Sep. 30–Chet Gerstenbluth never worried about investing in mutual funds … until this year.
Even as scandals engulfed publicly traded companies and big brokerages, the industry managed to stay relatively clean.
But then the systems analyst started hearing about investigations into fees and disclosure. Soon after, he learned of inquiries into shady sales practices by brokers. Finally, earlier this month, he found out that several funds were allowing a big investor to make illegal or improper trades at smaller shareholders’ expense.
“I thought these practices ended 30 years ago,” said Gerstenbluth, a Plainview resident.
All these probes have left Gerstenbluth and many of America’s 95 million mutual fund investors wondering about how the companies that hold $6.4 billion of their hard-earned savings and retirement money really operate.
In the future, they’ll likely learn a lot more.
Securities and Exchange Commission chairman William Donaldson is expected today to outline proposals at a congressional hearing to broaden mutual fund fee and conflict-of-interest disclosure and increase compliance within the industry. Among the reforms the SEC will likely suggest:
Requiring funds to disclose fees associated with a hypothetical $10,000 investment on shareholder statements rather than just in the prospectus, an agency spokesman said.
Making funds reveal financial arrangements and incentive programs they have with brokers.
Directing fund companies to create a compliance officer position to make sure the policies outlined in their prospectuses are followed.
Many mutual fund managers say they are all for disclosure, to a point. They question whether revealing complicated arrangements with brokerage companies would benefit shareholders, though they favor their current practice of disclosing expenses on a hypothetical $10,000 investment.
“Would there be meaningful value [in additional disclosure] for the shareholder?” said Gordon Forrester, a managing director at Putnam.
Advocates of disclosure think so, citing several industry practices that have drawn fire. Among them:
Hidden Costs: Many investors already know to watch out for sales commissions and annual expenses for management, administrative and distribution costs. Those are outlined in prospectuses and reports from services like Morningstar.
What isn’t disclosed is the cost of trading commissions and soft dollars, which are generated when funds pay brokerage firms higher commissions than necessary for research and other services. Shareholder advocates want full disclosure because the costs come out of funds’ assets and these arrangements could pose conflicts of interest.
Others argue the average investor would not be able to use the information anyway. Funds already provide more data on some of these matters in their Statement of Additional Information, but shareholders rarely ask for the document.
“They are in mutual funds because they don’t understand these types of issues,” said Robert Plaze, associate director of the SEC’s division of investment management, noting all costs are eventually reflected in the fund’s performance.
Fee Disclosure: Because these costs are hard to find, many shareholder advocates are pushing funds to disclose the amount each investor pays in fees on his or her account statements, rather than the charges on a hypothetical $10,000 investment in the prospectus.
“You should be able to compare fund expenses like you would the price of electronics and you can’t,” said Phil Edwards, managing director of funds research at Standard & Poor’s.
To be fair, for some investors, performance is the only thing that really matters.
“I don’t think [more fee disclosure] would do me much good,” said Ronkonkoma resident Clint Spahr, a retired elementary school teacher. “I look at the dollar amount — how much I’m losing and how much I’m gaining.”
Favoring Large Investors: A probe earlier this month by state Attorney General Eliot Spitzer revealed some mutual funds were bending their rules — and one violating the law — to allow a large hedge fund investor to engage in market timing and illegally trade after hours.
Spitzer’s complaint charged that four mutual fund companies allowed a private investment group to rapidly move money in and out of funds to take advantage of “stale” fund prices, waiving their rules to prevent this type of trading. This hurts the funds’ other shareholders by driving up commission and trading costs.
In one case, the hedge fund allegedly was allowed to buy into mutual funds after the markets closed at that day’s closing price instead of the following day’s. This “late trading” is illegal. The fund companies say they are looking into the allegations and their internal controls.
Sales Practices: Brokerage houses have come under fire for pushing investors into their own funds so the firms and brokers could reap larger profits.
Brokers also have “revenue-sharing” agreements with certain funds, which pay Wall Street houses money to get on their list of preferred funds that get pushed on clients. Though they are required to disclose these arrangements, Wall Street firms rarely do. Funds note their existence in their prospectuses, but don’t offer details.
And because of increasing concern that brokerage firms were funneling clients into more costly Class B shares, the National Association of Securities Dealers issued an investor alert in June warning shareholders that while Class B shares do not impose a front-end sales charge, they may have higher annual expenses and a deferred sales charge if the fund is sold within a few years.
Jerry Pollack of Plainview is all for more disclosure of brokerage arrangements. Two years ago, the retired assistant principal turned to a major Wall Street firm, which he declined to identify, to reinvest some of his money. To his horror, the then-novice investor found out he’d been directed to funds with back-end loads and much higher expenses than he’d been paying before.
“I wanted professional management, but they were very misleading,” said Pollack, who now researches his investments more thoroughly. “You keep asking for information and you just can’t get it from them.”
—–
To see more of Newsday, or to subscribe to the newspaper, go to http://www.newsday.com
(c) 2003, Newsday, Melville, N.Y. Distributed by Knight Ridder/Tribune Business News.
