Scandal Squeeze Moves on to Fees
December 8, 2003
WASHINGTON - If the fund industry thought it already had enough legal headaches from Fundgate, its next problem could be a profit squeeze.
Congress and some regulators, including the SEC, are beginning to link the market timing, late trading, directed brokerage and soft dollar issues to fees. During their hearings last month on fund trading practices, ranking members of the Senate Banking Committee challenged the sales, transparency and fee structure of mutual funds.
"We want to make sure mutual funds are operating as efficiently and fairly as the market demands," Sen. Richard C. Shelby (R-Ala.), chairman of the Senate Banking Committee, announced as the outset of the hearings where SEC Chairman William Donaldson and ICI President Matthew Fink testified (see MME 11/24/03).
Fees and the failure to deliver on the promise of economies of scale in an industry that has grown 60-fold since 1980, has continued to be one of the key mantras of New York Attorney General Eliot Spitzer (see MME 11/10/03). During his testimony, Donaldson set forth "An Investor's Bill of Rights," including the right to clear disclosure of fees and expenses.
On top of this, the general press is now calling the investing public to arms, telling them that at $35.2 billion a year, mutual fund fees are too high and that they are being bilked by inferior, at times, and, quite often, greedy fund managers. Though buried in fund prospectuses, sometimes cloaked in 12b-1 fees or loads, and averaging 1.59% a year, the fees "represent an enormous and troubling transfer of wealth from hardworking individuals to some seriously fat cats," last Sunday's New York Times business section reported.
Executives in the fund industry have remained largely silent on the issue of fees. The ICI has vehemently fought proposals to require funds to send investors billing statements, and recently won on a proposal to standardize fees in dollar amounts based on a $10,000 investment.
Bills in both houses seek fee transparency, extending far beyond recommendations of the SEC and the ICI. The Mutual Fund Transparency and Integrity Act, which passed by a near-unanimous vote in the U.S. House of Representatives Nov. 19, would require wider disclosure of fees. Similar bills proposed in the Senate are pending floor votes. Recently, the NASD proposed requiring funds to include fees in advertisements.
All of these proposals are designed to better educate investors as to how much they are paying funds. Downward pressure on fees is an important side benefit, shareholder advocates such as Jack Bogle, founder of Vanguard, have long argued (see MME 11/06/02).
Perhaps not surprisingly, fund executives has been mum on these issues that have now become part of the scandal dustup. One fund analyst told MME he cringes at the fervor of the press coverage, which, in many cases, he believes is unfair.
If the government people and consumer advocates have their way with transparency reforms, surely, then, fees could come down, putting some serious pressure on profit margins.
Neil Bathon, president of Financial Research Corp. of Boston, however, does not think that this is the case. Investors already have adequate information on advisory fees, listed in the front of every prospectus, Bathon said.
"It's pretty clearly laid out," he said. "As far as an additional $10,000 investment figure, that won't have any impact on any facet of the business," Bathon said. And as to whether the new measures might prompt investors to begin shopping around for better fees, "those who are interested already look at the expense ratio. But the thing is, no one really cares.
"They only care when their performance is down, and we have seen a cycle when interest in fees rose" come to an end, Bathon said.
But Douglas J. Klein, a retirement plan consultant with 401(k) Education, Inc., Verona, N.J., is sure fee reforms will push fees lower.
Pouring Over the DARs
In the short term, however, firms will be hit with a massive amount of new costs -- from having to hire more accountants, auditors, lawyers and a chief compliance officer -- to certify daily activity reports (DARs), Klein said.
But once the industry learns how to bear these additional recordkeeping, operations and technology expenses, fees will definitely go down, he said, driven primarily by the financial consulting community.
"The financial consultant will be working very diligently to show that he or she is working to add value. A reduction in annual fees is one way of doing that. It is really going to hurt the mutual fund companies in the 401(k) business," Klein said. "You can count on that."
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