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Industry Leaders Urge New Product Curbs

Washington, D.C. - The SEC should consider regulating products like separate accounts and hedge funds under the Investment Company Act of 1940 because they are increasingly available to the average investor who perceives them as a type of mutual fund, according to industry leaders.

Pre-packaged portfolios and wrap accounts are currently unregulated by the Investment Company Act and are growing in popularity, said Jack Brennan, CEO and president of Vanguard Group of Malvern, Pa.

"That's a big threat to investor protection, in our opinion," he said. "You can envision a world of Dickens - a tale of two types of products functionally similar, similarly promoted but dramatically unequal when it comes to the obligations to the shareholders and the regulatory protections."

The Internet has made it possible to offer these products that are similar to mutual funds, but different in how they are regulated, he said. The Internet has also made these products easily accessible to middle-income investors who most need the protection of the 40 act, he said.

"The Internet should not be ... a place where individuals place their hard-earned money in a packaged investment, whether it's a mutual fund or a fund look-alike, and have little more protection then if they bought a toaster," he said. "That's what is being proposed out there today."

Brennan spoke to industry executives here at an SEC-sponsored celebration of the 60th anniversary of the Investment Company Act of 1940. Vanguard does not offer managed portfolio products, said Daniel P. Weiner, editor of The Independent Adviser for Vanguard Investors of Potomac, Md.

There are those who say the 1940 Act is a document that has become a relic of a bygone era, said Matthew Fink, president of the Investment Company Institute of Washington, D.C.

"Every year, somebody makes an argument to the SEC, usually by people looking to escape regulation, that the 1940 Act is obsolete and outdated and archaic," he said. "I'm sad to say the idea seems to be afoot again today. Some proponents of the new economy argue that a 60-year-old statute by definition must be irrelevant in an age of instant communication and bountiful information."

To the contrary, one of the 1940 Act's strengths is its timelessness and the SEC's ability to apply its regulations to new pooled investment products, he said.

"Just as important, the SEC has used its flexible authority to bring new types of packaged investment products under the Act so that investors in those products would enjoy the protection of the Act," he said.

Robert Pozen, president of Fidelity Investments of Boston, also said the scope of the 1940 Act should be broadened and added hedge funds to the list of products that should be monitored by the SEC more closely.

"There are over 6,000 hedge funds and they have over $350 billion in assets," he said. "So for those who think that this is a small side show, it definitely is not." Attention should be paid to the growth of hedge funds because of the serious risks the funds often carry as demonstrated by the collapse of Long Term Capital in 1998. Hedge funds' use of leverage combined with fund managers' performance-based fees encourage "swing for the fences" risk taking that can have dire consequences for investors, Pozen said. At a minimum, hedge funds should be required to print financial statements twice a year, similar to mutual funds, he said. Currently, hedge funds have no filing requirements.

The SEC should carefully weigh the benefits of regulating these new products under the 1940 Act, said Marianne Smythe, a former director of the SEC. Smythe is currently a partner at Wilmer, Cutler & Pickering of Washington, D.C. and heads the firm's investment management practice.

"It may be there are products out there that deserve a second look," she said. "They should be looked at charitably and examined to see if they can offer investors the benefits of diversified investment products without all of the regulatory framework of the 1940 Act." Many of the bundled portfolios are not being sold as mutual funds and investors can distinguish between the two products, she said.