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U.S. mulls fund reforms
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October 20, 1999: 6:21 a.m. ET
SEC proposes new rules, while Congress studies legislative change
By Staff Writer Martine Costello
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NEW YORK (CNNfn) - Stock trading costs have been dropping like a stone as online investing goes mainstream, but the fees you pay to your mutual fund company keep going up every year.
It's one of the reasons the Securities and Exchange Commission is proposing rule changes about the directors on fund boards who make decisions on those fees that eat into your returns.
The proposal is among a number of changes hitting the industry from the SEC and Washington lawmakers.
"There seems to be a move towards responsible disclosure," said Russ Kinnel, editor of mutual funds at Chicago fund-tracker Morningstar. "That (fund fees) is one area where you can clearly see that fund directors are not doing their jobs. They're always willing to raise expenses. It doesn't make sense."
Directors for a fund adviser declare dividends, approve mergers, handle takeovers and regulatory problems, oversee personal investing practices of fund managers and approve so-called "12b-1" sales fees -- in addition to setting the management fees, according to the Investment Company Institute, a Washington trade group.
While some funds -- such as Vanguard Group and Janus -- are known for having good directors, others are little more than rubber stamps, Kinnel said.
Some directors make more than $100,000 a year and may serve on many different fund boards, he said. And a study by Morningstar showed that the more fund directors make, the higher the fees at the fund.
What's on the table
In the past, 40 percent of directors had to be independent from the fund adviser or underwriter. The SEC wants to require that at least half of the directors be independent. The SEC also proposes that independent directors nominate replacements and have their own legal counsel.
Fund companies would have to disclose more information about directors, their investments in the funds and potential conflicts of interest.
Read SEC chairman Arthur Levitt's comments on the proposed rule changes.
"We all understand that directors aren't required to guarantee that their fund has the lowest fees," SEC Chairman Arthur Levitt said during a roundtable discussion on the issue in February. "But they are required to ask whether fund investors are getting their money's worth. What do independent directors know about management's costs and their profitability?"
Other changes on the horizon
The SEC has been making noise about the fund industry for some time, Kinnel said. It approved a "plain English" prospectus to make it easier for shareholders to read. The commission also amended rules regarding personal trading by fund managers -- though some analysts said the changes didn't go far enough.
More recently, the SEC took on Van Kampen Funds for claims made in an advertisement about one-year returns of a fund. In the ad, Van Kampen used one-year returns on a fund that invests in IPOs. But the SEC found the ad raised unrealistic expectations because the fund was small and closed to investors.
Van Kampen agreed to a censure and fines to settle the case without admitting or denying the findings.
"The SEC is clearly staking out some valuable turf in terms of requiring that fund companies give truly accurate representations of their funds in ads," Kinnel said.
Northwestern University is creating the Mutual Fund Directors Education Council headed by David Ruder, a professor at the school and a former SEC chairman, to help directors do their jobs.
"It's not a mission to change the industry, but to provide education and assist directors," Ruder said. "I don't think there's any indication that directors are doing terrible things. …You worry about wanting to make sure you've done all you can to prevent things from going wrong."
SEC Commissioner Norman Johnson will be an advisory member of the panel.
"This effort will be an important addition … to encourage the education of fund directors," Levitt said.
Read about legislative and regulatory issues facing the fund industry tracked by the Investment Company Institute in Washington.
Meanwhile, in Washington, lawmakers have proposed a string of new laws. One, proposed by Rep. Paul Gillmor, R-Ohio, would require fund companies to report after-tax returns.
"There's no reason why buyers of mutual funds shouldn't have this information readily available," Gillmor said. "The fact is taxes have a major impact on returns."
Sen. Tim Johnson, D-S.D., proposed legislation in August requiring better disclosure of fees in 401(k)s because some plans charge 2.5 percent a year or conceal their fees.
"I believe we have an obligation to make sure that families have access to basic information about fees," Johnson said in August.
Johnson later put the idea on hold when pension leaders agreed to come up with a voluntary plan.
Kinnel, of Morningstar, said the proposals by Congress and the SEC are a step in the right direction. But he said true change won't happen until the shareholders started getting involved.
"The SEC has a fairly ambitious agenda," Kinnel said. "It seems like they have taken on a more shareholder-friendly view."
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