Look beyond labels when taking stock of investment options

Your Funds

April 30, 2000|By Charles Jaffe

In a 1995 mid-year report to shareholders, managers at Coca-Cola Co. compared their company to a global mutual fund.

"The more uncertain the times, the more you hear the old saying, `Don't put all your eggs in one basket,'" started the message from the late Coke Chairman Roberto C. Goizueta. "Your company not only has an abundance of `eggs,' but an abundance of `baskets.'"

The point was that the company was a participant in more than 200 markets around the world, a geographic diversification that was designed to weather downturns in any region.

Underlying the message was something left unsaid:

Mutual funds were diversified, less risky than stocks, and so widely accepted that companies wanted to cloak themselves in the fund banner to appease nervous investors.

Now fast forward to 2000.

In some investment circles, the mutual fund has become passe, derided as unable to beat market indices and for being frustrating from a tax standpoint.

A growing number of investors want to turn back to the individual stocks the general public moved away from in the booming stock market of the late 1980s and early '90s.

Among the most popular of those stocks today is Yahoo! Inc., and there is more than a little bit of irony that this popular stock, in the eyes of the Securities and Exchange Commission, might be a mutual fund.

You read that right.

It's not a status Yahoo! wants, nor a comparison that any "new economy" company would ever make in its shareholder communications, but the devil is in the details for Yahoo!, and an untold number of new economy stocks that act to some degree like funds.

What's more, it provides a timely reminder of the differences between stocks and funds, a refresher that's particularly worth looking at with the market having more ups and downs than a Slinky toy.

Here's how the situation breaks down:

At first blush, Yahoo! has little in common with a fund management firm such as Fidelity or Vanguard.

But the company has investments in other Internet companies that -- in spite of the recent techno-market downturn -- have grown to such a level that they represent at least three-quarters of Yahoo's total assets. (The company's $60 million investment in Yahoo! Japan, for example, is worth about $10 billion.)

The Securities and Exchange Commission's Investment Company Act of 1940 -- the defining legislation for the mutual fund business -- specifies that an "investment company" (read "mutual fund" for nonlawyer types) is any firm with more than 40 percent of its assets tied up in noncontrolling stakes of other companies.

In fact, Yahoo! has been living in the murky realm of these rules almost from the start.

Since July 1998, the company has invested its cash positions in government securities rather than in for-profit stocks in an attempt to comply with the rules. (Fancy that, a high-flying Internet company investing its cash in staid government bonds. How "old economy.")

None of the Internet stocks is shouting "Yahoo!" over this situation. It not only affects Yahoo!, but it has the potential to hit CMGI, Intel, Oracle and any number of Web stocks that have invested in other firms without buying control, or that have a significant amount of their worth tied up in intangible assets (like goodwill or intellectual property rights) that typically don't show up on a balance sheet.

If regulated as mutual funds rather than as stocks, these companies face a whole new level of regulation. Say goodbye to stock options as compensation; say hello to greater shareholder say in who serves on the board of directors.

What's more, mutual funds must pass along virtually all of the capital gains and dividends they earn in a year (which is why critics say they are tax-inefficient); the investing public would be amazed to see a dividend passed along by the high-flying tech stocks, but they'd get a doozy of a payout if any of these stocks were regulated as a fund.

Now that we have imagined the possibilities, forget about them. It's not going to happen.

Yahoo! raises some good points in asking for an exemption from the rules. Those include the fact that the SEC's rule applies to assets listed on a balance sheet, which excludes the intangible assets that many Internet companies have. (Yahoo! also is a hands-on investor in Yahoo! Japan, even if it does not own control.)

The bottom line is that situations such as this have come up periodically over the years and always have been settled quietly with an exemption or some legal and accounting maneuvers.

The one thing folks at the SEC can agree on in this case is that they are surprised anyone has noticed, if only because plenty of companies have gotten around these rules in the past. What's more, no one there seems to think Yahoo (or any of the other suspects on this issue) will get snagged here, though they acknowledge that the scrutiny this case is getting could make for some rethinking of the rules going forward.

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