While congressional committees consider whether bank customers would be better served by having the Securities and Exchange Commission regulate bank sales of mutual funds, the banking agencies are stepping up their efforts to see whether banks are providing suitable advice and adequate warnings about investment risk.
Whatever the outcome of these activities, which coincide with the banks' own undertakings to improve their procedures, some customers of some banks apparently continue to be poorly informed about funds.
For an illustration, look at the dilemma of a Minnesota reader who owned a certificate of deposit in an Individual Retirement Account at his bank and had to reinvest $77,000 when the CD matured recently.
"I was advised by their stockbroker," he wrote, "to roll over to a mutual fund they represent . . . The Voyageur (U.S. Government Securities) fund . . . Commission $3,500. Remainder $73,500 was invested.
"I was told that the fund paid 6.89 (percent) interest. I have received two reports . . . the status is approx $69,800 and no sign of interest. Total loss . . . about $7,200, which includes the commission. I don't know if there is a management fee and the broker doesn't know.
"I have an opportunity to buy a CD at 4 1/2 percent. Can I deduct the loss on my tax return? . . . Should I stick with it or take the loss & make a change?"
The Voyageur fund is an intermediate-term fund, which invests only in securities backed by the full faith and credit of the U.S. Treasury. For the last five years, it was sixth of 81 in Lipper Analytical Services' General U.S. Government Funds category; for the last year, it was 89th of 125.
However safe its portfolio securities may be from the risk of default, its shares are not equivalent to government-insured CDs. When interest rates rise, their price drops.
The fund prospectus, which the reader should have studied, raises this possibility: "An investment in the Fund involves investment risk including the possible loss of principal due to fluctuations in the Fund's net asset value."
The broker should have emphasized this and made certain that the customer understood before investing the $77,000 for him.
The broker was in no position to assure the reader that the fund would be paying interest at a 6.89 percent compound rate. Unlike that of a CD, a fund's yield fluctuates.
The reader apparently couldn't infer from his bank's statements that he was being credited with monthly income distributions -- instead of interest -- and that these had been reinvested in additional shares. The broker should have known, and candidly told his client about, the fees associated with buying and holding a fund's shares in an IRA at the bank.
As for the reader's loss, it's only on paper until he realizes it by selling. By holding and reinvesting dividends for several years, the reader could recover. It'll take longer because the 4.5 percent load is a big handicap to overcome.
If he can't hold on long enough, he couldn't offset the loss against taxable income unless he had funded his IRA with nondeductible (i.e., after-tax) contributions and met certain Internal Revenue Service tests.
Alternatively, take a Florida retiree who wanted to supplement his $6,200 of Social Security benefits by squeezing more income from the "fair sum" he had in an IRA at his bank. He agreed to switch it to Alliance Mortgage Securities Income Fund, whose Class A shares led the 18 funds in Lipper's U.S. mortgage funds category for the last five years but ranked 30th of 46 the last year.
"The person at the bank that sold these funds did tell me most of what I think I should have known.
"I was told by a friend that I don't have any insurance . . . and I don't remember if it's covered by FDIC.
"I was told it's a (3-year) hold with penalty. If I take out of principal in first year, I will loose much more (don't recall amount), [in the] second much less, and after third no penalty at all."
The question of whether bank-sold mutual funds are insured by the Federal Deposit Insurance Corporation is perhaps the most common source of misunderstanding among customers. They are not insured.
As for the fund's shares being "a hold with penalty," one of the advantages of mutual funds, written into law, is that investors can redeem them at any time. Mutual funds do not "have" to be held.