PALM DESERT, Calif. - Perhaps nobody captured the current mood of the mutual fund business better than Barry Barbash, a former Securities and Exchange Commission investment management director, when he told industry executives attending the annual Investment Company Institute meeting here last week that registration was still open for an upcoming "Regulatory Overload Conference."
"It's for those of you who just cannot take it anymore," joked Barbash, now a partner at the law firm of Shearman & Sterling in New York.
The dark humor didn't stop there, either, as Barbash's remarks prefaced a panel discussion featuring other SEC alumni, who each expressed an equal amount of exasperation over the regulatory state of the industry. Taken together, the quartet represents nearly 35 years of SEC rulemaking and fund industry counseling. Over their tenure, the industry has grown from a relatively obscure investment vehicle of the wealthy to one that manages more than $8 trillion in assets for people from all walks of life and income levels.
"The industry's success is both a blessing and a curse," said Kathryn McGrath, a partner at Washington-based Crowell & Moring and director of the division of investment management from 1983 to 1990. "It's almost become the public utility of the securities business. So many ordinary people in this country now invest in funds that they can hardly afford to lose.
"That's a big change. No mistakes are tolerated," she said.
McGrath drew an interesting parallel between today's fund industry and the money market industry of the 1980s and early 1990s. Touted as the next-best thing to insured deposits, McGrath noted, the popularity of money market funds exceeded consumer awareness of the investment risk. When investors began losing their rent checks in money market funds, she recalled, they cried foul to industry regulators and Capitol Hill lawmakers. That leads McGrath to conclude that the mutual fund industry needs fewer new rules and more accurate estimates on investor returns.
"It would be prudent for all of us to work on bringing expectations back in line with reality and emphasize, These are investments, there is investment risk. You should not expect to not have losses, and why don't you have money in government bonds and insured deposit institutions?'" she offered.
However, outgoing Investment Management Division Director Paul Roye, whose work since the scandal broke 16 months ago drew a standing ovation from the convention crowd of nearly 1,500, conveyed that SEC Chairman William Donaldson has pledged further activity.
"Chairman Donaldson has set forth an aggressive reform agenda, and pieces of that have to be worked through," said Roye, who will soon join the private sector after seven years as an SEC director.
Specifically, Roye cited the SEC's recent decision to impose voluntary redemption fees, a rule designed to prevent market timing by imposing a 2% charge on short-term trades. Industry comment is being sought on that rule, but it will go into effect in some form in late 2006.
Roye also said the Commission is moving ahead with a hard 4 p.m. close to curb late trading and that the Commission will address longtime dilemmas like soft dollars and 12b-1 fees. It will also begin limited activity in the 529 plan space, as well as re-examine "the enduring problem of how you ensure that investors get effective disclosure so that they can make intelligent investment decisions."
"What has to happen is a move to layered disclosures to try to accommodate all types of investors," he said.
Broad Changes Ahead
Barbash, who held Roye's post between 1993 and 1998, foresees dramatic changes in the regulatory environment over the next five years. He expects that lawmakers will tighten their pocketbooks as news of the scandal fades.
"Call me a pessimist, or an optimist depending on your perspective, but I think that the resources that the SEC and other regulators have had over the last couple of years are bound to go down," Barbash said of the Commission, which recently received a $113 million technology upgrade and 850 new employees from federal lawmakers.
"The SEC is going to find itself looking to regulate with fewer resources. That's the general nature of things. In the grand scheme, things [like the scandal] don't happen very often. The SEC will also face an industry that looks different over the next five years. It will be smaller, to some extent, with fewer participants through consolidation.
"The trend suggests that money management firms are going to focus more on money management, and the distribution arm will focus on selling. And the regulatory issues we've seen recently are going to be somewhat different down the road," he said, noting that technology will play an increasingly greater role in how the fund industry operates day-to-day and that the SEC, perhaps in response to enforcement activity among state attorneys general, will fight more fiercely to protect its turf. "That may not be fashionable to say, but regulators have the most knowledge in this area."
Barbash also predicted a new type of mutual fund to take the market by storm. "Over the next five years, I can predict with certainty that there will be a new product or service that will be touted as the be-all-to-end-all, the new-new, and that will be the product the SEC, at least in the beginning, will need to try to facilitate and allow investors to have - and then be very diligent about watching what happens with it and managing potential problems it causes," he said.
The Prospectus Reform Fight
But in terms of current rulemaking activity, the panel was nearly unanimous in suggesting that the SEC abandon prospectus reform, mostly because the document serves more as a means of protecting fund companies from liability than it does as a comparative shopping tool for investors.
"It's a waste of time to overhaul the prospectus," McGrath said flatly.
Addressing the larger issues of disclosure, however, Roye said a fresh perspective might yield better results.
"There has to be a more analytical, comprehensive, scientific approach than there has been in the past," Roye remarked. "The chairman has said that no ideas are off the table. Quite frankly, I think we have to get to something that is relatively short, that investors get at the appropriate point of time and through layers of information.
"You also have to recognize certain realities in terms of how funds are sold today. They're being sold principally through intermediaries, so how do you factor that into decisions on how information is imparted? How do you facilitate comparisons for investors looking at different funds? These are all part of the equation," he said, proposing that prospectus reform could follow a blueprint recently set down with point-of-sale disclosures, where focus groups helped shape the look and content of the documents (see MME 2/7/05).
"We tend to look at the prospectus as the center of the universe, and it's not," Barbash added. "A lot was made about focus groups in the point-of-sale disclosure release from the SEC, but if you listen closely to what investors want in a document, it's a document that tells them the answer."
He continued: "Should they or should they not invest in this, is what they want to know. A document can't tell them that. A person can tell them that, but a document cannot," he said, suggesting that intermediaries should impart investors with much of the information included in the prospectus and that perhaps liability should be adjusted if greater candor is truly the goal of reform.
Arguably the No. 1 challenge facing regulators going forward, though, is the increasing complexity and variety of distribution channels, where in many instances the SEC has not traditionally had jurisdiction.
In terms of the late-trading and redemption fee abuses, Roye concurred, much of the activity was reserved to intermediaries who weren't regulated by the SEC. Although the Commission is expected to consult with other regulating organizations, such as the Department of Labor, that's effective only to a certain point. Limited jurisdiction, Roye said with a degree of frustration, is what led to the controversial hard 4 p.m. close rule.
Marianne Smythe, a 62-year-old industry firebrand and partner at the Washington firm of Wilmer Cutler Pickering Hale and Dorr, who served as investment management director at the SEC between 1990 and 1993, colorfully shared Roye's vexation over the level of cooperation that exists between enforcement agencies.
"My whole view of this late-trading thing is this: There are some [people] walking around out there whose asses should be in jail for having facilitated what was clearly illegal behavior. Nobody had to go to law school to know it was illegal," Smythe said.
"And, indeed, the most severe critic of the SEC had the best chance to make that message by putting the biggest [offender] of all's ass in jail - and that guy's still walking around in the daylight. What we have in the case of late trading is an awful lot of hand wringing, where throwing a high hard one at the head of the people who brought disgrace to themselves and the industry would be a lot more effective than many, many regulations."