Bullard Calls for Overhaul, While Execs Warn of Overregulation
July 5, 2004
CHICAGO--During a star-studded Morningstar investment conference panel, investor advocate Mercer Bullard called for a complete overhaul of the way fund companies conduct business, while Bob Pozen and Ed Haldeman warned of the unintended consequences of overzealous regulation.
During the session, entitled "Reforming the Fund Industry," Bullard, the founder of Fund Democracy, called for an overhaul of the relationship between the product and distribution sides of the fund business. Meanwhile Pozen, MFS' non-executive chairman, and Haldeman, Putnam's chief executive, complained that too much in-depth disclosure of portfolio manager compensation and personal investment information could create a brain drain in the industry and give other competing investment products an unfair advantage.
"Down the road, there is a storm brewing, and that is in the relationship between a product and distribution," Bullard said. The debate over the point-of-sale disclosure document and the SEC's companion proposal that brokerage compensation be shown in the confirmation statement "is going to raise the level of the debate to a much higher crescendo than we saw with the independent chairman" rule, he said. This is because it relates to the way funds are regulated, Bullard continued, noting that they are currently governed in a way that links the distributor and the product.
"If I told you that IBM was going to get paid a little extra every time Merrill pushed IBM stock in a secondary market transaction, you would all be offended as retail investors, and the SEC would crack down on it immediately," said Bullard, a former SEC attorney. "But we have no problem legally with the same thing happening when a Merrill Lynch broker is getting paid more for pushing one fund complex than another."
To remedy this inherent conflict, the industry and the SEC are moving toward inevitably "delinking" the product and distribution sides of the business, Bullard contended. That way, a broker will be able to collect a fee, even if it is an obscene 5% or 6%, directly from the investor, and will truly be free to recommend the best fund for his or her client.
In order to undertake such a massive overhaul, a number of steps are required, including reforming 12b-1 fees and revenue sharing as well as "unfixing" commissions by letting brokers charge an amount they feel is appropriate for the services they provide instead of having that amount set forth in the prospectus, Bullard added.
"You are going to see it played out in this battle about point-of-sale disclosure and the confirmation disclosure, which is just beginning, but is really about this broader structural change that is inevitable in this industry and is just a matter of how quickly we are going to get there," Bullard said.
Pozen called the idea an "interesting concept" but said the "radical rethinking" Bullard is suggesting is unlikely to come about very expeditiously. There will likely be a tightening of the 12b-1 rule, and the 2% redemption fee for rapid trades is likely to be adopted, Pozen said. While the fee is likely to curb market timing, it could harm some ordinary investors, incur added costs and lead to compliance complications with regards to exemptions. "I don't see an easy answer," he said.
Of more immediate concern to Pozen and Haldeman was the topic of disclosure and transparency. "I think we haven't done a good job there [and] as an industry have to take initiative on our own. If not, it should be imposed on us, to come up with real and meaningful disclosure," of fees, expenses and commissions, Haldeman said. "And have it be up front, clear and understandable, not buried in the back of the prospectus."
Tiered disclosure beginning with a one-page disclosure document will help cure the ills of industry, MFS' top dog added. The one-page document would direct investors to read the prospectus or to the company Web site if they would like more detailed information. "We can't keep kidding ourselves that people read these very long and turgid documents," he said of the prospectus.
However, the two said they are not in favor of all disclosure proposals, especially when it comes to providing insight into the compensation and personal investments of portfolio managers and top executives. Were that to happen, it would become "tougher for us to keep the very talented investment people," who might move "into the private world, hedge funds or the equivalent," Haldeman said.
Further, it could prompt managers to ask for more money and open the floodgates to a lot of other forms of disclosure, Pozen added. "The mutual fund industry keeps being pushed to have one more disclosure, one more detail," Pozen said. "We're competing actively with hedge funds, public banks, and public insurance companies for talent, and they aren't even in the same ballpark. The reality is that sometimes in the mutual fund industry we feel like the only bears in captivity."
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