Industry Urged to Re-Examine Share Class System
March 1, 1999
WASHINGTON - The alphabet soup of fund share classes has become so confusing that the mutual fund industry, the SEC and Congress should examine whether the law that created the system should be changed, according to an industry executive.
Jessica Bibliowicz, president and chief operating officer of John A. Levin & Co., said that the use of various classes of mutual fund shares is confusing investors more than benefitting them. Investors primarily are concerned with their net performance rather than how they pay to purchase their funds, Bibliowicz said. In addition, the class system - in which investors pay sales charges by purchasing an A, B, C or some other class of fund - increasingly is not reflecting the economic reality of the marketplace, Bibliowicz said.
All parties involved should consider whether the federal law which established share classes, the Investment Company Act, should be revised to allow those who sell funds to negotiate sales commissions, Bibliowicz said.
"It's worth a look in today's environment," Bibliowicz said.
Bibliowicz made her comments here during the SEC's roundtable, "The Role of Independent Investment Company Directors." At the two-day conference, more than 40 independent directors, mutual fund industry lawyers and academics discussed the current role of mutual fund directors and how it might be changed.
Mutual fund executives in a panel discussion on fund distribution arrangements acknowledged that the current system of share classes is confusing. And there was a consensus that improved clarity would help.
"The more complicated the alphabet gets, the less sophisticated the investor," said Charles Schwab, founder, chairman and co-ceo of the company bearing his name.
Bibliowicz, an independent director for the Eaton Vance funds and former top executive for Smith Barney's mutual fund group, said the system of share classes is both confusing to investors and missing a growing segment of the mutual fund universe, investment advisers.
Advisers typically purchase funds at net asset value (NAV) for their clients. They then charge clients a fee, often based on assets under management, for the adviser's advice.
The investment advisers' charges are assessed without the scrutiny of independent fund directors, Bibliowicz said. It may be time to consider simply selling all funds at NAV, with various distribution channels negotiating their own charges, Bibliowicz said. She urged the SEC to encourage debate on the issue.
SEC Chairman Arthur Levitt took part in the discussion on fund distribution issues but offered no immediate reaction to the suggestion from Bibliowicz. SEC officials have said that they expect last week's discussion to spur work on possible changes to fund governance.
Distribution charges and the manner in which they are assessed are frustrating executives. Faith Colish, an independent director of the Neuberger Berman funds, described multiple share classes as resembling a Rube Goldberg device in their complexity.
Executives expressed a common lament. The law and regulations have not kept up with industry practice when it comes to distribution fees. For example, Rule 12b-1 fees initially were expected to pay for marketing expenses and now primarily serve as trailing commissions for intermediaries, several executives said.
Nevertheless, fund directors essentially are forced to fit what amounts to an ongoing commission charge into the box of a marketing expense. Investors are not well served by the illusion, executives said.
"If you're spending money on distribution, say it," said Paul Haaga, executive vice president of Capital Research & Management, an investment adviser in Los Angeles.
Haaga said in a statement that regulators and the industry should "spend less time and energy on labeling services and expenses as distribution' or non-distribution'" and instead evaluate whether the expenses are valuable to shareholders.
The panels at the SEC forum largely were comprised of industry executives. There were some outsiders' voices, however.
Harold Evensky, an investment adviser from Coral Gables, Fla., was critical of industry practices on fees and fee disclosure. The SEC should support a more rigorous legal standard governing what makes mutual fund fees reasonable, he said. The existing standard, which essentially permits all fees which are reasonable, provides so much latitude that an independent director has little leverage to change fees unless the law regulating fees is changed, he said.
Evensky also said that independent directors usually appear uninformed about the interests of their shareholders, an assertion which fund executives challenged.