Q&A; : Mutual Funds: What the SEC Has Proposed
In one of the most sweeping investor reforms in two decades, the Securities and Exchange Commission last week proposed new regulations that could drastically change disclosure, competition and fees in the mutual fund industry.
Here are the main points of the plan and what they mean to individual investors:
Q: Under the proposals, how would fund fees change? A: The SEC proposals would affect fees in two ways. They would create a new type of “uni-fee” fund and would allow brokers who sell “load funds” to negotiate commissions charged to investors.
Q: What is a uni-fee fund, and how would it work? A: It is identical to any other fund, except that it would charge one fee to cover all sorts of expenses that are now charged separately.
Funds now must separately disclose annual management fees, marketing fees and loads (sales commissions paid to brokers and brokerage firms). Portfolio managers must allocate expenses into these categories as well. Money collected for a marketing fee can’t pay a manager and vice versa.
The single-fee fund would allow the fund company to simply disclose the total annual cost to investors in one number. That would make accounting easier for fund companies, but it could also help investors, who would be able to compare fees without adding up all the separate charges.
Q: Would fund companies have to offer this single fee on all funds?
A: No. Fund companies would have the option of using the single fee or disclosing fees as they now do. Companies that opt for the traditional route would face no change in the amounts or disclosure requirements of their annual management and marketing charges, often called 12b-1 fees.
Q: How would sales commissions change?
A: Funds that sell through brokerage houses often charge loads that are paid directly to the brokers and brokerage firms. There is now no way to negotiate these fees. If the load is 5%, you pay 5% regardless of whether you bought the fund through a full-service or discount brokerage.
The SEC would eliminate that rule and allow brokers to negotiate these fees with investors.
Jack White & Co., a San Diego-based discount brokerage, says this change would allow it to treat a load fund purchase like the purchase of a no-load fund. The firm would simply charge either investor a basic trading fee.
In dollars and cents, that trading fee amounts to $60 on a $25,000 purchase in a no-load fund, the company says. That compares to the $1,000 an investor would pay if the fund purchased charged a 4% load. Net savings: $940.
Ultimately, industry experts say, mutual fund loads would work the same way brokerage commissions do. Brokerage firms would tell their customers in advance how much their sales commission amounted to, and it would be up to the consumer to decide whether to shop around for a better deal.
The SEC would also allow a secondary market in mutual fund shares, which may cause brokers to pay premium prices to individual investors for hard-to-get shares and resell them at a markup. Although that could increase investor costs, it could also allow greater investor access to high-performing funds that have stopped accepting new customers, said Mark Skousen, Orlando-based author of “Scrooge Investing.”
Q: How would disclosure requirements change?
A: Disclosure requirements would change in two main areas.
First, those who invest in mutual funds through company-sponsored 401(k) retirement-savings plans would be guaranteed to get the same information as investors who bought their shares outside of company-sponsored plans. Currently, 401(k) investors get only fund prospectuses (booklets containing detailed fund information) if they specifically request them, and they often do not receive annual performance reports and other information sent to individual investors.
Meanwhile, customers of no-load mutual funds would be able to buy funds through advertisements before receiving a prospectus. Only those investors who go through a broker and pay a load can now buy mutual fund shares without the prospectus in hand.
The SEC believes that the fund ads would actually enhance shareholder disclosure because they would be regulated to ensure that they were clear, complete and honest, said Marianne K. Smythe, director of the SEC division of investment management. Because many investors have a hard time reading through the legal jargon in a prospectus, these shorter ads may get through to thousands of investors who would otherwise not understand the relative risks and rewards. At minimum, the ads will have to clearly spell out the risks, costs in fees and details about fund performance. However, exact advertising standards have not yet been developed.
Q: How would fund choices be enhanced?
A: The SEC wants to let more foreign firms register and sell their shares in the United States. Right now, U.S. investors can invest in foreign securities markets through mutual funds, but the funds must usually have a domestic manager. If the SEC is satisfied with the foreign country’s consumer protection and disclosure laws, it would allow foreign-managed funds to sell here too under certain circumstances.
Many of the details of this proposal are still unclear, however, so it is hard to estimate whether this provision would significantly increase the number of fund offerings or increase investor risks.
The agency also wants to allow new products called interval funds. These funds would allow investors to cash out only at stated intervals--perhaps once monthly, quarterly or yearly. That would allow fund managers to invest in less-liquid securities and give investors another set of mutual fund choices.
Q: When might these proposals take effect?
A: That’s unclear. These are staff recommendations that must go to the SEC commissioners for comment and approval. If the commissioners approve the rules, some could go into effect after a public comment period, while others would need to wait for congressional approval.
Notably, the changes that would make sales commissions negotiable and allow greater foreign competition would require congressional action. Although the legislation required to make these changes could, in theory, be proposed and passed this year, SEC officials say such swift action is unlikely.
Q: Is there anything consumers can do to push for or against these proposals?
A: Yes. Write to the SEC. Smythe is personally encouraging correspondence from investors who believe that these rules would affect them positively or negatively. Letters can be addressed to Marianne K. Smythe, c/o Securities and Exchange Commission, 450 5th Street N.W., Washington, D.C. 20549.
