There are 95 million mutual fund investors in America, and only one advocate for mutual fund shareholders: Mercer Bullard.
That may seem like a Promethean task, but the former
Securities and Exchange Commission
official has proven game. Since founding the not-for-profit
Fund Democracy less than four years ago, Bullard has aggressively pursued unsavory practices in the mutual fund world with the fervor of a vengeful superhero.
Bullard's articles on potential market-timing abuses for
in 2000 helped lay the groundwork for the allegations of fund-trading abuses in September -- indeed, the articles merited a prominent citation in New York Attorney General Eliot Spitzer's complaint.
Bullard, who doubles as a securities law professor at the University of Mississippi at Oxford, has been popping up in an increasing number of stories about the mutual fund industry these days -- as a tireless advocate for fair, honest treatment of individual investors, at times criticizing the fund industry's attempts to clean up its act in the wake of the latest scandal. The fund world may find it comforting that there is only one Mercer Bullard.
However, as today's 10 Questions demonstrates, Bullard believes the fund industry has earned its stellar reputation as a responsible steward of investors' assets. He also gives the lion's share of the credit to his former boss, the SEC. In today's column, Bullard weighs in on the fund-industry scandal that began with allegations of market-timing abuses at
One Group Funds and Strong Funds, and late-trading abuses at
Bank of America's
Nations Funds. Read on to hear Bullard's thoughts on the good, bad and criminal of mutual funds -- including more scandalous behavior among funds, and the fund firms that he trusts with his money.
1. What is Fund Democracy, and what led you to start it?
I started in private practice working on SEC enforcement matters and moved to mutual-fund law in the 1990s. In 1996, I went to work for the SEC, where I found that there was very little input from shareholders regarding most issues relating to mutual funds regulation.
I left the SEC's Division of Investment Management and started Fund Democracy in January 2000 in order to fill that void. Fund Democracy's members are large organizations such as the AFL-CIO, the Consumer Federation of America and the Financial Planning Association. Its purpose is to provide those organizations with a specialized expertise needed to effectively lobby the SEC on certain mutual fund regulatory issues.
Mutual fund law is an esoteric area, and it's too complicated to expect consumer and employee groups, let alone individuals, to understand the inner workings of most mutual fund rules.
2. The fund industry, until quite recently, has had a fairly pristine reputation. Do you think it deserves that reputation?
Yes. The fund industry's relatively scandal free reputation is deserved. Most of the credit, however, goes to the regulatory scheme under which it operates and the effectiveness of the Securities and Exchange Commission in enforcing the regulations.
3. Has the SEC done enough to police the mutual fund industry?
In light of Spitzer's complaint, it's easy to point out lapses in the SEC's enforcement program. But on the whole, the SEC deserves most of the credit for the growth of the industry and its relatively scandal-free reputation.
Criticism of the SEC's handling of stale pricing and late trading shouldn't distort the bigger picture, which is that the SEC continues to be our most effective federal agency. I'm proud to be an SEC alumnus.
4. Is the unfolding scandal over abusive market-timing and illegal late trading of funds the tip of the iceberg, or is this the work of a few bad apples?
With seven or eight major firms already implicated, we're pretty well into the iceberg. But the real question is when will the other regulatory shoe drop with Spitzer's and the SEC's final responses to these frauds. The question regarding Spitzer is: What kind of settlement will he reach with the fund managers? The question for the SEC is: What new regulations and guidance will it issue in the wake of this scandal?
5. Have the boards of directors at mutual fund companies done enough to protect investors?
What's really most disheartening about this is the continued irrelevance of fund directors. The Spitzer allegations evidence an inexcusable lapse by directors. It is Compliance 101 that fund directors must take steps to ensure fund managers are updating their prices and not cheating their own funds' shareholders. Directors should be making spot checks to ensure that fund managers are complying with the law, which includes investors' receiving the commission breakpoints they are entitled to, pricing the fund accurately, and preventing buying fund shares after the 4:00 deadline.
Part of the problem with directors is that there's a strong reluctance on the part of judges and regulators to hold directors personally responsible. That has got to change -- and this applies across Corporate America, not just with mutual fund companies.
Thirty years ago, it was clear that directors had to make specific inquiries to management and follow up to ensure that the firm was in compliance -- that's no longer the case. And fund directors are merely living down to the lowered expectations we've set for them.
6. What will spur a change?
Some heads have to roll. In particular, you need to the SEC to tack some director hides to the wall. And I think the SEC
going to tack some hides to the wall. The first may be some of the independent directors of the Heartland funds. Now going on three years after causing a 70%, one-day, mispricing loss to investors, the board is still almost unchanged.
7. What other questionable fund activities do you think will be unearthed as the fund industry comes under greater scrutiny?
The big issue is really fee disclosure. Going forward, it's vital that the SEC or Congress improve the transparency of the costs of owning funds. Toward that end, two parts of the Baker bill would have an impact that would make Spitzer's allegation look like minor irritations.
First, the bill would require that a fund's expense ratio include portfolio transaction costs. Including commissions in expense ratios will drive down portfolio turnover, because many funds will otherwise appear too expensive to survive. And it will put the spotlight on soft dollars.
Second, the bill requires that the transaction confirmation show how much the broker got paid for pushing the funds. Studies have shown that price transparency spurs competition. If investors saw on confirms the actual dollar amount the broker was being paid, there would be more competition. Showing sales commissions on confirms would have a strong depressing effect on sales compensation.
The relative savings would be substantial. Spitzer's settlement will likely run in the hundreds of millions, with total losses resulting from stale pricing abuses running less than $1 billion. The two measures in the Baker bill would result in more than a billion dollars saved every year.
8. What are the red flags for investors looking to see if their fund families are engaging in dirty tricks?
Investors should be looking for two things: The quality of a fund firm's shareholder services and their fees. Regarding fees, there's no reason to even think about investing in a fund that has an above average expense ratio.
And funds that have good services are likely to have similarly effective compliance systems. Investors would be well-served by reconsidering their investments the funds that have been named in these complaints. Investors should not invest with fund managers that are brought up on charges and are convicted or settle. It astounds me that people still invest in the Heartland funds -- especially fiduciaries of employee benefit plans, who have a responsibility to serve their clients' best interests and may be personally liable for losses resulting from any further fraud that they should have anticipated.
9. So many of these fiduciaries are exposing themselves to legal repercussions by continuing to invest in these funds?
Yes, it's once burned, twice liable. There was no reason to think before the Spitzer allegations that
Bank of America
would have allowed late trading and other abuses. But to invest in any NationsFunds now, you'd be ignoring explicit warning signs.
10. What fund firms do you trust with your money?
Vanguard, Fidelity, American Funds
T. Rowe Price
are the big firms at the top of my list -- although I use only two of them.
If you limited yourself to those five fund firms, I don't think you'd go wrong.