PALM DESERT, Calif. - The Securities and Exchange Commission will certainly have its hands full for the next 12 months, as a spate of issues within the mutual fund industry have landed in its crosshairs. Despite a robust agenda, the SEC told fund executives at the Mutual Fund Investment and Management Conference two weeks ago that it will "marshal all of the resources [it] can" so that each item is carefully examined and dealt with in a timely fashion.

But many skeptics are saying that recent intervention from Congress will only serve to protract an already slow-moving process. The House Committee on Financial Services recently sent a letter to SEC Chairman William Donaldson advising him to review the merits of up to 18 industry practices following an airing of the grievances on Capitol Hill last month. The recommendation from the House is yet further evidence that Chairman Michael Oxley plans to continue his crusade to improve corporate governance and restore investor confidence.

More importantly, it leaves the SEC in the lurch to the extent that it adds a lion's share of work to the heap of proposals already on its plate. The longstanding complaint from the SEC is that it is asked to cover all the bases with limited appropriations. Now, more than ever, the SEC is in need of a more extensive budget, according to ICI Senior Counsel Amy Lancellotta, a panel member at the conference.

While it was evident from the facial expressions of the panelists that the SEC would be stretched thin in handling that workload, Paul Roye, director of the division of investment management at the SEC, maintained a perspective on the seemingly daunting task.

"Any time we receive a letter from Congress, we take it very seriously," Roye said. He also stressed the importance of cooperation between industry leaders and the SEC as the best way to expedite reforms.

One major point of contention is the pending compliance officer rule. The SEC has recommended that fund complexes appoint chief compliance officers and put specific internal compliance programs in place. "I can think of 13,000 reasons" for this requirement, said Lori Richards, director of the office of compliance, inspections and examinations at the SEC. "There are 5,000 funds and 8,000 advisors," she quipped.

The industry, which has been operating under an informal procedure for many years, opposes the proposal, citing its strong track record in dealing with potential conflicts. The SEC, however, wants more stringent compliance procedures similar to those in the banking and broker/dealer industries, which have a mandated and comprehensive set of requirements.

"Codified procedures and experienced compliance officers will limit potential violations," Richards said. She noted that slack controls enable violations to go undetected. She also addressed confidentiality concerns, stating that compliance records would not be made public.

In a related issue, members of the panel discussed the possibility of forming a self-regulatory organization, or SRO, in order to actively police the industry. Glen Payne, senior vice president and general counsel at Invesco Funds Group, expressed his staunch opposition to the proposal, saying it wouldn't eliminate regulation but, rather, cause duplication in exams. He dubbed the proposal "a phoenix rising from the ashes," alluding to the fact that it manages to resurface every five or six years after being squashed.

"It doesn't necessarily mean duplicity," Roye retorted. "It doesn't have to supplant the SEC." Roye noted that it would serve as more of a supplementary body. Richards agreed, saying, "The SRO staff brings expertise the SEC may not have."

Roye continued to hammer away at various issues, including soft dollar arrangements, 12b-1 fees and breakpoint discounts, which were among the 18 points in Congress' letter. With respect to the soft dollar issue, Roye acknowledged that the SEC has been investigating that problem for many years, and he suggested there is some overlap in many of the areas outlined by Congress. He offered stricter record keeping as a possible solution.

"Oral agreements using soft dollars creates confusion and potential conflicts," Richards said, adding that they should be eliminated altogether.

As for investors not receiving breakpoint discounts, Richards said that a SEC task force would be cracking down on the problem, calling it a "disturbing" development. Roye again flexed his muscle on the panel, saying that fund companies need to take more responsibility for the viability of such features. "You can't just bury your head in the sand on this issue," he said rather rigidly.

Some panelists suggested putting breakpoint discounts back in the prospectus would help alleviate the problem of overblown fees. Marguerite Morrison, a vice president and chief legal officer at Prudential Investments, dismissed the idea. "The cost of putting breakpoint discounts back in the prospectus will be borne by the investor," Morrison said.

Clearer Shareholder Reports

But perhaps the most significant item on the SEC's agenda, Roye believes, is generating more transparent shareholder reports. He stressed that steps must be taken to streamline the report, including providing the investor with access to the full portfolio or at the very least all holdings that make up 1% or more of the portfolio. Tabular and graphical presentations are one of the things that should be mandated along with relevant discussions on performance, Roye said. Fund shops' fee structures also need to be clearly defined, he added. He suggested that shareholder reports contain the expected rate of return on a $10,000 investment, illustrating the net return after fees and expenses.

Lastly, the frequency of inspections and examinations was also on the agenda. Given the stronghold the largest firms have on the majority of assets, the SEC intends to give them enhanced focus. Indeed, the top 100 firms control 60% of assets under management. Among those firms, the top 20 advisory firms and affiliated fund groups will be subject to an inspection every two years. The remaining 80 firms will face inspection contingent upon their risk, with no firm going more than four years without being inspected.

The criteria for assessing risk will include the consistency of portfolio management decisions with clients' mandates, allocation of block and IPO trades and order placement practices, just to name a few. In these and other areas, examiners will dissect compliance and control procedures and evaluate their efficacy accordingly. "We hope to catch less serious deficiencies before they become serious, and ensure that new advisers understand their compliance obligations," Richards said in a speech to industry executives last October.

Copyright 2003 Thomson Media Inc. All Rights Reserved.,

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.