REGULATION & COMPLIANCE
July 17, 2000
The General Accounting Office's report on fund profitability, which draws no conclusion as to whether fund companies have taken advantage of economies of scale to reduce fees but does encourage more disclosure of fees, has elicited a range of responses. It has been dismissed by some industry analysts as a self-serving move by politicians and welcomed by consumer advocates.
"The fund industry is a highly profitable industry but it is a highly competitive industry," said Burton Greenwald, president of B.J. Greenwald & Associates, a mutual fund consultant in Philadelphia. "There is transparency regarding the intrinsic value of the product that is unrivaled by any other industry. So in that sense, to me a lot of this is a political exercise. Given the fact that 50 percent of homes own funds, this becomes a viable political football. ... there has been a total absence of public demand for this information. There hasn't been consumerism revolt on this topic."
The GAO report, released July 5, studied trends in mutual fund fees and profitability, how funds compete with one another, how fees are disclosed to investors and what fund directors' responsibilities are regarding fund fees. The report's conclusions are based on a study of the fees charged by 77 of the largest mutual funds.
The report recommends the SEC require fund companies to disclose the dollar amount each investor spends on operating expenses in account statements. The report claims there is a lack of fee competition among funds as a result of the emphasis the industry places on performance in selling and marketing funds. It also states that fee competition is hindered by regulations that require fund directors to ensure that fees are not excessive and that they fall in line with the fees of similar funds.
Rep. John D. Dingell (D-Mich.) and Michael G. Oxley (R- Ohio), both members of the Committee on Commerce, requested the report. The report has been one of Dingell's "prized projects," according to David Butowsky, a lawyer in the New York office of Mayer, Brown & Platt of Chicago. Butowsky is a former chief enforcement lawyer for what is now the SEC's division of investment management.
The report's recommendation that funds disclose costs in dollar amounts on shareholder reports would be very costly to implement and would raise fund expenses, he said.
Calculating costs for each individual investor also may place too great an emphasis on costs rather than performance, Greenwald said. Investors may be inclined to select funds with lower costs, ignoring the performance of the fund and the overall return, he said. Comparing changes in net asset values is more meaningful than comparing fund expenses because the net asset value is net of overall expenses, he said.
Studies conducted by the SEC, however, show that most investors do not pay attention to fund fees and expenses, said Barbara Roper, the director of investor protection for the Consumer Federation of America, a non-profit consumer advocacy group in Washington D.C. Publishing specific dollar figures for individual investors would force them to take notice of fees, she said.
"The SEC has put educational materials on its website to encourage investors to pay more attention to fees," she said. "Research suggests [investors] do read account statements and if you put fees in concrete terms I think you'd see more investors paying attention."
The mutual fund industry's criticism of the GAO report's recommendation for greater disclosure is predictable, she said.
"There are three things you hear when you ask them to provide greater disclosure," she said. "One is that investors do not want the information, two is they won't understand the information and three is it's too expensive. Technology available today minimizes those costs. I approach that argument with some skepticism ... I'm not convinced that costs would be that high."
The GAO report is not political posturing, Roper said. The industry's profitability and the fees it charged was brought to Congress' attention because of the industry's explosive growth.
Paul F. Roye, director of the SEC's division of investment management, disagreed with the GAO's conclusions - that there was minimal fee competition in the industry and that the precise fees investors pay should be included in quarterly reports, in a letter to Thomas McCool, director of the GAO's office of financial institutions and markets.
"Although one could certainly argue that there should be more competition in the industry, it is hard to argue that there is an absence of price competition," Roye wrote in a letter May 10. Letters from Roye, the ICI and NASD were appended to the GAO report when it was released. Roye also commented on the SEC's efforts to educate investors on fund fees.
"The primary focus of our disclosure effort has been to make fund fees and expenses more transparent to investors and to allow investors the ability to compare fees and expenses between different funds, as well as to educate investors about the importance of fees," he wrote.
Matthew Fink, president of the ICI, also criticized the report in his May 3 letter to McCool.
"The draft report notes in several places that mutual funds compete primarily on the basis of investment performance," he wrote. "Less prominent attention is given to the fact that by law, mutual fund performance results must be calculated after fees and expenses are deducted. Because of this requirement, investors' decisions are indirectly taking into account the impact that fees can have on a fund's returns. The indirect consideration of fees through performance appears to be highly relevant to shareholders' investment decisions."
Fink also objected to the recommendation that funds disclose fund expenses for individual investors.
"No other financial product provides disclosure that is this comprehensive and we were disappointed to see the draft report suggest otherwise," he wrote. The SEC is expected to issue its own report on fund fees soon.