Despite its key role in promoting sound corporate governance and restoring public trust, the mutual fund industry is not taking the necessary steps to right the ship.
A recent PricewaterhouseCoopers survey revealed that the industry has not yet taken on the leadership role it could even though it understands the need to move in that direction. In fact, 60% of the 43 senior executives polled said that trust in financial institutions has been eroded so much that major structural reform is required, both at a regulatory and individual level. More than 80% of the respondents said that failure to upgrade their own standards of governance could have an adverse effect on capital and make their stock more volatile and less appealing to investors.
The fund industry, in particular, has recognized the need for stronger governance procedures as a means of boosting investor confidence, but up until this point, it has been mostly idle chatter. "We all talk about these issues, but no one is willing to take the first step," said Chip Voneiff, director of PricewaterhouseCoopers' U.S. investment management industry group, speaking at the National Investment Company Service Association's general membership meeting last Monday. Voneiff urged industry leaders to step forward to become part of the solution rather than simply pointing out the problems in the system.
"We need to address the concerns that are out there, rebuild trust and prove to regulators and the investing public that we are capable of self-governance. If we don't, then we risk continued market uncertainty, further loss of investors and more regulation," he said.
Voneiff noted that there is a major flaw in disclosure practices in that most firms only report information that is required by law. Few are reporting any predictive analysis of business conditions or non-financial information that may be vital to operations. The reason for this, the survey indicated, is that many executives are feeling pressure to produce higher quarterly earnings and cannot direct their attention toward improving governance.
More than half of the participants said that the pressure comes from federal regulators and investors as opposed to management. Voneiff identified this as a problem for the industry saying, "genuinely effective change has to be embraced internally, not driven externally." He suggested that public trust can only be achieved through action based on three essential principles: accountability, transparency and integrity. In other words, each individual tasked with preparing the information must be willing to stand up and attest to its validity.
Transparency has been a point of contention because many industry members believe mutual funds already provide investors with enough transparency. Congress is expecting to hear from the Securities and Exchange Commission later this month on the matter. The third principle, integrity, is something that no regulatory requirements can bring about; it must come from within, Voneiff said. Essentially, it means doing the right thing instead of the profitable thing.
Action Steps
After laying the philosophical groundwork for rebuilding a relationship with investors, Voneiff outlined a series of concrete action steps for mutual fund companies. He recommended working with regulators to establish a global accounting standard - an international version of U.S. generally accepted accounting principles.
Another critical step is retooling disclosure, particularly as it relates to non-financial information. Those companies that choose not to disclose information that may be useful for equity analysts and investors will find themselves at a competitive disadvantage down the line. Voneiff called for an expansion of Regulation FD, one that will create a set of industry-specific metrics to be used consistently among fund companies.
Technology is also a vital cog in restoring investor confidence. Voneiff stressed the importance of developing a Web-based reporting tool that will make disclosure and information-sharing more efficient and enhance analytical capabilities. Extensible Business Reporting Language (XBRL), for one, is a digital reporting tool that is being marketed to public companies to automate their financial statements.
In terms of governance, investment managers should establish a set of guidelines not only for their own firm but also seek to strengthen standards at the companies they invest in. Voneiff commended Putnam Investments for taking the initiative in publishing its proxy voting guidelines on its Web site.
Lastly, Voneiff urged fund executives to implement a better system of checks and balances within their firms, particularly the role of independent directors.
The bottom line is that the industry needs to change its line of thinking if it is to be successful in restoring public trust. Good relationships are fostered over time. There is no quick fix. Clearly, there is at least one industry figure with his finger on the pulse.
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