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SEC Alumni Call for an End to Regulatory Binge: Seek Less Rulemaking, More Prosecutions

PALM DESERT, Calif. - Perhaps nobody captured the current mood of the mutual fund business better than Barry Barbash, a former Securities and Exchange Commission investment management director, when he told industry executives attending the annual Investment Company Institute meeting here last week that registration was still open for an upcoming "Regulatory Overload Conference."

"It's for those of you who just cannot take it anymore," joked Barbash, now a partner at the law firm of Shearman & Sterling in New York.

The dark humor didn't stop there, either, as Barbash's remarks prefaced a panel discussion featuring other SEC alumni, who each expressed an equal amount of exasperation over the regulatory state of the industry. Taken together, the quartet represents nearly 35 years of SEC rulemaking and fund industry counseling. Over their tenure, the industry has grown from a relatively obscure investment vehicle of the wealthy to one that manages more than $8 trillion in assets for people from all walks of life and income levels.

"The industry's success is both a blessing and a curse," said Kathryn McGrath, a partner at Washington-based Crowell & Moring and director of the division of investment management from 1983 to 1990. "It's almost become the public utility of the securities business. So many ordinary people in this country now invest in funds that they can hardly afford to lose.

"That's a big change. No mistakes are tolerated," she said.

McGrath drew an interesting parallel between today's fund industry and the money market industry of the 1980s and early 1990s. Touted as the next-best thing to insured deposits, McGrath noted, the popularity of money market funds exceeded consumer awareness of the investment risk. When investors began losing their rent checks in money market funds, she recalled, they cried foul to industry regulators and Capitol Hill lawmakers. That leads McGrath to conclude that the mutual fund industry needs fewer new rules and more accurate estimates on investor returns.

"It would be prudent for all of us to work on bringing expectations back in line with reality and emphasize, These are investments, there is investment risk. You should not expect to not have losses, and why don't you have money in government bonds and insured deposit institutions?'" she offered.

However, outgoing Investment Management Division Director Paul Roye, whose work since the scandal broke 16 months ago drew a standing ovation from the convention crowd of nearly 1,500, conveyed that SEC Chairman William Donaldson has pledged further activity.

"Chairman Donaldson has set forth an aggressive reform agenda, and pieces of that have to be worked through," said Roye, who will soon join the private sector after seven years as an SEC director.

Specifically, Roye cited the SEC's recent decision to impose voluntary redemption fees, a rule designed to prevent market timing by imposing a 2% charge on short-term trades. Industry comment is being sought on that rule, but it will go into effect in some form in late 2006.

Roye also said the Commission is moving ahead with a hard 4 p.m. close to curb late trading and that the Commission will address longtime dilemmas like soft dollars and 12b-1 fees. It will also begin limited activity in the 529 plan space, as well as re-examine "the enduring problem of how you ensure that investors get effective disclosure so that they can make intelligent investment decisions."

"What has to happen is a move to layered disclosures to try to accommodate all types of investors," he said.

Broad Changes Ahead

Barbash, who held Roye's post between 1993 and 1998, foresees dramatic changes in the regulatory environment over the next five years. He expects that lawmakers will tighten their pocketbooks as news of the scandal fades.

"Call me a pessimist, or an optimist depending on your perspective, but I think that the resources that the SEC and other regulators have had over the last couple of years are bound to go down," Barbash said of the Commission, which recently received a $113 million technology upgrade and 850 new employees from federal lawmakers.

"The SEC is going to find itself looking to regulate with fewer resources. That's the general nature of things. In the grand scheme, things [like the scandal] don't happen very often. The SEC will also face an industry that looks different over the next five years. It will be smaller, to some extent, with fewer participants through consolidation.