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Proposed Bill Would Mean Greater Transparency

Mutual fund investors may get a better understanding of fund costs and greater insight into the relationships and possible conflicts of interests of fund management.

House Capital Markets Subcommittee Chairman Richard H. Baker (R-LA), introduced legislation last Wednesday calling for increased disclosure of soft-dollar arrangements and revenue-sharing agreements, as well as expanded information on costs and discounts of a fund. The House Capital Markets Subcommittee is scheduled to hold a hearing on the proposed bill, the Mutual Funds Integrity and Fee Transparency Act of 2003, this coming Wednesday.

Baker said that it is only proper that Congress ensure that the millions of ordinary, working families participating in the markets via mutual funds get the facts they need to make informed investment choices and that those they hire to manage their money act in the most professional manner.

If passed, the bill would require funds to inform investors of operating expenses in dollar amounts. It would also require funds to make portfolio transaction costs available in a way that will allow comparisons to other funds. Funds would have to disclose, in a document other than the prospectus, soft-dollar arrangements as well as revenue-sharing and directed brokerage agreements for fund distribution, and they would have to submit an annual report on these issues to directors. The bill also asks the Securities and Exchange Commission to conduct a study on soft-dollar agreements and consider taking away the safe harbor for them.

The bill would help on the corporate governance front as well by requiring two-thirds of all board directors and the fund chairman to be independent. It would bar any person with a business or family relationship to the investment advisor from the board. It would also require funds to disclose how portfolio managers are compensated and would apply Sarbanes-Oxley reform to mutual funds, ensuring auditor independence and accountability.

Roy Weitz, industry critic and publisher of, said he expects the industry to "go nuts" over a few areas of the proposed legislation such as personalized account statements on individual expenses and the disclosure of portfolio managers' compensation. "That's something they really don't want to do. The industry showed how weak it was on the proxy disclosure issue. They lost a lot of credibility. I think they're going to put up a fuss, but I wouldn't be surprised to see this passed pretty much as is," Weitz said.

The SEC Report

A day earlier, the SEC issued a report indicating that increased transparency in the $6.4 trillion mutual fund industry is necessary, but hinted large-scale changes are not likely due to their impracticality. The SEC issued the report in response to a letter Baker sent the commission back in March.

"The SEC held its punches" in the report, said Gary Gensler, former U.S. undersecretary of the U.S. Treasury. Gensler noted that the commission suggested tightening some things such as the definition of independence for mutual fund boards and soft dollars. However, the SEC's recommendations in the report "still failed to get at the core issue of governance," Gensler said. "Do mutual fund directors have a responsibility to shop around and get the best services and best prices? Until you address that fundamental point you are really holding back," Gensler said.

Weitz, said the report is "very responsive in one respect, but fairly unresponsive in another." He said the SEC pointed out several solutions to questions raised by Baker, but then each time found a side effect or flaw to the solution. "If you don't want to do something, you find a way to look cooperative, but [look] to put it off," he said.

"Although proposals to quantify transaction costs are attractive in theory, it is difficult to see how they could be feasible," the SEC wrote in its report.

One of the main topics in the report was the disclosure of fees. The commission said that while transactional fees in mutual funds are "relatively transparent," ongoing fees are less evident. Additionally, only a small percentage of mutual fund investors understand what they are being charged or the impact fund expense ratios have on their returns.

The SEC proposed additional disclosure of ongoing expenses late last year, but said it was also considering the General Accounting Office's June 2000 proposal. The GAO report called for funds to provide each investor with an exact dollar figure for fees in each quarterly statement.

In response to the SEC report, The Investment Company Institute issued a statement, saying that it supports "strong, appropriate regulation" and that it remains committed to maintaining the trust of fund investors. It also said that it will work with Congress and the SEC "to make our strong system of regulation even stronger."

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