Nearly two years after the Spitzer probe into mutual funds began, MME thought it wise to ask leading executive and legal minds the begging question: Have the regulators gone into regulation overload and is Spitzer killing capitalism?

Following is the beginning of a heated discussion hosted by Max Rottersman.

Joining Rottersman, founder of Fund Forensics, are Martin E. Lybecker, partner, Wilmer Cutler Pickering Hale and Dorr, and Ted Benna, affectionately known in the fund industry as the "Father of the 401(k)" [see MFMN, 12/13/02].

Rottersman: Ted, you took an obscure regulation and turned it into a trillion-dollar industry.

Benna: Section 401(k) was expected to have very little impact on tax revenue and capital markets when the legislation was passed, adding this little paragraph to the IRS code during the fall of 1978.

But it enabled 401(k)s, as we now know them, to happen.

These plans, with $2 trillion-plus of assets, have been credited with playing a major role during the prolonged bull market.

ERISA, which was passed during 1972 to save the defined benefit system, is an example of how legislation can impact the retirement industry. ERISA is the major reason for the death of the retirement industry.

Rottersman: Amazing. All that from one paragraph of a small inclusion in a tax bill. Do you think they thought it out thoroughly?

Benna: Well, with ERISA, for example, this legislation was passed to "save" our pension system. But it is having the opposite long-term effect.

The bill that made the 401(k) possible was never expected to be a big thing until I used this section of the IRS tax code in a very different way than was intended when the legislation was passed.

This and other experiences I have had with legislation is why we need to be so concerned about current proposed legislation. In my opinion, legislative changes are a bigger threat to the financial services industry than regulation. Regulation impacts how these entities do business; legislation impacts what business opportunities will be available.

Rottersman: Interesting point. What do you make of the current legal challenges to the SEC's rule mandating an independent board chairperson?

Lybecker: I wouldn't be surprised if they remand the independent board chairman rule for further proceedings, rather than trying to decide the constitutional question of whether the SEC exceeded its authority. That lets them do it again without having to decide the larger questions.

Rottersman: Because I'm not a lawyer, Marty, can you explain what that means, exactly?

Lybecker: Believe it or not, most courts don't want to decide fundamental questions if there's some more procedural question they can deal with.

Here, the three different choices would be: Decide the SEC was beyond their authority to strike the rule. Or, you could decide if they did a lousy job and never get to the question of, "Do they have the authority?" But if they didn't do the job well, whether or not they have the authority, it's simply not a good rule.

So, what is likely to happen is, the Federal court system will send the rule right back to the SEC and make them draft another version.

The third choice would be to say, "They have the authority and did their job right, and the rule's just fine." The last one seems to be the least likely of the three choices.

Rottersman: My biggest question is why the funds and the SEC didn't fight Eliot Spitzer when he clearly overstepped his line. And I don't say this easily. I believe in what he started, and I believe the fund industry needed a wake-up call.

But in the end, I don't feel anyone has come out ahead. It feels like one big lose-lose. Take the Pilgrim-Baxter case. There was $90 million in various fines, and Spitzer wanted to get over $100 million. At one point, he threw around a number of $1 billion.

So, in the case of Mr. Pilgrim and Mr. Baxter, Spitzer seems to say, "O.K., we have to get another $10 million to reach that number."

In calculating expenses for mutual funds, the law expects everything to have some sort of metric, some semblance of scientific basis. Of course, shareholders don't understand or care, but good people in the industry, well it's just disheartening.

Look for the complete "CrossFire" debate, and who wins it, in an upcoming edition of MME.

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