Lieberman: Mutual Fund Reform Bill is Important Step Toward Restoring Integrity to Embattled Industry

WASHINGTON – Governmental Affairs Committee Ranking Member Joe Lieberman, D-Conn., Wednesday joined with Senators Daniel Akaka, D-Hi., and Peter Fitzgerald, R-Ill., in introducing legislation to require greater disclosure and accountability from the mutual fund industry.

The Mutual Fund Transparency Act of 2003 would strengthen the independence of boards of directors and enhance the transparency of financial transactions by requiring, among other things, that:

  • 75 percent of a board’s members be independent from the fund
  • brokers’ compensation for individual transactions be disclosed
  • brokerage commissions be counted as an expense, and
  • compensation of fund managers be disclosed

    “Mutual funds hold the nest eggs, the retirement savings, and the college funds for many of America’s working families,” Lieberman said. “In a very real sense, these mutual fund investments are investments in the American dream. We must act now to protect them, and to restore integrity to the mutual fund industry.”

    Lieberman said the legislation was an important step toward reforming an industry that has been embarrassed by recent revelations of illegal practices and profiteering by mutual fund officials at the expense of their shareholders.
    Echoing a letter he sent to Securities and Exchange Chairman William Donaldson, Lieberman suggested additional reforms in his floor statement, including:

  • Implementing a strict time deadline for trades to arrive at the mutual fund
  • Enhancing the effectiveness of mutual fund boards by installing a compliance officer reporting directly to independent directors and limiting the number of boards on which any one member can serve
  • Requiring clearer disclosure to investors on their monthly statements of the actual dollar amount of fees paid and disclosure of other information
    Following is Senator Lieberman’s floor statement on introduction of the legislation:

    Mr. President, I rise today to join with my colleagues Senator Daniel Akaka and Senator Peter Fitzgerald and cosponsor legislation that would begin the crucial process of reforming the mutual fund industry. In the wake of shocking revelations of abusive trading and self-dealing in some of America’s largest funds, it is imperative that we act quickly, and I commend my friend Senator Akaka for his leadership. We must do two things in order to reassure the 95 million Americans who invest in mutual funds that they have not misplaced their trust. We must find out how this was allowed to happen, and we must put safeguards in place to prevent these widespread abuses from poisoning our markets again.

    As the deceptions and conflicts of the Wall Street analysts were uncovered last year in the wake of the Enron scandal, the oft-heard advice to the average investor was to invest in mutual funds. Investors took this advice in droves. Half of all American households own shares in mutual funds, and of the $7 trillion invested in mutual funds, $2.1 trillion of it is invested for retirement.

    Perhaps these working families felt comfortable entrusting their precious savings with mutual funds because these funds offer one of the most highly regulated investments available. Mutual funds, their directors and their managers owe their investors a statutory fiduciary duty. Mutual funds are overseen by the SEC through a prescribed registration and reporting process as well as a regular examination and audit process, pursuant to the Investment Company Act of 1940.

    Unfortunately, the trust of these American families has been abused. According to a just-released survey conducted by the Securities and Exchange Commission, half of the largest 88 mutual funds have permitted a practice called “market-timing,” which allows some investors to trade quickly in and out of the funds, even though many of those funds had explicit policies against such trading because of its detrimental impact on other investors in the fund. Many fund companies admitted providing portfolio information, unavailable publicly, to certain large investors to help them make trading decisions. Also, a full one-quarter of the brokerage firms surveyed indicated that they had allowed certain customers to engage in late-trading, an illegal practice that allows favored investors to execute trades based on that day’s price, but after the market close, when new information has come to light. Perhaps most shocking, Stephen Cutler, Director of the SEC’s Enforcement Division, has said that there is evidence that officials at fund companies profited personally at the expense of their customers by market-timing their own funds.

    The SEC didn’t discover these abuses on its own initiative, however. It acted only after the New York State Attorney General and the Massachusetts Secretary of the Commonwealth took steps to investigate and stop this conduct. The SEC didn’t discover the abuses through the extensive reporting process mutual funds go through; the SEC didn’t discover the abuses through the broad and regular examinations the SEC does of these mutual funds; the SEC didn’t even discover the abuses after it received a tip from an insider, who went to the SEC with his attorney, evidence in hand.

    Yesterday, I sent a ten-page letter to SEC Chairman William Donaldson, demanding to know how the SEC could have failed to uncover such a sweeping problem in the mutual fund industry. I asked how the SEC planned to change its practices in order to ensure that it is never again caught so unaware. Congress gave the SEC the responsibility to monitor the mutual fund industry, and we must ensure that the SEC does its job.
    This is not the first time the SEC has been caught off guard with a scandal on Wall Street. In October 2002, the staff of the Senate Governmental Affairs Committee, of which I was then the Chairman, released a report, Financial Oversight of Enron: The SEC and Private-Sector Watchdogs, detailing the ignored red flags and the missed opportunities that kept the SEC from detecting the problems at Enron before that company collapsed, taking with it the jobs and retirement savings of thousands of Americans. Again, despite being fully aware of the troubling conflicts faced by Wall Street analysts, the SEC turned a blind eye to that problem until this Committee and others held hearings on the issue and New York State Attorney General Eliot Spitzer exposed how deeply deceptive many analyst recommendations truly were. I hope this mutual fund scandal represents the last time the SEC is playing regulatory catch-up.

    In addition to holding the SEC accountable, Congress must also act to protect investors by fixing the holes in the statutory scheme for mutual funds. That’s why I’m pleased to cosponsor the Mutual Fund Transparency Act of 2003, which enjoys widespread support from consumer groups. It contains many of the policy changes I urged the SEC to consider in my letter to Chairman Donaldson. It would strengthen the independence of mutual fund boards of directors by tightening the definition of independence and by requiring that 75 percent of the directors be independent. The bill would also require that mutual fund boards have nominating committees comprised solely of independent directors, so that directors are not chosen by management.

    In my letter to the SEC, I also criticized the opaque or, in some cases, lack of, disclosure to investors about mutual fund fees. The Mutual Fund Transparency Act would significantly improve such disclosure to investors, by including in the fees disclosed to investors the costs the fund incurs when it executes trades of its holdings. Currently, such costs are not included among these more visible fees, which are disclosed in documents provided directly to mutual fund shareholders. Trading costs are currently only disclosed in filings with the SEC, but if this bill became law, trading costs would be included among the fees provided directly to investors. Such information is useful because it can give investors a sense of how often their funds are buying and selling assets and at what expense. The bill would also require funds to tell shareholders how fund advisers are compensated. Public companies are required to tell their shareholders how their managers are paid; mutual fund shareholders should have the same information. Finally, the bill would require that brokers offering mutual funds to investors inform those investors of any fees or incentives those brokers are receiving for making those sales in a sale confirmation.

    The bill also mandates that the SEC study three initiatives to improve mutual fund oversight and transparency. The first two ask the SEC and the Comptroller General, respectively, to look at financial literacy among mutual fund investors and at mutual fund advertising, to determine how relevant information can be made clearer and more readily understandable to the average investor. In my letter to the SEC, I suggested the agency consider using consumer research methods in order to achieve such a result. The third study required by the bill relates to the formation of a Mutual Fund Oversight Board to take over the frontline efforts of mutual fund regulation from the SEC, while remaining under that agency’s oversight. This may be a good approach, but I have concerns about the costs of such a board being borne by mutual fund investors, which is one of the areas suggested for study. I hope other options would be explored.

    The Mutual Fund Transparency Act is clearly an important first step in closing some of the gaps in the laws governing these important investment vehicles. But there is more work to do, and I look forward to working with Senator Akaka and the other cosponsors of this bill in making further necessary improvements. For example, we should consider strengthening the fiduciary duties owed by mutual fund directors and managers to their shareholders. In addition, as I indicated in my letter to the SEC, guidelines must be developed to prevent mutual fund directors from serving on more boards of funds than they can effectively oversee; at some of the major funds, directors serve on a hundred or more boards. Compliance officers at the funds must be elevated to emphasize their role. I suggested in my letter to the SEC that such a compliance officer should be active at each fund and should report directly to an independent committee of the board.

    Moreover, as I pointed out to the SEC in my letter to Chairman Donaldson, we must close the loophole that allowed so many brokers and mutual funds to circumvent the law on late trading. Imposing a hard deadline of a time at which trades must be into the mutual fund may be the solution to this problem. We also must provide even more, clearer information to investors about the fees they are actually paying to participate in mutual funds. In my letter the SEC, I asked the agency why investors should not receive on their monthly statements detail about the fees they actually paid to the fund during that time period, similar to the finance charge information that credit card consumers get. I also suggested that funds be required to provide comparative fee information. This would help people make better investment decisions, and might also encourage more competition among funds to reduce expenses.

    Mutual funds hold the nest eggs, the retirement savings, and the college funds for many of America’s working families. Through those investments in their own futures, those families are also feeding capital into today’s economy, fueling the engine that creates and maintains American jobs. In a very real sense, these mutual fund investments are investments in the American dream. We must act now to protect them, and to restore the integrity to the mutual fund industry.

    Once again, I thank Senator Akaka for his leadership on this issue, and I urge my colleagues to support this important and timely legislation.

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