If you're looking for something new for your list of New Year's resolutions, here's one you might not have considered before: Become an activist mutual fund shareholder. And to help you get started, I've put together a list of fund regulatory reforms that, if adopted, would make mutual funds a more profitable place to put your money.
The SEC Has a Long List of New Year's Resolutions for Fund World
A few thousand missives from investors would go a long way toward persuading the
Securities and Exchange Commission
to make these reforms a reality. If any or all of the following wish list items strikes your fancy, just drop Chairman Arthur Levitt a note at the Securities and Exchange Commission, 450 Fifth Street NW, Washington, D.C. 20549, or send an email message to
email@example.com. Feel free to borrow the best arguments from the related articles linked below, or, if you're pressed for time, just print, sign and send the prewritten letter at
Web site. And be sure to wish the chairman a productive New Year.
Improve Portfolio Disclosure
Mutual fund shares are the one holiday gift where you still don't know what you've gotten even after it's been unwrapped. Funds are required to disclose their portfolios only twice a year, 60 days after the holding date. Such inadequate disclosure deprives investors of the information they need to make informed investment decisions and helps conceal portfolio abuses, such as portfolio pumping and window dressing.
Since June, 14 groups have petitioned the SEC to require more frequent online disclosure of fund portfolios. The
, the giant labor organization, recently upped the ante by petitioning the SEC to require funds to disclose their proxy voting policies and voting records. (More on that on Thursday.) Add your voice to the chorus. The SEC file number is 4-439. The time to act is now.
For background, see:
SEC Prepares to Battle Portfolio Pumping and Window Dressing
SEC Demurs on More Frequent Disclosure by Mutual Funds
Expose Hidden Fund Fees
Figuring out what fund fees are costing you is not as easy as those tables in your fund prospectuses make it seem. The tables omit one of the biggest expenses for funds: brokerage commissions. A recent study found that stock mutual funds spend 0.7% of their assets on commissions annually, or about
of the average stock fund's expense ratio.
A fund's expense ratio, which is provided in the fee table, includes management fees, 12(b)1 marketing fees and other operating expenses, each of which is also broken out on a separate line. So while a shareholder with a $10,000 account in an average stock fund can figure he'll pay about $140 each year in expenses, he'll be left in the dark about the additional $70 he pays for the fund's portfolio trades.
Help may be on the way. The SEC recently said that its staff will release a fee study any day now that will recommend that funds be required to disclose expenses in dollars, not percentages. This will be a welcome improvement, but the expenses still won't reflect brokerage commissions, and the additional disclosure can't compensate for keeping investors in the dark about the impact of brokerage on fund performance. With a little prodding from activist shareholders, the SEC might be persuaded to make disclosing brokerage commissions a priority for 2001.
For more on hidden fund fees, see:
SEC Preparing to Shine a Brighter Light on Fees
Crackdown on Misleading Fund Ads
Some argue that the phrase "misleading advertisement" is an oxymoron. Advertisements are
to stretch the truth, so the argument goes. But why should the SEC require that ads be more misleading than they need to be?
One of the SEC's biggest criticisms of the fund industry has been its emphasis on short-term performance, as exemplified in ads hyping outsized returns in 1999. Yet SEC rules
fund ads to display one-year performance results, even when they don't reflect current conditions. Thus, while fund returns were heading steadily downhill in 2000, many were still touting their spectacular 1999 performance. The SEC needs to reconsider the utility of one-year performance figures.
That's not all it needs to think about. SEC rules also permit funds to advertise: pretax performance even when after-tax performance may be drastically lower; months-old performance even when current performance has dropped off significantly; five-star rankings even when the category used doesn't match the fund's investments; and performance numbers in bold, large print in the center of the page even when legally required disclaimers are provided in diminutive fonts and buried in footnotes.
The SEC has talked the talk on strengthening fund advertising rules, but it hasn't walked the walk. Last July, SEC staff promised to issue tougher guidelines for fund ads by the end of 2000, but nothing has been forthcoming. Put pen to paper and remind the SEC that even in Washington, some promises really should be kept.
For more on misleading fund ads, see:
Misleading Fund Performance Claims? 'The SEC Made Me Do It'
Stand Firm on Affiliated Transactions
Commentators often point to fund advertising rules and disclosure requirements as the lifeblood of investor protection, but the real heart of the fund regulatory system is the affiliated-transaction rules. Congress outlawed deals between funds and their affiliates in 1940 after decades of exploitation of funds by their managers.
Sixty years later, the fund industry makes no secret of its desire to weaken the affiliated transaction rules, even as unrelenting consolidation in the financial services industry increases the risks of abusive practices. These rules are largely responsible for the fund industry's relatively scandal-free history. It's worth fighting to keep it that way, so let your voice be heard.
For more on why we need these rules, see:
Heartland Fiasco Shows Need for Conflict of Interest Rules
Eliminate Arbitrage Opportunities
Many funds, particularly those focused on foreign stocks, have standing invitations to arbitragers to line their pockets at fund shareholders' expense. These funds sometimes use stale prices on overseas issues to calculate their net asset values, thereby giving arbitragers an opportunity to buy shares at prices that they know will rise the next day.
Federal law requires funds to use "fair value pricing" when market prices are stale, but the SEC has done little to enforce this rule. It apparently is waiting for shareholders to notice that arbitragers are walking off with their hard-earned savings. If you would rather the SEC act than wait, then let it know.
For more on how arbs have taken advantage of some funds, see:
International Funds Still Sitting Ducks for Arbs
Your International Fund May Have the 'Arbs Welcome' Sign Out
SEC Should Live By Its Own Rules
The SEC has made admirable progress in ensuring fair and equal access to market information by Wall Street and Main Street alike. But when it comes to its own regulatory agenda, it appears to share Bismarck's oft-quoted view that one should never ask how laws or sausages are made.
The SEC routinely exercises its broad authority to give funds and their affiliates a free pass on rules designed to protect investors. Yet all too often it does so in private. The SEC frequently exempts industry players from rules imposed by Congress without any opportunity for public comment, much less notification of affected shareholders.
How laws are made may not be a pretty sight, but only if they are made in public view will investors' interests be fully considered through coverage by the press and activism by investor advocates. So let the SEC know you have a stronger stomach than it gives you credit for, and demand full disclosure of the regulatory process.
For background, see:
SEC's Push for Disclosure Often Stops at Its Front Door
Fight For 401(k) Investors' Rights
This list of needed regulatory reforms notwithstanding, investors should be thankful for a legal framework that has made mutual funds one of the best deals money can buy. That is, as long as you aren't one of the 65 million investors who own mutual funds through a 401(k), 403(b) or other employee benefit plan.
All the securities laws in the world count for little if they don't apply, and Congress, in its infinite wisdom, decided that they should not apply to retirement plan beneficiaries. Federal law relieves mutual funds of any obligation to provide participants in 401(k) and other defined contribution plans the information they would receive if they invested in the funds directly, outside the plans. Unlike direct shareholders, plan participants can't vote their fund shares, and they don't have the right when they cash out to get that day's share price.
But don't blame this one on the SEC. The commission for years has politely pointed out this inequity to Congress. So for the truly motivated, take your activism one step further: Ask your elected representatives on
to give workers who own mutual funds the same rights as everyone else.
You have the list. Now all you have to provide is a little New Year's resolve. Becoming a mutual fund shareholder activist might not help you lose weight, quit smoking, get to the gym more often or improve your relationships, but sending a few letters or email messages to the SEC is a cheaper and easier way to make a substantial difference in your investment success in 2001.
Mercer Bullard, a former assistant chief counsel at the Securities and Exchange Commission, is the founder and CEO of Fund Democracy, a mutual fund shareholder advocacy group in Chevy Chase, Md.