulators seem to have keyed in on the main aspects of the financial crisis and want to understand the problem first and figure out what led to the current situation, Weber said.
Whatever changes happen, C-level executives will be "on the hook for knowing what's going on in the business," she said.
Money managers should be sure to keep abreast of any regulatory changes, Bobroff agreed.
"Don't reduce your compliance and regulatory staff," he said. "This is the time to redouble your efforts. Investment advisors need to focus on the types of securities they may be creating, and they need to fully understand the nature of the investment and its components."
Earlier this month, the SEC's Office of Compliance Inspections and Examinations wrote an open letter warning that staffing and operational cutbacks in compliance will not be tolerated.
"Compliance programs have made huge strides in recent years in becoming more formalized and more robust," said SEC Chairman Christopher Cox. "Experience has taught us, again and again, that giving short shrift to regulatory and compliance subjects a company's investors, employees, management, directors and every other stakeholder to unacceptable risks."
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