SEC Issues Rules on Fund Fee Disclosure

The Securities and Exchange Commission, seeking to rebuild public faith in the scandal-tainted mutual fund industry, called Wednesday for the banning of special incentive payments to brokers and ordered that funds disclose more about the fees charged to investors.

The disclosure rules were the first to be issued by the SEC since it began considering a flurry of proposals aimed at ending conflicts of interest and improving investors’ knowledge of the $7.4-trillion mutual fund industry.

The agency has been widely criticized for failing to rein in mutual fund abuses. Regulators insisted Wednesday that they were serious about reform and pushing hard to complete additional measures in the coming months.

“The commission is deeply committed, and is working on all fronts, to try to restore investor confidence in fund investments,” said SEC Chairman William H. Donaldson.

Later this month, he added, regulators will take aim at the market-timing abuses that have figured prominently in recent scandals. Market timing is a technique for exploiting temporary discrepancies between a fund’s share price and the value of its holdings, which can dilute the gains of long-term shareholders.

Under the new rule, adopted unanimously, mutual fund companies must disclose their holdings quarterly, instead of twice a year. In addition, funds will have to tell shareholders twice a year about the typical costs associated with a $1,000 investment.

“I think that the investor is the big winner today,” said SEC Commissioner Roel C. Campos.

Some critics chided regulators for moving too cautiously.

Earlier this week, Sen. Peter Fitzgerald (R-Ill.) and two colleagues introduced a bill that would require funds to tell investors at least once a year about the actual dollar amount the investors paid in costs -- not those associated with a hypothetical $1,000 investment.

SEC staff members said that such an individualized approach, long promoted by consumer advocates, would be much too costly.

Also Wednesday, the SEC proposed that fund boards provide shareholders more information about the advisory fees they approve. And the agency said it would study the controversial and costly 12b-1 rule, which allows mutual fund companies to pass on marketing costs to shareholders. The Fitzgerald bill, by contrast, would kill the rule.

“The SEC actions seem like a quarter of a loaf,” said Roy Weitz, publisher of the watchdog Fund Alarm.com. Although the SEC’s steps are positive, Weitz added, “compared to what other people in Washington are doing, they’re not much.”

In its proposed ban on special incentive payments, known as directed brokerage commissions, regulators moved toward banning arrangements in which fund companies reward brokers who distribute their funds. An SEC study found that brokers are more likely to recommend such funds to customers, who are often unaware that the broker has a conflict of interest.

“It has become painfully clear that the practice ... presents opportunities for abuse,” Donaldson said. Even more troubling, Donaldson added, is that “its impact is hidden from investors.”

The proposal reflected a shift in the SEC’s approach.

In January, regulators had recommended that brokers disclose whether they receive financial incentives for selling particular funds. That would address the problem of customers believing they are getting objective investment advice when in reality the advice has been influenced by financial reward to the broker.

By moving to a clear prohibition, the SEC is proposing a tougher step and acknowledging concerns that disclosure alone may not always be effective.

Reactions to the proposed restriction on brokerage commissions were mixed.

The Securities Industry Assn., which represents the brokers who could lose money under a prohibition, “will evaluate the SEC’s proposed rule,” President Marc E. Lackritz said in a statement.

The Investment Company Institute, which represents mutual fund companies, applauded the idea. The proposal “is a reform milestone that will benefit fund investors and strengthen the operating integrity of mutual funds,” said Matthew P. Fink, president of the institute.