HOUSTON–(BUSINESS WIRE)–Dec. 22, 2003–As former mutual fund company CEOs and Chairmen of the Investment Company Institute, the industry’s trade association, we are appalled by the recent scandals,involving a number of fund groups, which have stained the entire industry.
For over half a century the investment needs of millions of Americans have been well served by the mutual fund industry. It is an industry that has grown to $7 trillion in assets based on the trust and confidence of its 95 million shareholders. It is an industry that has, until recently, avoided serious scandal for many decades.
More recently, however, some in the fund industry, which has grown into America’s most profitable large business, have too often appeared to put their desire for asset growth and profitability ahead of the needs of their shareholders. The SEC and other regulators appear to be well on their way to dealing with the issues of inappropriate trading and market timing. We applaud the recent stand on “soft dollars” and “directed brokerage” taken by ICI Chairman Paul Haaga and the Institute’s board of directors.
But there are other critically important changes that must be made to eliminate serious industry flaws and which would substantially benefit shareholders.
Expenses must be lowered, fund returns must be improved, and disclosure must be far more open and timely.
Following are eleven important steps that we believe will go a long way toward meeting these objectives and, at the same time, help restore full confidence in an industry that has served so many, so well, for so long.
1. Amend rule 12b-1 to exclude all marketing and “service” payments. Requiring existing fund shareholders to pay for the distribution cost of acquiring new shareholders, or the expense of having financial advisors “service” shareholder accounts is unfair. These marketing and “service” payments are a costly burden on shareholders and, if necessary, should be paid by fund management companies.
2. Eliminate all “soft dollar” payments for research. Soft dollar payments are like soft money in politics, a pervasive evil that confounds every effort to curtail their many abuses. Soft dollar payments are nothing but the use of shareholder assets to pay for “research” that advisors decline to pay for out of their own pockets. With trading commissions averaging 1-2 cents per share, soft dollar “research” costs can add 0.10 to 0.20 percent or more in annual expenses to shareholders. This is a cost that should be paid out of investment management fees, not a hidden expense to fund shareholders.
3. Add fund commission expenses to the comprehensive fee table in the prospectus. Trading costs are such a significant expense to shareholders, often 0.25 to 0.50 percent or more annually, that they must be disclosed along with management fees, 12b-1 expenses, and transfer agent expenses. This expense ratio should also be disclosed more frequently in quarterly reports and marketing materials.
4. Require quarterly disclosure of after-tax fund returns. Trillions of shareholder dollars are held in taxable accounts. Investors cannot easily compute their after-tax returns due to the difficulty of identifying the effect of long and short-term gains on their performance. Taxable investors need to be able to compare their returns to other comparable funds with substantially different turnover rates. High turnover has a substantial negative effect on taxable investors who are forced to pay high short-term capital gains rates. High turnover funds can cost taxable investors at least 0.50 to 1 percent of after-tax return annually.
5. Require fund companies to adopt the industry’s “best practices” code of ethics that was recommended by an ICI blue-ribbon committee several years ago. The code requires that all senior executives, portfolio managers and analysts pre-clear all trades and regularly disclose all personal stock and fund holdings in their funds’ complex. Since the opportunity for conflict between management and the fund shareholders in IPO allocations, front-running, etc. is considerable, full and timely disclosure is appropriate. Annual prospectus disclosure is not adequate.
6. Disclose all portfolio holdings in excess of 1 percent within 15 days of the end of each month and all sector weightings within 10 days of the end of each month. Such disclosure would enable investors and their advisors to have a better understanding of the risk and return characteristics of each fund.
7. Support high fees on all redemptions made within 10 days after purchase of any non-money market fund. Such fees, 4 percent on equity funds and 2 percent on fixed income funds, should be collected and paid to the fund. Eliminating market timing that takes advantage of short-term market pricing anomalies or insider information is essential. However, it is also important to preserve the legitimate right of shareholders to actively rebalance their portfolios to take advantage of significant shifts in valuations of asset classes or market sectors.
8. Require all fund board chairmen and all board committee chairmen to be independent directors. Also require that independent directors comprise at least two-thirds of each fund board.
9. Prohibit fund management company payments for “shelf space.” Brokers and other financial intermediaries have a fiduciary duty to their clients to make investment recommendations based solely on “suitability” and should not be influenced by hidden payments received by them or their firm from fund management companies.
10. Adopt rules to address potential money manager conflicts that could arise within an organization managing other types of investment accounts in addition to mutual funds, such as pension accounts, hedge funds, private accounts etc. Require disclosure to mutual fund directors all other accounts managed by each mutual fund portfolio manager and all holdings, transactions and investment performance of the other accounts.
11. Require compensation structure disclosure so that shareholders can ascertain whether their manager’s compensation is consistent with shareholder objectives. Also require that specific portfolio manager and manager team compensation be disclosed to fund directors to be used in their consideration when approving management fees.
These are our personal recommendations and do not necessarily represent the views of any organization with whom we have been affiliated, past or present.
But we believe the reforms outlined above must be implemented now to restore confidence in the US mutual fund industry. We recognize that some of these steps will need changes in legislation or regulation. However, many of them can be made immediately by fund executives and directors. We urge fund industry leaders to make these changes in order to improve industry practices, restore public confidence and better serve the investment needs of its 95 million shareholders.
About Jon S. Fossel
Jon S. Fossel was President/CEO of OppenheimerFunds Inc. from 1987 to 1996. He served as chairman of the Investment Company Institute from 1994 to 1996. Fossel is currently an independent board trustee of 35 Oppenheimer mutual and variable annuity funds. Fossel lives in Ennis, Montana. [email protected]
About Don G. Powell
Don G. Powell was CEO of Van Kampen Investments and its predecessor, American Capital Management & Research, from 1987 to 1999. He served as chairman of the Investment Company Institute from 1996 to 1998. Powell lives in Houston, Texas. [email protected]
