The umpire strikes back. Investors are finally getting the right calls, as regulators have unveiled a series of aggressive steps to improve fund governance and eliminate hidden fees charged to shareholders.

Responding to a wave of criticism for failing to catch widespread trading abuses and questionable sales practices, the Securities and Exchange Commission last Wednesday proposed three regulatory initiatives designed to better protect the 95 million investors in mutual funds. The nation's top securities regulator has been blasted repeatedly by New York Attorney General Eliot Spitzer for being behind the eight ball on the fund scandal, and finally, the SEC appears to be stepping up to the plate to get its house in order.

"The SEC is really doing an about-face and taking a very aggressive position that will have shareholder advocates dancing in the streets," said Mercer Bullard, founder of investor advocacy group Fund Democracy and an assistant law professor at the University of Mississippi.

Perhaps the most groundbreaking change put forth by the SEC staff are rules that would enhance the information brokers provide their customers regarding certain transactions. The first of these precedent-setting proposals would require brokers to tell customers at the point of sale, likely over the telephone, what distribution fees are associated with a particular fund and what percentage of those fees would be paid to the broker.

This would include sales loads incurred at the time of purchase, asset-based sales charges and service fees and the maximum deferred sales load that they will pay if the shares are redeemed within a one-year period. Brokers would then document their disclosure in keeping with compliance standards. Under the terms of the rule, the customer would reserve the right to cancel any order made prior to the point of sale disclosure. Bullard characterized the point of sale directive as a "radical departure from the structure of the Securities Act."

"If investors are paying a sales load for a fund, they should know where that load is going and into whose pocket," said Samuel Lieber, chief executive of Alpine Woods Investments and president of Alpine Funds. He suggests that funds can better align themselves with shareholder interests by handing customers a one-page signoff sheet highlighting the costs involved with each transaction.

The second rule would require further disclosure at the time a trade has been confirmed, not only reiterating the sales loads and broker fees but also disclosing any revenue-sharing agreements in place. The most pro-shareholder aspect of this rule is that it will also require brokers to provide comparative information on fees, commissions and revenue sharing so that investors can make a more informed decision on their investment.

This is not likely to sit well with the brokerage community because its members often receive fatter commissions and kickbacks for pitching certain funds or share classes. In recent years, brokers have been calling the shots in the fund industry, partly because they're able to get paid in a way that makes it appear that fees are being imposed by the fund manager when, in actuality, they come from the broker.

"This will affect the dynamic between pure fund managers and distributors," Bullard said. "The brokers will be absolutely livid and will roll out the costs too much, too confusing' arguments, which will demonstrate that you've hit them where it hurts -- their profits." Mutual fund purists, on the other hand, will applaud the move since they are fed up with having to play second fiddle to distributors.

Boardroom Blitz

Another facet of the SEC proposal takes aim at overhauling the boardroom, a comprehensive plan that includes requiring funds to have 75% of its board members be independent as well as have an independent chairman. The purpose of this rule is to strengthen the board's hand when dealing with management, which has often been accused of bullying other board members to further their objectives.

Despite unanimously approving the provision for public comment, the panel of commissioners seemed divided on whether a more independent board would effectively address the two biggest concerns for investors -- fees and performance.

"My concern is that this may put form over substance," said SEC Commissioner Cynthia Glassman, a Republican appointed by President Bush. She argued that there is no empirical evidence to support the notion that independent directors prove to be more effective.

In support of her argument, she noted that Alliance, Putnam, Bank of America and Bank One each had at least one of those requirements in place at the time they were allowing their funds to be manipulated by market timers. Glassman added that she would support the rule if it didn't impose any further costs on investors, which is often the case when funds are forced to meet new regulatory standards.

The changes in the boardroom could be achieved through the resignation of current board members or increasing the size of the board, which may or may not require the approval of the shareholders, according to Paul Roye, the regulatory agency's director of investment management.

"There are moments where logic and experience and anecdotal evidence compel certain conclusions," said Commissioner Harvey Goldschmid, a Democrat. "Independent directors must be made stronger and more active. They must bark and, where appropriate, they must bite."

Indeed, board independence will be a source of controversy in the coming months with the Investment Company Institute likely to swing back with its own proposal. ICI President Matthew Fink issued a statement calling the reforms "bold and far-reaching" and essential in addressing issues of investor confidence but said that they may not "achieve the benefits that are hoped for."

Additionally, conducting annual self-evaluations of fund boards, calling separate meetings without the presence of management and allowing the directors to hire their own staff when seeking specific expertise are also on the docket.

A third regulatory initiative tabled by the SEC was the adoption of a code of ethics for investment advisers, the purpose of which is to reinforce the fiduciary responsibility of fund personnel. Key tenets of the code pertain to safeguarding material non-public information including requiring certain individuals, other than advisors, to report their own personal securities holdings, particularly transactions in mutual funds advised by the fund's advisor or an affiliate.

"All these things put together will have significant downward pressure on fund pricing," Bullard said.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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