Why Products Are Unavailable in Some States

As the Berger 100 Fund was racing to a gain of 89% last year, all that investors in Arizona and 20 other states could do was sit and watch.

Because the highflying portfolio had registered for sale in only 29 states, it was off-limits to prospective shareholders everywhere else.

Investors normally don’t have to worry about a mutual fund’s availability. Two of every three stock portfolios are registered for sale in all 50 states, including nearly all the products from the biggest fund complexes.

The odds that a given fund will be registered are even higher in population centers such as California.

But occasionally a fund you might be watching won’t be able to accept your application and money--or even send you a prospectus. This happens most often with smaller, newer funds--the type that sometimes grow into tomorrow’s stars.

Try as you might, if you live in a state where it’s not registered, it’s unlikely that you will be able to persuade the fund’s representatives to sell you shares. Fund companies don’t like to turn away business, but they also don’t want to run afoul of “rescission” laws.

Simply put, if shares were sold to investors in an unregistered state and the fund’s price dropped, the laws would let people ask for their original money back--and possibly seek damages.

“This gives rise to possible civil and criminal liability,” says Dee Harris, director of the securities division of the Arizona Corporation Commission. “The investor might have the right to get his money back or sue for treble damages.”

Why wouldn’t a fund register in every state? For starters, a company might pass up areas where it either doesn’t have a distribution channel or doesn’t see much of a market for its shares.

But a more important consideration is money.

The cost to register one fund in all 50 states can exceed $35,000 a year, according to Stephen Doyle, chairman and chief executive of Montgomery Asset Management, a San Francisco fund company. Shareholders wind up paying for these costs over time.

Within each state, registration costs often vary, depending on the amount of business the fund does or expects to do each year. In California, the maximum ranges as high as $2,500 per fund annually, while Arizona’s top fee is $1,500 a year. Little New Hampshire charges up to $1,000 a year, which explains why a lot of funds skip the state.

All told, state registrations cost the industry about $60 million a year, estimates Lawrence Rogers, general counsel for the Investment Company Institute, a Washington-based trade group. Smaller funds, many of which aren’t yet profitable to run, tend to feel the impact more than larger ones, he says.

For an industry with $1.4 trillion in assets, $60 million isn’t much more than a drop in the bucket. Yet some fund company executives wonder what they’re getting in return. After all, the federal Securities and Exchange Commission already regulates mutual funds.

“There is duplication with the federal registration process,” says Hank Schmelzer, president of the TNE Fund Group in Boston. “This is a revenue-generator for the states.”

Registration fees don’t inhibit the business, but they can be a problem for smaller fund companies, Schmelzer says. And in general, these expenses have been rising in recent years, he adds.

Another complaint is that state officials sometimes slow down the registration process. Typically, a fund can expect to gain state approval within two months, Schmelzer says. Much of this lag period isn’t dead time, though, if a fund is concurrently applying for SEC approval (which itself often takes several weeks and costs several thousand or more dollars a year).

However, certain funds might not get the green light in a few states for weeks, if not months, after they gain SEC approval. For example, one state is demanding that the Montgomery Small Cap Fund limit its holdings of illiquid stocks to 5% of portfolio assets, compared to a maximum of 10% as listed in the prospectus, Doyle says.

The state still hasn’t granted regulatory approval, even though the fund debuted in July, 1990.

Ironically, Montgomery Small Cap, which surged 99% last year, no longer is accepting money from new shareholders in order to keep its size at a manageable level.

“Since the fund closed its doors before it was (registered) in all states, you have to ask whether the regulations are precluding some residents from opportunities,” Doyle says.

Although the revenue-generating complaint has some validity, state officials defend their fees. “Regulations in general, whether at the state or federal level, are not always deemed to be very important to the people being registered, and naturally they would prefer to avoid the fees,” says Harris of the Arizona Corporation Commission. “Yet the industry benefits if investors perceive they are not dealing with crooked brokers or fund companies.”

According to Harris, state regulators often focus on problems that the SEC doesn’t worry as much about. And he says many states are active in a lot of useful ways, from monitoring consumer complaints to inspecting brokers to taking action against securities law violators. “I am sympathetic to people who feel fees shouldn’t get out of hand,” Harris says. “But I certainly don’t think they are choking the industry.”

Fund Availability Investors throughout the country enjoy a wide choice of mutual funds. However, the selection is narrower in some states with small populations, tougher regulations or higher registration fees. This chart shows the percentage of nearly 1,000 stock portfolios tracked by Morningstar Mutual Funds that were available for sale in the states listed: New York: 97% California: 95% Arizona: 92% Wisconsin: 91% North Dakota: 85% New Hampshire: 81% Source: Morningstar Mutual Fund Sourcebook 1991