SEC and GAO Studying Mutual Fund Fees - TheStreet

SEC and GAO Studying Mutual Fund Fees

But the question remains whether excessive fees can be successfully challenged.
Publish date:

WASHINGTON -- In the late 1800s, John D. Rockefeller's

Standard Oil Co.

found itself under fire even as kerosene prices were falling from 26 cents a gallon to only six. Sure, prices were down, trustbusters argued, but how much lower would they be if Rockefeller didn't have a stranglehold on the market?

These days, some are asking the same kind of question about the nation's mutual fund industry. Although funds have made strides in cutting expenses, many investors argue that costs are still too high, causing returns to suffer. And now, the issue is about to get a fresh airing.

Two major studies of mutual fund fees are due to be released in coming weeks, one from the

General Accounting Office

, Congress' investigative arm, and the other from the

Securities and Exchange Commission


Those involved aren't providing many details on conclusions, but investigators are known to be focusing on some of the following questions: Is the $7 trillion industry sufficiently competitive? As funds grow larger, do they achieve cost-saving "economies of scale," and if so, have investors shared in those gains? How much of the fees compensate intermediaries like brokers? Are fee disclosure requirements adequate? Are funds' boards of directors aggressive enough in checking high fees?

In short, investigators are focusing on the same kind of little-known issues that, when exposed to sunshine, have created pressure to cut investor costs in other financial services.

The drive behind the probes is two-fold: With the booming stock market of recent years, more Americans than ever have become shareholders, especially in the form of employer-sponsored retirement plans, which often invest in mutual funds. Today, about 83 million individuals, representing about half of all U.S. households, are fund investors.

At the same time, many investors don't appreciate how much fees can corrode their returns.

For example: Say you invest $10,000 in a fund with an annual return of 10% before expenses. If the fund has annual costs of 0.5%, you'll end up with $60,858 after 20 years, according to the SEC. But if the fund had expenses of 1.5%, the ending balance would drop to $49,725 -- an 18% slice off your total return.

The industry touts cost-cuts in recent years. Its trade group, the Washington-based

Investment Company Institute

, says that total shareholder costs for stock funds fell 40% from 1980 to 1998. Bond and money market fund costs fell by 29% and 24%, the ICI says.

"There's so much misunderstanding," says ICI spokeswoman Elizabeth Powell. "It seems like competition is working well, and prices are coming down."

But critics say the figures are incomplete. For instance, 12b-1 fees charged by stock funds that levy an upfront "load," or sales charge, have more than tripled since 1985, partially offsetting other declines. Mutual fund companies can levy these fees for marketing efforts, administrative services or as an alternative to sales charges used to pay salespeople.

There are also complaints that huge inflows into popular, low-cost fund companies, such as

Vanguard Group

, have obscured fee run-ups at other funds. One example: Funds

, a Palo Alto, Calif.-based investment firm, recently proposed boosting fees for a money market fund by 260%. (The company did not return calls seeking information on whether the bid was approved at a recent shareholder meeting.)

Again, the industry's own data provide ammunition to the critics: An ICI report indicates that about 40% of the overall decline in costs is attributable to investors shifting money from load to noload funds, or from higher-cost to lower-cost funds.

And many are skeptical that funds have shared economies of scale with their customers.

Still, the industry says, investors are voting with their dollars to stay put. "With more shareholders and continued strong flows into stock funds and money market funds, I don't think there's any sign of shareholders being dissatisfied with the funds," says ICI spokesman John Collins.

While the GAO and SEC studies are welcome for spotlighting fees, the real issue is whether possibly excessive expenses could be successfully challenged, said Mercer Bullard, former assistant chief counsel in the SEC's investment management division. According to Bullard, courts have set a standard so high for proving excessive fees that a successful civil suit has never been brought.

"It can't be a meaningful standard if it's never

been violated," says Bullard, who now heads an advocacy group for mutual fund investors. What's needed is congressional action to establish a realistic standard that would actually protect investors and start to have some effect in the marketplace, he says.

Otherwise, he says, bringing to mind the Rockefeller era, "even if fees have gone down, maybe they've gone down only half as much as they should -- we don't know."

The upcoming reports could serve as the basis for new laws or regulations. But any remedies, at least initially, are expected to go down the path of greater disclosure, not fee regulation.

"The result of the study can't be that the SEC regulates fees," says Paul Roye, director of the SEC's investment management division. "The marketplace ought to be the arbiter of that. Our job is to make those fees and costs more transparent to investors."

That's why, in a related issue, the SEC is proposing disclosure of after-tax fund performance data. Like mutual fund fees, "taxes are a cost," Roye says.

In any case, watch for release of the two reports and attendant publicity to put mutual fund fees in the spotlight in coming months.

"That will reignite the issue," says Bullard.