While the Investment Company Institute and politicians are endorsing proposed legislation to reform the mutual fund industry, critics are crying foul, saying recent revisions have gutted the bill of its integrity.
The Mutual Fund Integrity and Fee Transparency Act of 2003, also known as H.R. 2420, was proposed in June by House Capital Markets Subcommittee Chairman Rep. Richard H. Baker (R-LA), and recently approved by the House Financial Services Committee. The bill was intended to shed some light on the dark areas of the $6.5 trillion mutual fund industry in an attempt to create transparency and to help build greater investor awareness and confidence.
"The basic idea of what the bill was trying to do was on the right track, but it looks like the mutual fund industry has been pretty successful in fighting off the reform," said Don Phillips, managing director at Morningstar. Phillips characterized the legislation as "well intended and basically a good move," but said that it falls short in many areas. "This is a benefit for investors, but isn't the radical reform that the industry could have been held to," he said, noting that individualized account statements would have been a revolutionary change for the industry.
The bill, proposed in June, recommended that mutual fund companies provide individualized statements to investors, detailing, in exact dollar amounts, the fees being charged by the fund. The ICI said this level of detail is unnecessary and offered a counter proposal in which mutual fund companies would provide investors with their fee amounts paid based on a hypothetical $1,000 investment. The individualized account statement was scrapped in favor of the ICI solution.
Matt Fink, president of the ICI, applauded the move, saying lawmakers are to be commended for their efforts, and that the organization will work with the Securities and Exchange Commission and Congress to reinforce investor confidence.
The original version of the bill also required that the chairman of a fund's board of directors be independent. However, that provision was deleted and replaced with an amendment giving boards of directors the option to elect an independent chairman.
"It started out with some very strong testimony and the first draft was pretty strong and consumer friendly. This version is much weaker," said Roy Weitz, industry critic and publisher of FundAlarm.com. "The only positive thing is the added requirement that managers disclose their holdings as well as their compensation. Other than that, the general sense is that the bill is watered down and also has the kitchen sink thrown into it," he said, referring to some odd provisions, such as one that exempts board members from being present at all board meetings under certain circumstances.
A representative for Baker said he doesn't understand how critics can claim the bill has been watered down when several new amendments were included during revisions. The Congressman's stance is that many of the changes were made to strengthen the bill while retaining the original intent of the bill and provide better information to investors.
"A dozen amendments were added to make the bill stronger," said Michael DiResto, Baker's press secretary. DiResto said that certain parts of the bill had to be changed because of lack of support, but that those changes do not detract from the strength of the overall product. "It was an amendment Congressman Baker wanted to include, [but he] discovered there wasn't adequate support for it," he said of the individualized account statement provision that was replaced with a requirement of including fees on the basis of a hypothetical $1,000 account. He said that rather than force the issue and have the bill face a crushing defeat, the necessary changes were made. Other new amendments to the bill require that brokers disclose whether they have received extra financial incentives to sell a particular fund or class of shares as well as making fund managers disclose any holdings they may have in the funds they manage.
Recordkeeping of soft-dollar transactions would be required if the bill becomes law. In addition, summaries of reports of fund distribution agreements would have to be made public. The SEC has also been instructed to clarify the definition of a no-load fund to make sure investors are not being led astray. Portfolio turnover rates will also have to be presented to shareholders in a way that facilitates comparison among funds. The notification in brokerage account statements that fees have been deducted would also be mandated.
Mercer Bullard, the founder of shareholder advocacy group Fund Democracy, said that although he is disappointed and baffled by the revision to the individualized account statement amendment, the bill, as it stands today, has some significant reform measures that will have an impact on fees and benefit shareholders.
Others are not so sure. Susan Breakefield Fulton, president of investment advisory firm Fulton Breakefield Broenniman of Bethesda, Md., said she is concerned about the limited concrete legislation relating to soft-dollar arrangements, something she sees as a big problem in the industry. "I don't see that issue being addressed in any real way," she said. She is not pleased with the bill overall, either. "What's happened is they've wrapped the package, but they've taken the present out of it."
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