Major Changes Urged in Mutual Fund Purchases
The Securities and Exchange Commission on Thursday offered the most sweeping plan in more than 20 years for overhauling the mutual fund industry, issuing proposals to create a wide range of new funds, make purchases easier and reduce fees paid by investors.
The huge industry, with $1.4 trillion in assets owned by 36 million investors in 3,500 funds, could capture even more of the nation’s financial assets under the plan proposed by the SEC’s staff in a 525-page report.
“We need to provide new incentives to save, to invest, and to take risks, so more wealth can be created at every level of our society,” said SEC Chairman Richard C. Breeden in unveiling the proposals to the Investment Company Institute, an industry trade association.
Breeden, a strong advocate of deregulation, virtually assured his audience that the SEC would enact many of the proposals, which are certain to boost the rapidly growing industry. Only the bank and insurance industries have more funds.
Mutual funds are companies run by professional money managers who pool the money of many shareholders, investing it in a wide portfolio of stocks, bonds or other securities. They offer small investors the convenience, professional management and flexibility with minimal risk through a diversified portfolio.
The SEC staff’s recommendations made up the biggest package of changes since the basic mutual fund law was given its last significant amendments in 1970. The report, prepared by the SEC’s division of investment management over the last two years, calls for several significant changes to the regulations governing mutual funds.
One proposal would allow customers to buy into a fund with tear-out coupons from newspaper and magazine advertisments. The customer could send a check, and would receive the prospectus along with the confirmation of the order. This would save time from the current system, in which a potential buyer must first request a prospectus and then mail in an order.
Another proposal would create “interval” funds, with investors permitted to redeem their shares only at specified intervals, such as monthly, quarterly or annually. Currently, the value of many funds is established at the close of trading each day, and investors can redeem their shares at any time. An interval fund would permit managers to make longer-term investments, knowing they can avoid the pressure of meeting immediate demands for redemption.
The report also recommends the licensing of more foreign mutual funds to sell their shares in the United States, in return for the opening of overseas markets to American funds.
In addition, the SEC staff seeks expanded sales of mutual funds for “sophisticated investors with high net worth.” These funds would be permitted to invest in highly risky small business enterprises or new commercial ventures. Currently, such funds are private placements and cannot be sold to more than 100 investors.
These changes could be carried out by the SEC, after a public comment period. Congressional approval would be needed for more controversial proposals, including the creation of a new secondary market for mutual funds that could drive down the fees charged to investors.
More than two-thirds of mutual funds have a sales charge, or “load.” The average is about 5% and it is not negotiable.
The staff report calls for a change in the law that would allow investors to negotiate the sales commissions charged by funds. Brokers would not have to stick to the load listed in a fund’s prospectus but could charge anywhere up to the current limit of 8.5%. The SEC staff believes that the competition would force mutual funds to reduce the sales charges.
“This would drive down the price to the public,” said Marianne K. Smythe, director of the SEC division of investment management.
She acknowledged that the idea, which has been proposed three times since 1966 by the SEC staff and then rejected by the commission itself, will be opposed by the industry because it means less money for the companies marketing mutual funds.
“They will fight us,” she said. “Where money is involved, people get emotional.”
Matthew Fink, the trade association president, said his industry already is highly competitive. Allowing brokerage firms to buy big blocks of mutual fund shares could cause severe market instability, he warned.
In a market crash, like the 1987 plunge, the big investors would dump their shares, forcing the mutual funds to sell stocks at fire-sale prices to raise the cash to redeem their shares, Fink said. The resulting losses could cripple small investors because their mutual fund shares would plummet in value, he warned.
Breeden carefully avoided endorsing the secondary market proposal by his staff, saying only that it deserved further study and public comment.
The SEC staff also wants the law changed to provide better information to workers who buy mutual funds through corporate retirement plans. These plans, known as 401-K programs, allow workers to select from a menu of investment choices.
Workers do not receive a prospectus about the mutual fund in their retirement account unless they specifically request one. The report said the investors should be given the same prospectus and regular shareholder reports sent to other mutual fund investors.
To provide capital for small businesses, the staff report proposes new rules to create securities backed by loans to small businesses. There already is a growing market for securities based on credit-card debt and automobile loans.
While Breeden hopes the SEC can send a legislative package to Capitol Hill this year, he said the chance of it being enacted this year is “pretty remote.”
Mutual Fund Reforms
The Securities and Exchange Commission has proposed sweeping changes to the laws regulating the mutual fund industry, seeking to fuel competition and make it easier for investors to find the best bargains. Here are some of the main proposals:
Allow investors to purchase mutual fund shares directly through advertisements without first having to send for a prospectus. The ads would contain information about fees and expenses, performance data and risks.
More foreign funds would be allowed to register and sell in the United States. In return, overseas markets would be opened to American funds.
Companies could establish “interval funds,” with customers allowed to cash in their shares at intervals such as a month, or a quarter, or a year. This would allow funds to make longer-term investments, knowing they wouldn’t have to redeem shares immediately.
Change existing law to allow a secondary market in mutual funds. Brokerage firms could buy shares from the fund and the public, and later resell them to the public. Competition would drive down the “load” or sales charge by the fund.
Source: Securities and Exchange Commission
