SEC shouldn't tinker with mutual fund industry

Your Funds

Dollars & Sense

February 09, 2003|By CHARLES JAFFE

THE ASSUMPTION with virtually every type of securities regulation is that it needs fixing, that something was broken during the bull market that led to all of the scandals that have tainted Wall Street in the past two years.

But when it comes to the mutual fund industry, the regulatory system isn't broke. That's the primary reason why investors should be against fixing it, particularly with the changes being considered by the Securities and Exchange Commission.

The latest idea from the SEC would have the mutual fund industry create a self-regulatory agency, similar to the National Association of Securities Dealers, to oversee the $6.6 trillion business and the thousands of investment advisers involved in it. Aside from the basic fox-in-the-henhouse feeling anyone should get from the idea of a "self-regulating industry group," the big fear investors should have is that creating a new agency would weaken fund oversight rather than improve it.

To see why that is, let's consider the basic reasons why the SEC would consider making the change, and the logical outcomes from such a move.

The SEC's motivation is clear and simple: Officials have said repeatedly that they lack the manpower to drastically step up supervision of the fund world. The new agency would have the manpower to focus on fund issues - and not have to worry about broader concerns as the SEC does - so that it could sniff out evildoers.

But the fund industry doesn't have too many villains. There are bad performers and money losers aplenty, but downright rogues - the kind who rip off their clients - are few. The major investment scandals of the past 75 years, roughly the life span of the fund business, have been in stocks and bonds, not mutual funds.

The SEC also is slated for a budget increase of 77 percent at a time when most agencies are cutting back, so its manpower situation should be improving in the near future. Changing the regulatory direction now, before it is clear if the additional regulatory muscle can smooth the rough edges off the fund business, would be premature.

Also unspoken during most discussions of a potential change is the cost of funding it. The SEC and Congress are worried about the impact of expenses on fund investors, but the companies that have to pay for any self-regulatory agency are going to pass those costs directly to consumers. While it's easy to agree to a proposal that gets pitched as "better regulation," few investors will want to pay for it, particularly if they don't believe it's needed.

The change isn't necessary for other reasons, too, most notably the progress the SEC has made in shaping fund oversight. One of the agency's big agenda items under then-Chairman Arthur Levitt was to step up the role of independent directors. Now, under the guidance of departing SEC Chairman Harvey L. Pitt, the funds have added independent counsel for those directors. And fund audits are all conducted independently.

These have all been positive steps. They're not perfect safeguards - I believe any directors who serve on the boards of 50 funds at one firm will feel less like they are independent and more like they've got a desk job with the company - but the lack of something more hasn't put individual investors into grave financial peril.

SEC critics would suggest that the one case that might show the system needs a change involves two Heartland funds that in 2000 suffered huge one-day losses because of the mispricing of junk bonds.

The SEC took over the funds, but no regulatory action has been filed against Heartland's principals.

It's a weak argument, however, as the SEC took the unusual step of shuttering the funds, the move that provided the most protection for shareholders and the action that any new agency would have been compelled to make.

In the end, it becomes clear that much of the sentiment for more regulation is borne out of frustration with the stock market.

Something similar surfaced more than a decade ago but faded away with little fanfare, because investors weren't as concerned then as they are today.

Indeed, while improved disclosure and tweaks in the regulatory situation would be an improvement, a nice strong bull market rally will have most investors ready and willing to forget the whole idea.

A new regulatory agency for the fund world is an answer to a question that investors haven't asked yet; one hopes that the SEC will stop asking about it soon, too.

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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