[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]




 
                 H.R. 2420--THE MUTUAL FUNDS INTEGRITY
                    AND FEE TRANSPARENCY ACT OF 2003

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                     CAPITAL MARKETS, INSURANCE AND
                   GOVERNMENT SPONSORED ENTEREPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                             JUNE 18, 2003

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 108-39



91-544              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
____________________________________________________________________________
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska              PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana          MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair   JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                GREGORY W. MEEKS, New York
JIM RYUN, Kansas                     BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio           JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North          CHARLES A. GONZALEZ, Texas
    Carolina                         MICHAEL E. CAPUANO, Massachusetts
DOUG OSE, California                 HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois               RUBEN HINOJOSA, Texas
MARK GREEN, Wisconsin                KEN LUCAS, Kentucky
PATRICK J. TOOMEY, Pennsylvania      JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut       WM. LACY CLAY, Missouri
JOHN B. SHADEGG, Arizona             STEVE ISRAEL, New York
VITO FOSSELLA, New York              MIKE ROSS, Arkansas
GARY G. MILLER, California           CAROLYN McCARTHY, New York
MELISSA A. HART, Pennsylvania        JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia  JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio              STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota           ARTUR DAVIS, Alabama
TOM FEENEY, Florida                  RAHM EMANUEL, Illinois
JEB HENSARLING, Texas                BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey            DAVID SCOTT, Georgia
TIM MURPHY, Pennsylvania              
GINNY BROWN-WAITE, Florida           BERNARD SANDERS, Vermont
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona

                 Robert U. Foster, III, Staff Director

  Subcommittee on Capital Markets, Insurance and Government Sponsored 
                              Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

DOUG OSE, California, Vice Chairman  PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio                DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama              BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware          GREGORY W. MEEKS, New York
PETER T. KING, New York              JAY INSLEE, Washington
FRANK D. LUCAS, Oklahoma             DENNIS MOORE, Kansas
EDWARD R. ROYCE, California          CHARLES A. GONZALEZ, Texas
DONALD A. MANZULLO, Illinois         MICHAEL E. CAPUANO, Massachusetts
SUE W. KELLY, New York               HAROLD E. FORD, Jr., Tennessee
ROBERT W. NEY, Ohio                  RUBEN HINOJOSA, Texas
JOHN B. SHADEGG, Arizona             KEN LUCAS, Kentucky
JIM RYUN, Kansas                     JOSEPH CROWLEY, New York
VITO FOSSELLA, New York,             STEVE ISRAEL, New York
JUDY BIGGERT, Illinois               MIKE ROSS, Arkansas
MARK GREEN, Wisconsin                WM. LACY CLAY, Missouri
GARY G. MILLER, California           CAROLYN McCARTHY, New York
PATRICK J. TOOMEY, Pennsylvania      JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia  JIM MATHESON, Utah
MELISSA A. HART, Pennsylvania        STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota           BRAD MILLER, North Carolina
PATRICK J. TIBERI, Ohio              RAHM EMANUEL, Illinois
GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
KATHERINE HARRIS, Florida
RICK RENZI, Arizona


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    June 18, 2003................................................     1
Appendix:
    June 18, 2003................................................    51

                               WITNESSES
                        Wednesday, June 18, 2003

Bogle, John C., Founder, The Vanguard Group......................    25
Bullard, Mercer, Founder and President, Fund Democracy, Inc......    27
Haaga, Paul, Chairman, Investment Company Institute, Executive 
  Vice President Capital Research and Management Company.........    32
Hillman, Richard J., Director, Financial Markets and Community 
  Investment, U.S. General Accounting Office.....................     6
Hobson, Mellody, President, Ariel Mutual Funds...................    29
Roye, Paul F., Director, Division of Investment Management, U.S. 
  Securities and Exchange Commission.............................     4

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    52
    Clay, Hon. Wm. Lacy..........................................    54
    Emanuel, Hon. Rahm...........................................    55
    Gillmor, Hon. Paul E.........................................    56
    Kanjorski, Hon. Paul E.......................................    58
    Bogle, John C................................................    60
    Bullard, Mercer..............................................    66
    Haaga, Paul..................................................    90
    Hillman, Richard J...........................................   117
    Hobson, Mellody..............................................   135
    Roye, Paul F.................................................   140

              Additional Material Submitted for the Record

Kanjorski, Hon. Paul E.:
    Securities and Exchange Commission, letter with attachment, 
      June 11, 2003..............................................   165
Hillman, Richard J.:
    General Accounting Office Report, ``Mutual Funds-Greater 
      Transparency Needed in Disclosures to Investors''..........   260


                 H.R. 2420--THE MUTUAL FUNDS INTEGRITY
                    AND FEE TRANSPARENCY ACT OF 2003

                              ----------                              


                        Wednesday, June 18, 2003

                  House of Representatives,
        Subcommittee on Capital Markets, Insurance,
               And Government Sponsored Enterprises
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to call, at 10:05 a.m., in 
Room 2128, Rayburn House Office Building, Hon. Richard Baker 
[chairman of the subcommittee] presiding.
    Present: Representatives Baker, Gillmor, Royce, Oxley (ex 
officio), Kelly, Ryun, Green, Miller of California, Toomey, 
Capito, Kennedy, Tiberi, Brown-Waite, Harris, Kanjorski, 
Inslee, Gonzalez, Capuano, Ford, Lucas of Kentucky, Clay, Baca, 
Matheson, Lynch, Miller of North Carolina, Emanuel and Scott.
    Chairman Baker. [Presiding.] I would like to call this 
meeting of the Capital Markets Subcommittee to order. Our 
purpose here today is to receive testimony with regard to H.R. 
2420, the Mutual Funds Integrity and Fee Transparency Act of 
2003.
    The committee has engaged in market review of the various 
sectors of market performance, beginning almost 2 years ago, 
preceding many of the unfortunate events in corporate 
governance. The committee has acted in a significant way, the 
Financial Services Committee particularly, with the passage of 
Sarbanes-0xley and other reform measures to enhance disclosure 
and transparency in market performance to investors.
    It is exceedingly clear to me that the world has changed 
dramatically over the past 20 years, where historically the 
managed funds, institutional investors, and sophisticated 
investors constituted the bulk of investment of significance in 
our capital markets. Today, working families through pension 
funds, 401(k)s or direct investment are significant 
participants in providing capital for the continued expansion 
of economic activity and job creation.
    In recent months, with concerns about the ability of the 
average investor's capability to get access to information on a 
timely and unbiased basis, many have chosen not to further 
participate in the markets and have in fact taken the money and 
put it on the sidelines for fear that they do not understand 
the risks that they may be taking. To that end, the committee 
is engaging today in better understanding the function of and 
the need for, if necessary, any potential reform in the way in 
which an investor may analyze the performance of individual 
mutual funds, and to determine if there is comparability in the 
data provided at year end.
    I bring to this debate some personal observation. Last 
year, my son came to me, who is doing far better in life than 
I, and has several mutual fund investments. He came to me and 
said, ``Dad, you are the smart guy; sit down and explain this 
to me,'' and I could not do it, to provide him with some 
measure of comparable information about which fund was actually 
performing to the highest level of professionalism. It made 
clear to me that at least a review of our disclosure regime was 
not only appropriate, but needed. The bill before us makes 
several recommendations. However, there are some areas which 
have yet to be resolved. In response to some who have indicated 
we have dodged the issue of soft-dollar arrangements, I merely 
point out that we have not reached some final determination, 
awaiting the SEC's professional review and recommendation. It 
is clear that disclosure would be highly warranted.
    Some would go to the issue of banning those relationships, 
which is the issue, at least in my mind, before the committee, 
and we hope to get further insights into the benefits of those 
arrangements and how the expenditures made can actually work to 
the investor's best interest. On the other hand, if the funds 
are spent for a weekend in the south of France, that raises an 
entirely new consideration.
    I am certain there are other issues within the legislation 
that will generate comment, but we appreciate all the 
witnesses's participation this morning in the committee's 
ongoing interest to provide a marketplace which is transparent 
and treats all stakeholders equitably. We look forward to 
hearing from you.
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    I look forward to this hearing in regard to the Mutual 
Funds Integrity and Fee Transparency Act. The dynamic mutual 
fund industry constitutes a major part of our equities market 
and it has without question worked to democratize investing for 
millions of Americans.
    Despite this tremendous success, securities experts have 
continued to regularly examine how we can improve the 
performance of the mutual fund industry in order to advance the 
interests of investors. As you know, Mr. Chairman, I have made 
investors's protection one of my top priorities in my work on 
this committee. I consequently share your concerns that our 
committee must conduct vigorous oversight to examine whether 
our regulatory system is working as intended, and to determine 
how we can make it stronger.
    During our last hearing on mutual funds, several 
individuals raised concerns that some practices within the 
mutual fund industry, because we identified no consensus for 
addressing these matters, I joined with my colleague, 
Congressman Bob Ney, in writing to the SEC after the hearing. 
In replying to our letter, the Commission staff suggested 
several areas for reform and for further study. In order to 
ensure that today's hearing record is complete, I request 
unanimous consent to enter into the record the response that 
Congressman Ney and I received from the Commission.
    Chairman Baker. Without objection.
    [The following information can be found on page 165 in the 
appendix.]
    Mr. Kanjorski. In addition, Mr. Chairman, you also 
contacted the Commission after the last hearing to request 
their observations and recommendations regarding mutual funds. 
H.R. 2420 attempts to codify several reforms proposed by the 
Commission in its response to you. In general, H.R. 2420 seeks 
to enhance the disclosure of mutual fund fees and costs to 
investors, improve corporate governance for mutual funds, and 
heighten the awareness of boards about mutual fund activities.
    While many of these reforms may be good ideas, we should 
explore whether they can instead be achieved without a 
legislative mandate, either through the adoption of industry 
best practices or the promulgation of regulations by the 
Securities and Exchange Commission. As you know, Mr. Chairman, 
I generally favor industry solving its owns problems through 
the use of self-regulation or the adoption of best practices 
whenever possible.
    Nevertheless, if we decide to mark up H.R. 2420 in the 
weeks ahead, we should ensure that each provision of the bill 
is properly designed to help individual investors to make 
better decisions. We should also examine the effects of the 
changes on smaller mutual funds and whether those reforms will 
create barriers to entering the mutual fund marketplace. We 
should further determine whether the benefits of imposing a 
reform will outweigh its costs.
    Moreover, H.R. 2420 contains provisions not included in the 
Commission's report. In my view, we must carefully examine 
these additional legislative mandates to ensure that they will 
not produce unintended consequences. For example, H.R. 2420 
would prohibit an interested person from serving as Chairman of 
the Board of a mutual fund. While recognizing that there may be 
benefits to an independent Board Chairman, the Commission's 
report questions whether there is a need to mandate such a 
change if a majority of the mutual fund board is already 
independent.
    In closing, Mr. Chairman, I look forward to hearing from 
our distinguished witnesses on this important legislation. 
Mutual funds have successfully worked to help middle-income 
American families to save for an early retirement, higher 
education and a new home. We need to ensure that this success 
continues. I therefore hope that we will not rush into a markup 
on H.R. 2420 before we can work together on these matters.
    I yield back the balance of my time.
    [The prepared statement of Hon Paul E. Kanjorski can be 
found on page 58 in the appendix.]
    Chairman Baker. I thank the gentleman for his statement.
    Mr. Scott?
    Mr. Scott. Thank you very much, Chairman Baker and Ranking 
Member Kanjorski. I want to thank you for holding this hearing 
today regarding the mutual fund industry.
    Arthur Leavitt, former Chairman of the SEC, calls the high 
cost of owning some mutual funds the deadliest sin of owning 
mutual funds. Some funds are able to get away with overly high 
fees because investors do not understand how fees can reduce 
their returns. I firmly believe that the individual investor is 
empowered when given the tools to compare varying investment 
funds. I want to thank you, Chairman Baker, for introducing 
H.R. 2420 as an important step to providing transparency for 
investors. Given that more than half of all U.S. households now 
hold shares in mutual funds, any step towards transparency will 
have an impact on millions of investors throughout this 
country.
    As Ms. Mellody Hobson, the CEO of Ariel Mutual Fund Group 
will testify later today, we must ensure that any additional 
regulations do not put small funds at a disadvantage. I 
certainly look forward to working with Ariel on financial 
education and literacy and investor education initiatives. I 
look forward to hearing from today's distinguished panels about 
the best way to arm investors with strong information on mutual 
funds.
    Thank you very much, Mr. Chairman.
    Mr. Green. [Presiding.] Mr. Miller is recognized for a 
brief opening statement. No opening statement? Then we will 
turn to our panel.
    Our first witness will be Mr. Paul Roye, the Director, 
Division of Investment Management at the U.S. Securities and 
Exchange Commission. Mr. Roye, welcome.

   STATEMENT OF PAUL ROYE, DIRECTOR, DIVISION OF INVESTMENT 
      MANAGEMENT, U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Roye. Thank you.
    Chairman Baker, Ranking Member Kanjorski and members of the 
subcommittee, on behalf of the Securities and Exchange 
Commission, I am pleased to discuss H.R. 2420, the Mutual Funds 
Integrity and Fee Transparency Act of 2003, which recently was 
introduced by Chairman Baker and cosponsored by several members 
of the subcommittee. It is a pleasure and honor to be here.
    This bill would provide investors with useful information 
regarding their investments in mutual funds, as well as 
strengthen the corporate governance standards for mutual funds. 
In addition to providing mutual fund investors with disclosure 
about estimated operating expenses, soft-dollar arrangements, 
portfolio transaction costs, sales load breakpoints, directed 
brokerage and revenue sharing arrangements, the bill would also 
require disclosure of information on how fund portfolio 
managers are compensated and require fund advisers to submit 
annual reports to fund Directors on directed brokerage and 
soft-dollar arrangements, as well as revenue sharing.
    It also would recognize fiduciary obligations of fund 
Directors to supervise these activities and assure that they 
are in the best interests of the funds and their shareholders. 
In addition, the bill would require the Commission to conduct a 
study of soft-dollar arrangements to assess conflicts of 
interest raised by these arrangements and examine whether or 
not the statutory safe harbor in section 28(e) of the 
Securities Exchange Act of 1934 should be reconsidered or 
modified.
    As outlined in our written testimony, the Commission 
supports the goals of the bill and commends Chairman Baker and 
the cosponsors of this legislation for their initiative and 
support of a regulatory regime that best serves the interests 
of mutual fund investors. We particularly support the goals of 
enhancing disclosure and the expanded authority the bill would 
provide the Commission to define which Directors can be 
considered independent. Overall, the bill has the potential to 
assist in maintaining investor confidence in the fairness of 
the operations of mutual funds, which is clearly the investment 
choice for millions of Americans today.
    Specifically, the Commission supports the goal of section 
2(a) of the bill, which would increase the transparency of 
mutual fund expenses, including a mutual fund's portfolio 
transaction costs, as well as require improved disclosure of 
the use of a fund's brokerage Commissions and revenue sharing 
payments by fund advisers. The Commission has long been 
committed to full disclosure of mutual fund costs, as well as 
other key information so that investors may make informed 
investment decisions.
    The bill also would require improved disclosure of the 
structure and method of compensation of individuals employed to 
manage the fund portfolios. This disclosure is one way to 
provide fund investors with information that will be helpful in 
assessing the incentives of the individuals who are responsible 
for managing their assets. We are concerned about the growth of 
soft-dollar arrangements and the conflicts they may present to 
money managers. The bill would require improved disclosure of 
information concerning a mutual fund's policies and practices 
with respect to soft-dollar arrangements, whereby brokerage 
Commissions are paid to a broker who provides research and 
other transaction services. We agree that fund Directors and 
investors should be provided with better information about 
these arrangements. We further support the required report of 
section 28(e) that is included in the legislative package.
    Once the reforms called for in the bill that relate to soft 
dollars are implemented, the Commission and the Congress will 
need to consider whether further revisions are needed. To 
accomplish this, policymakers will need current information on 
soft-dollar practices, their impact on fiduciary obligations of 
advisers, competition between broker-dealers, the impact on the 
securities markets and the clients and investment advisers, 
including mutual funds.
    The bill would require improved disclosure of information 
concerning available discounts on front-end sales loads, 
including minimum purchase amounts required for such 
disclosures. Again, we believe that this improved disclosure 
could be helpful to investors in determining the sales load 
discount that they are entitled to when they buy front-end load 
mutual funds.
    Section 3 of the bill would amend section 15 of the 
Investment Company Act to require each adviser to an investment 
company to submit to a fund's board of Directors on a regular 
basis a report on revenue sharing, directed brokerage, and 
soft-dollar arrangements. Again, the Commission supports these 
amendments. They acknowledge the important role that fund 
boards play in the supervision of fund brokerage arrangements 
by recognizing a federal duty to supervise these arrangements, 
and by requiring advisers to provide boards with the 
information so that they can fulfill their obligations and 
safeguard the interest of fund shareholders.
    We strongly support the bill's grant of rulemaking 
authority, which would permit the Commission to close gaps in 
the Investment Company Act that have permitted persons to serve 
as independent Directors who do not appear to be sufficiently 
independent of fund management. Section 5 would extend to 
mutual funds certain audit committee requirements, similar to 
those for listed companies required by section 301 of the 
Sarbanes-Oxley Act of 2002. Extending these audit committee 
requirements to mutual funds, again, is one way to further 
benefit and protect mutual fund investors.
    In conclusion, the Commission supports efforts to improve 
transparency in mutual fund disclosures, to provide fund 
investors with information they need to make informed 
investment decisions, and to enhance the mutual fund governance 
framework. We look forward to working with this subcommittee to 
further these important goals.
    Chairman Donaldson asked me on behalf of the entire 
Securities and Exchange Commission to thank Chairman Baker and 
Ranking Member Kanjorski and this entire subcommittee for the 
strong leadership you provided in sponsoring and supporting 
H.R. 658, the Accountant Compliance and Enforcement Staffing 
Act of 2003. Its unanimous passage yesterday by the House of 
Representatives was welcome news at the Commission and will go 
a very long way to ensure that we can rapidly hire the 
significant numbers of accounts, examiners and economists the 
SEC needs to serve America's investors.
    With that, I would be glad to answer any questions.
    [The prepared statement of Paul F. Roye can be found on 
page 140 in the appendix.]
    Mr. Green. Mr. Roye, thank you for your testimony.
    Our next witness is Mr. Richard Hillman, Director, 
Financial Markets and Community Investment for the U.S. GAO. 
Mr. Hillman, welcome, we look forward to your testimony.

 STATEMENT OF RICHARD HILLMAN, DIRECTOR, FINANCIAL MARKETS AND 
                 COMMUNITY INVESTMENT, U.S. GAO

    Mr. Hillman. Thank you very much. I am pleased to be here 
today to discuss GAO's work on the disclosure of mutual fund 
fees and the need for other related mutual fund disclosures to 
investors. The fees and other costs that mutual fund investors 
pay as part of owning fund shares can significantly affect 
their investment returns. As a result, it is appropriate to 
debate whether the disclosures of mutual fund fees and fund 
marketing practices are sufficiently transparent and fair to 
investors.
    Today, I will summarize the results of our recently issued 
report entitled Mutual Funds: Great Transparency Needed in 
Disclosures to Investors, and describe how the results of this 
work relates to certain provisions of the proposed Mutual Fund 
Integrity and Fee Transparency Act of 2003 or H.R. 2420.
    Specifically, I will discuss, one, opportunities for 
improving mutual fund fee disclosures; two, the extent to which 
various corporate governance reforms are in place in the mutual 
fund industry; three, the potential conflicts that arise when 
mutual fund advisers pay broker-dealers to sell fund shares; 
and four, the benefits and concerns over fund advisers's use of 
soft dollars.
    Regarding our first objective on mutual fund fee 
disclosures, we found that mutual funds disclose considerable 
information about their costs to investors, but unlike many 
other financial products and services, they do not disclose to 
each investor the specific dollar amount of fees that are paid 
on their fund shares.
    Consistent with H.R. 2420, our report recommends that the 
SEC consider requiring mutual funds to make additional 
disclosures to investors, including considering requiring funds 
to specifically disclose fees in dollars to each investor in 
quarterly account statements. SEC and industry participants 
have indicated that the total cost of providing such dollar 
disclosures could be significant. However, on a per-investor 
basis, we found that the costs might not represent a large 
outlay.
    In addition, our report also discusses other less-costly 
alternatives that could increase investor awareness of fees 
they pay on mutual funds, including requiring quarterly 
statements to include the same information that SEC is now 
proposing to include in the funds's semiannual reports, which 
would show the actual dollar amount of fees paid on a $10,000 
investment. Doing so would place this additional fee disclosure 
in the document generally considered to be of the most interest 
to investors. An even less costly alternative could be required 
to have quarterly statements include a notice that reminds 
investors that they pay fees and to check their prospectus and 
with their financial adviser for more information. These or 
other possible disclosures would provide investors with more 
information about fees in the document that they regularly use 
to check their account value.
    Regarding our second objective on mutual fund corporate 
governance practices, we found that the popularity of mutual 
fund investing and the increasing importance of such 
investments to investors's financial well-being and ability to 
retire securely increases the need for regulators and industry 
participants to continually seek to ensure that mutual funds's 
corporate governance practices are strong. Recent corporate 
scandals have resulted in various reforms being proposed to 
improve the oversight of public companies by their boards of 
Directors. We have supported regulatory and industry efforts to 
strengthen corporate governance of public companies.
    Although many of the reforms being sought for public 
companies are already either embodied in regulatory 
requirements or recommended as best practices by the Investment 
Company Institute, additional improvements to mutual fund 
governance such as mandating super-majorities of independent 
Directors as proposed in H.R. 2420 would further strengthen 
corporate governance practices and ensure that all funds 
implement these practices.
    Regarding our third objective, we found that mutual fund 
advisers have been increasingly engaged in a practice known as 
revenue sharing under which they make additional payments to 
the broker-dealers that sell their fund shares. Although we 
found that the impact of these payments on the expenses of the 
fund investors was uncertain, these payments can create 
conflicts between the interests of broker-dealers and their 
customers that could limit the choices of funds that broker-
dealers offer investors.
    For example, some brokers require fund companies to make 
revenue sharing payments to become one of six or seven fund 
companies on the preferred list of funds of their sales 
representatives. However, under current disclosure 
requirements, investors may not always be explicitly informed 
that their broker-dealer, who is also obligated to recommend 
only suitable investments based upon the investor's financial 
condition, is also receiving payments to sell particular funds. 
Consistent with H.R. 2420, our report also recommends that more 
disclosure be made to investors about any revenue sharing 
payments that broker-dealers are receiving.
    Finally, as part of our final objective, we also reviewed a 
practice known as soft dollars, in which a mutual fund adviser 
uses fund assets to pay Commissions to broker-dealers for 
executing trades in securities for the mutual fund's portfolio, 
but also receives research or other brokerage services as part 
of the transaction. These soft-dollar arrangements can result 
in mutual fund advisers obtaining research or other services, 
including from third party independent research firms, that can 
benefit the investor in these funds. However, these 
arrangements also create conflicts of interest that could 
result in increased expenses to fund shareholders if a fund 
adviser trades excessively to obtain soft-dollar research or 
chooses broker-dealers more on the basis of their soft-dollar 
offerings than their ability to execute trades efficiently.
    SEC has addressed soft-dollar practices in the past and 
recommended actions could provide additional information to 
fund Directors and investors, but SEC has not yet acted on some 
of its own recommendations. Consistent with H.R. 2420, our 
report recommends that more disclosure be made to mutual fund 
Directors and investors to allow them to better evaluate the 
benefits and potential disadvantages of their fund adviser's 
use of soft dollars.
    In conclusion, the work that GAO has conducted at the 
request of this committee addresses several of the areas in the 
recently introduced Mutual Funds Integrity and Fee Transparency 
Act of 2003. Passage of the Act's provisions in these areas 
would help to ensure management integrity of mutual fund 
companies and help to ensure that investors have the facts they 
need to make informed investment decisions.
    Mr. Chairman, this concludes my prepared remarks and I 
would be pleased to answer any questions that you or other 
members of the subcommittee may have at an appropriate time.
    [The prepared statement of Richard J. Hillman can be found 
on page 117 in the appendix.]
    Mr. Green. Thank you, Mr. Hillman, and thank you, Mr. Roye, 
for your testimony.
    Mr. Hillman, as you referenced in your testimony, some 
industry representatives have criticized the GAO 
recommendations that funds provide specific dollar disclosures 
in the shareholder account statements on the basis that it will 
be unduly expensive. I don't know if your report makes this 
estimation or others do, but they believe it will amount to 
approximately $266 million. Do you have any estimate as to what 
this additional cost increase would mean for the average mutual 
fund fee, on an average basis what it would cost?
    Mr. Hillman. Yes. If mutual fund companies charge the 
entire $266 million, which includes estimates prepared by the 
Investment Company Institute, who surveyed about 77 percent of 
the assets in the mutual fund industry to ask them what the 
costs might be to include specific dollar disclosures, they 
found for that portion of the industry that they surveyed, that 
if the $266 million in the first year were charged, that the 
mutual fund fee would increase. Basically, we have determined 
that the mutual fund increase would be about .000038 percent, 
or really about one-third of a basis point.
    Mr. Green. The report in its discussion of the merits of 
enhanced disclosure of portfolio transaction costs cited a 
number of commentators who said that having mutual funds 
disclose information such as the report as suggested and you 
have testified to, would increase competition amongst funds on 
the basis of those costs and lead to lower expended costs for 
investors. Can you elaborate on that? Do you believe that would 
spur cost-based competition among investors and funds?
    Mr. Hillman. We surveyed a number of individuals as part of 
the study requested by this committee. In particular, we talked 
to a number of financial planners who indicated the disclosing 
transaction costs would benefit investors. The overall view was 
suggested that with more information, investors would be able 
to compare costs across funds, which would likely result in 
more competition based upon those costs. It was also suggested 
that more disclosure of such transaction costs perhaps might 
help reduce turnover of funds, unnecessary trading that mutual 
fund complexes may engage in.
    Mr. Green. If you could elaborate on that point. I am not 
sure I follow.
    Mr. Hillman. With the increased disclosure based upon the 
costs of trading, including Commissions associated with 
trading, if fund investors were aware of those costs it might 
have interest on the part of fund advisers and others to ensure 
that those costs remain as low as they can possibly be, and 
therefore potentially reducing unnecessary trading for other 
Commissions.
    Mr. Green. Is there a danger that the information provided 
under this legislation and pursuant to your report will be 
information that investors are unable to use or to process? Can 
it be misleading? Is there a risk that disclosure will not lead 
to providing more useful information to the average investor?
    Mr. Hillman. I think there is always a risk that 
information in disclosures may not be interpreted correctly. 
Therefore, I think it is essential that as part of producing 
any additional disclosures, that sufficient work be done to 
consult with investors and others to make sure that the 
disclosures that are provided are clear and understandable and 
useful to investors. However, I do believe that such additional 
disclosures are necessary, and if implemented properly should 
have the desired results.
    Mr. Green. Mr. Roye, do you believe that the increased 
disclosures will be a practical answer to the problem of 
regulating soft-dollar practices? Do you believe disclosure 
will be a sufficient approach to that?
    Mr. Roye. Historically, the Commission's approach on soft 
dollars is to encourage transparency of those arrangements. I 
think the bill would call for additional disclosure in that 
area and we view that as a positive. In the fund area, we look 
to fund Directors principally to oversee these arrangements and 
to make sure that they are in the best interest of the fund and 
the shareholders. So through our examination program and 
through other means, we have encouraged Directors to focus on 
this issue. Again, disclosure would be beneficial.
    Whether or not it is the complete answer to issues 
regarding soft dollars I think in our responses to Chairman 
Baker and Ranking Member Kanjorski, we indicated that we had 
some questions about disclosure and the limitations of 
disclosure. That has been the traditional approach, and indeed 
our federal securities law scheme is based on disclosure.
    But in looking at some of the conflicts that soft dollars 
create, and as alluded to in the GAO report and in our response 
to the congressional inquiries, we do think it may be time to 
go back and reassess how the soft-dollar arrangements are 
working, what kind of impacts they are having, what do these 
conflicts lead to, and maybe a broader reexamination of soft-
dollar arrangements.
    Mr. Green. So disclosure may not be enough, is that what 
you are saying?
    Mr. Roye. Yes, sir.
    Mr. Green. Okay. Thank you.
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    Mr. Roye, to put some perspective here for myself and maybe 
for the record, there are a little over 7,000 equity mutual 
funds and a little more than 1,000 money market funds, is that 
correct?
    Mr. Roye. It depends on how you count them. There are 
probably 7,000 entities, but each of them oftentimes have 
separate portfolios so there are probably more like 30,000.
    Mr. Kanjorski. Okay, let me get a handle around this. How 
many of these are guilty of abuses that you have clearly seen 
or have come to your attention, say, in the last year?
    Mr. Roye. In the mutual fund area, we find problems that 
merit enforcement actions from time to time, but it is not 
extensive.
    Mr. Kanjorski. Give me some numbers. In the last year, how 
many enforcement actions have been taken against mutual funds?
    Mr. Roye. In the last year, you could probably count them 
on one hand.
    Mr. Kanjorski. So potentially out of 30,000 mutual funds, 
only five enforcement actions. What did these enforcement 
actions emanate from? A failure to disclose soft money 
problems? What was the genesis of the actions?
    Mr. Roye. We have had some situations where we have had 
some valuation issues, mis-pricing of securities.
    Mr. Kanjorski. Mistakenly mis-pricing or intentional?
    Mr. Roye. It is really sort of negligence overseeing the 
process. I am trying to think of what some of the other actions 
have been. We have brought actions related to mutual funds, but 
they tend to be sales practice type of abuses.
    Mr. Kanjorski. What would you say of these five areas of 
abuse in the last year, how much did that cost the investors 
that were invested in those funds?
    Mr. Roye. It is difficult to estimate.
    Mr. Kanjorski. Billions?
    Mr. Roye. It has not been that substantial, given the $6 
trillion.
    Mr. Kanjorski. Billions of dollars?
    Mr. Roye. Not billions of dollars.
    Mr. Kanjorski. Hundreds of millions of dollars?
    Mr. Roye. Probably in the millions of dollars.
    Mr. Kanjorski. Millions of dollars, something under $100 
million. It seems to me that if we are going to establish a new 
army of regulators here, 30,000 funds, we are going to have to 
build you a much larger office building and hire you an awful 
lot of people and pay a lot of salaries. Has there been a cost 
analysis made here of what we are talking about, the increased 
cost of regulation as opposed to what we would be preventing or 
what we would be saving? What is the cost-benefit analysis that 
you have come up with?
    Mr. Roye. Yes, we have not done a cost-benefit analysis.
    Mr. Kanjorski. Don't you think we ought to do that?
    Mr. Roye. Certainly, the Commission in its process of 
considering regulations, we consider the costs and benefits in 
doing that. The bill would call for the Commission to take 
regulatory action in various areas and obviously that is an 
exercise.
    Mr. Kanjorski. I listened to Mr. Bogle's testimony last 
time, and I was impressed that he is very seriously worried 
about some abuses in the mutual fund industry. I am just 
wondering whether or not we shouldn't concentrate more on those 
abuses than trying to do the mathematical calculations of 
telling an individual mutual fund holder what the cost of their 
fund is. That could be extraordinarily expensive. It would seem 
to me before we do that, I would prefer the IRS to calculate my 
tax requirements so that I don't have to spend a week going to 
an accountant to do that. Where is the role of government here?
    Mr. Roye. I would make this observation. The bill 
essentially calls for improved disclosure in a number of areas. 
At the Commission, we agree that in these areas we can improve 
the disclosure. We think investors ought to understand.
    Mr. Kanjorski. I know you can improve the disclosure, but 
the question is the cost of improving that disclosure, is it 
worthwhile to the investor and to the marketplace? We can all 
write regulations. You can send me a 300-page prospectus, but 
it all depends on whether it is really worth it.
    Mr. Roye. Yes. I think when you look at some of the 
disclosures that are called for from a cost standpoint, I don't 
think they really incur a lot of costs.
    Mr. Kanjorski. They are negligible.
    Mr. Roye. It is information that is within the fund 
organization that would be surfaced to fund investors.
    Mr. Kanjorski. In this regard, though, several members of 
Congress requested from the SEC reports lately, and those 
reports came in last week. Does this bill contain anything 
beyond what the SEC recommended?
    Mr. Roye. The congressional inquiries asked specific 
questions. Your letter asked specific questions. We did our 
best to provide you with comprehensive and complete answers to 
those questions.
    Mr. Kanjorski. But my question is, I am not trying to put 
you on the hook here for anything, I am just asking does this 
bill go beyond the recommendations made by the SEC to the 
members of Congress in those two reports?
    Mr. Roye. I think there are areas that clearly tie in and 
flow from the recommendations. I think there may be some areas 
where we clearly did not address in our response, but are 
reflected in the bill.
    Mr. Kanjorski. Right. I just have one additional 
observation to make.
    Mrs. Kelly. [Presiding.] Go right ahead.
    Mr. Kanjorski. I will tell you what I am worried about. I 
am worried about the expenditure of money and additional 
regulation. I see now, because we have had this downturn in the 
stock market and Enron and all these problems, that all of us 
are rushing around as part of the bucket brigade to put out 
sometimes phantom fires. I make the other observation that 
every day we are eating food with an awful lot of chemicals and 
a lot of dyes and everything else, and the argument is made 
across the board, we don't have to tell the consumer; it can 
only kill him.
    We are taking an awful lot of time and effort to try and 
save some dollars. And I am not against that, but quite frankly 
if somebody is an investor and they have extra capital, at some 
point there should be a stimulus there for them to make and 
live by the judgments they make in financial matters, rather 
than being spoon-fed by the government or so over-protected by 
the government as to make it ludicrous. Do you feel that we are 
going close to that edge?
    Mr. Roye. I think you make an important point. I think with 
some of this, the devil is in the details in terms of how you 
implement some of these approaches to enhancing the fee 
disclosure, for example. The General Accounting Office has made 
some recommendations. The Commission has an existing proposal 
outstanding on those issues. We try to balance the cost and 
benefits of enhancing the disclosure. So I think in a lot of 
these areas, you are right. We have to be sensitive to 
overkill. We have to make sure that the benefits outweigh the 
costs. We try to accomplish the goal and objective, but we do 
it in a cost-effective way.
    Mr. Kanjorski. You are causing me a little bit of 
schizophrenia here. On this side of the aisle, we are supposed 
to be for regulation. That side of the House is supposed to be 
against regulation.
    [LAUGHTER]
    Something has happened here in the last several months, so 
you have to give us some guidance down there.
    Thank you very much.
    Mrs. Kelly. Thank you.
    Mr. Tiberi?
    Mr. Tiberi. Thank you, Madam Chair.
    Mr. Roye, could you comment, give us your thoughts on the 
issue of fund Directors's role in this entire process, and if 
you believe that it is important or not important to have two-
thirds of the Directors be independent?
    Mr. Roye. Clearly in the mutual fund framework, where you 
have funds that are separate entities organized by a management 
company, sponsored by a management company, there are inherent 
conflicts of interest in those arrangements. The statutory 
framework contemplates a certain percentage of independent 
Directors who are there as watchdogs to protect the interests 
of fund investors and to monitor and oversee these conflicts.
    We view the role of independent Directors as essential in 
this framework. Indeed, we think the reason for the mutual fund 
industry being relatively free of scandal is the fact that 
independent Directors are present in the framework. The 
Commission several years ago proposed and adopted some rules 
that would effectively encourage most funds to have at least a 
majority of independent Directors. We see that as a positive 
benefit, and independent Directors playing a positive role in 
this framework.
    Mr. Tiberi. Does the Commission have an opinion on whether 
the Chairman of the Board should be independent or not 
affiliated with the company?
    Mr. Roye. We recognize that there may be benefits to having 
an independent Chairman in terms of controlling the agenda to 
make sure that the appropriate issues are raised in the board 
meetings for consideration by the board. We pointed out in our 
testimony that once you get to a majority or two-thirds, 
effectively the independent Directors have the ability to 
dictate who the Chairman of the Board is.
    Mr. Tiberi. So the SEC's opinion would be if there is a 
majority of independent Directors on the board that it would 
not be necessary to regulate either from a congressional 
standpoint or from a regulatory standpoint that the Chairman be 
independent.
    Mr. Roye. Quite frankly, within the building the 
Commissioners had some interesting discussions about that 
issue. I think that while the Commissioners saw benefits, they 
also recognized that effectively independent Directors have the 
power to dictate this now if they want it. Indeed, there are 
funds that have independent board chairmen who operate and 
those who don't. So I guess at best we were sort of maybe 
neutral on that point.
    Mr. Tiberi. Mr. Hillman, can you comment on both issues?
    Mr. Hillman. GAO has in the past as part of the Sarbanes-
Oxley Act come out in favor of a super-majority of independent 
Directors on boards. The real idea there is giving increased 
voice to independent Directors, as well as investors in the 
decisionmaking that takes place on the board.
    Regarding the notion of having an independent chair, we 
have come out in the past supporting separation from the CEO 
and the Chairman's position. We have not really discussed 
specifically the notion of an independent chair. I agree with 
SEC and Mr. Roye that it includes some positive aspects as well 
as potentially reducing the flexibility that a board may have 
in nominating its members. I also agree with a super-majority, 
which would be more than a simple majority, that independent 
Directors would have an ability to nominate potentially who 
they chose to be chair.
    Mr. Tiberi. So your thought is that if we regulate the fact 
that a super-majority would be independent, that we would not 
need to regulate the independence of the Chairman.
    Mr. Hillman. It may be less important to do so, yes.
    Mr. Tiberi. Less important to do so. Can you comment a 
little bit about the relationship between the fund and the 
management company, and if you see there being conflicts in the 
way that the structure is often set up between the fund and the 
management company?
    Mr. Hillman. Perhaps that might be a question best 
addressed to the SEC.
    Mr. Tiberi. It will be.
    Mr. Hillman. The fund and the investment company have very 
close relationships. That is why you really want to have strong 
representation of independent Directors to help ensure that the 
interests of investors are heard.
    Mr. Tiberi. Mr. Roye, can you comment on that?
    Mr. Roye. Sure. Again, the typical structure is you have an 
external investment management company that is sponsoring and 
organizing the fund which technically is a separate entity. You 
typically have management company personnel who serve as 
officers of the fund. You have them typically represented also 
as Directors, but the typical framework is that you have a 
majority of independent Directors.
    The management company is interested in making a profit and 
receives management fees for managing the fund. Obviously, the 
more money they make from managing the fund, the more 
profitable the enterprise. From the standpoint of the fund and 
the fund's investors, the lower those fees the higher their 
return. So there is an inherent conflict there and again, the 
Directors are there to scrutinize the reasonableness of those 
fees and the relationship between the fund and the management 
company.
    Mr. Tiberi. So having the super-majority of independent 
Directors helps solve that potential conflict that you talked 
about?
    Mr. Roye. It certainly enhances the independence of the 
Board.
    Mr. Tiberi. Thank you.
    Thank you, Mr. Chairman.
    Chairman Baker. Mr. Miller?
    Mr. Miller of North Carolina. Thank you, Mr. Chairman.
    Mr. Roye, I understand that the proposed legislation that 
is before us does not really provide any specific changes in 
what will constitute an independent Director. Most of the 
criticism about independent Directors has not just been that 
there are not enough of them, but that they are not independent 
enough. They tend to be recent employees, recent retirees from 
the fund management. They may in fact serve on the boards of 
several related funds. They may be making $200,000 a year 
serving as supposedly independent Directors for the same family 
of funds.
    Why is it we cannot decide now on some of the restrictions 
that we might impose upon what constitutes an independent 
Director, to include in the legislation? And what kinds of 
requirements or restrictions would you look at by way of 
regulation?
    Mr. Roye. What the bill does is actually give the SEC the 
authority to expand the definition of independent Directors 
really in two areas, because of business or professional 
relationships or because of family relationships. Indeed, we 
have seen some family relationships that are outside the 
current definition that give us some concern, as well as some 
business relationships that we would have to actually commence 
a proceeding to have the Director to be deemed interested, and 
then they would only be deemed interested on a prospective 
basis.
    So we welcome the authority to be able to respond to 
situations that we see as problematic. You mentioned the 
retired executive from the management company of being an area 
of concern. Quite frankly, we do not see a lot of that, but we 
have seen it and it concerns us. We would like the ability to 
deal with it. Technically, we responded to what was in the 
legislation and we welcome that authority. I suppose you could 
give some thought to trying to specifically deal with the 
definition and close those gaps.
    I think what the rulemaking authority does is give the 
Commission the opportunity to propose rules, to get comments, 
to react to circumstances, change circumstances, relationships 
that maybe we could not identify and think of today, but 10 
years from now may be problematic. It would give the Commission 
the ability to respond and assure the independence of the 
Board.
    Mr. Miller of North Carolina. Mr. Hillman, do you think 
there are certain restrictions we could decide upon now, that 
we know enough now to include in the legislation, and then have 
the SEC have the authority to promulgate other regulations to 
deal with circumstances we have not considered or had not 
considered sufficiently?
    Mr. Hillman. This is not a subject that we specifically 
covered in our report. However, we are aware of concerns 
associated with retirement issues and individuals coming back 
in serving as independent Directors, and also close family 
relationships as being potential problems. It seems that there 
ought to be an opportunity to quickly close those gaps in the 
corporate governance structure. You could do that either 
through legislation or through the SEC.
    On an interesting parallel, the major exchanges, the New 
York Stock Exchange and the NASD, also as part of the Sarbanes-
Oxley Act and in response to recent corporate failures, are 
also reconsidering their listing standards for issuers on their 
exchanges.
    The NASD, for example, is looking at perhaps a 3-year 
cooling-off period before an individual would be allowed back 
on a board. The New York Stock Exchange is looking at a 5-year 
period of time. So there is a lot of debate and a lot of 
interest about trying to find just what the right gauge is, and 
it is certainly something worthy of debate.
    Mr. Miller of North Carolina. Okay. How about simply a 
restriction on the sheer number of related boards that a board 
member could serve on? Would that help?
    Mr. Roye. On that issue, you do have situations where you 
have Directors serving on multiple fund boards. There can be 
benefits to that. When you have a fund complex, there are 
common issues, common areas of concern. Having that consistency 
with the Directors there overseeing the group of funds can be 
beneficial. We see it working well in a number of 
circumstances.
    Quite frankly, maybe at some point you get to a level where 
you ask questions whether or not a board can effectively 
oversee the number of boards that they may be asked to serve 
on. But I think that the industry has put out best practices in 
this area, recommended self-evaluation on the parts of board to 
go through as to whether or not they can be effective given the 
number of boards they serve on.
    So it is an area that we have not, quite frankly, we do not 
have the authority to dictate the limits in terms of numbers of 
boards, but we do see fund groups with different arrangements. 
Some have cluster boards where they have a group of Directors 
that may be responsible for all the equity funds; another group 
responsible for bond funds; another group responsible for funds 
that are sold as variable annuities and variable life 
insurance, where there are different issues. So we see funds 
with all different sorts of arrangements. It can work.
    Chairman Baker. The gentleman's time has expired.
    Ms. Kelly?
    Mrs. Kelly. Thank you, Mr. Chairman.
    One of the things that I am concerned about is the fact 
that we have a need to help people feel comfortable in trading. 
In reading some of the information that we have here, I am 
interested in the fact that we talk about the fact that revenue 
sharing is not clearly disclosed. This is one of the areas I 
believe of discomfort for people who are currently looking at 
mutual funds. When we talk about the different ways that people 
do revenue sharing, I think this is part of the confusion.
    Is there any way for us to see a more standardized effort 
out there with regard to revenue sharing, so people can get 
their arms around what exactly is being talked about?
    Mr. Roye, do you want to answer that?
    Mr. Roye. Yes. You point up a very serious issue and a 
serious concern. We have strived in the disclosure area in the 
fund area to try to standardize the presentations with regard 
to fees. In the fund prospectuses, there is a standardized fee 
table that has the transactional expenses, the ongoing expenses 
that the funds pay. But revenue sharing is one of these areas 
where the payments are growing, the distribution channels 
through which funds are sold, they are demanding more in the 
way of compensation.
    This compensation is coming from the advisers out of their 
so-called profits. It is an area where we think the disclosure 
can clearly be improved. We think it is an area where there are 
probably limitations in terms of what you can put in the fund 
prospectus to describe these arrangements.
    It is really maybe the broker-dealer who is selling the 
shares, who is getting the payment, and the investor ought to 
understand the incentives and the compensation that broker has 
in promoting the fund or trying to sell the fund to you. So 
that is an area where the Commission has been focused, directed 
the staff to formulate some recommendations in this area, and 
certainly we want to frame it in a way that investors can 
understand it as clearly as possible.
    Mrs. Kelly. Are you currently engaged in any kind of an 
educational effort for the general public? My concern is that 
anyone could get numbers on a statement. Unless they understand 
the numbers, the numbers do not mean anything. Is there any way 
to help the general public understand those statements they are 
getting, and what the cut of the revenue sharing is when they 
get the statement?
    Mr. Roye. Again, this is a real challenge for us. I think 
for example if you go to our Web site and look at our investor 
education materials, you will find a fair amount of information 
there that is designed to help mutual fund investors. We have 
something called a mutual fund cost calculator on our Web site, 
which allows you to take the information out of the disclosure 
documents and facilitates comparison of one fund to another.
    We have the investor education materials that talk about 
the importance of fees and how they can reduce your return. We 
have a whole office dedicated to trying to educate investors in 
this area. We are open to ideas about how we can enhance 
investor understanding. This is the ultimate challenge for us.
    Mrs. Kelly. In your testimony, you talk about portfolio 
transaction costs and you mention that they are substantial in 
the mutual funds for many of the funds. Do you think that 
investors really would benefit from the enhanced information 
about the costs? Can you talk about what that impact might be 
on their choices, then, of the mutual funds that they use?
    Mr. Roye. We pointed out in our responses to Chairman Baker 
and Ranking Member Kanjorski in their inquiries that trying to 
get your arms around transaction costs is really very difficult 
and complicated. The Commissions are easily determinable. The 
funds know what they pay in terms of Commissions, but spreads 
are not readily apparent. How do you measure market impact of 
trades, opportunity costs?
    With all that being said, we think that we ought to work 
toward trying to improve the disclosure in that area and having 
investors come away with a better understanding that these 
additional costs are something that they are bearing. The 
return numbers that you see reflect those costs, but you ought 
to have a better understanding of those costs. We think there 
may be some ways to do that, although it is a very complicated 
area, as we pointed out.
    Again, we are back to your question of how do you get 
investors information in a way that they can understand and 
make use of it. So we view it as a challenge, but something 
that we think that we have to continue to work toward.
    Mrs. Kelly. I just want to ask one more question, and that 
is, how frequently would you see this kind of information 
getting to an investor? Would it be better to have it there 
monthly, semi-annually? What would you at the SEC feel would be 
a valid response time for giving information to the investor?
    Mr. Roye. That is a good question. I think it is something 
that we would have to analyze and think about. There are 
various vehicles now that potentially could be used. There is 
the fund prospectus that investors get when they buy fund 
shares. Typically as a fund investor, you get the updated 
prospectus every year because the funds are continuously 
selling shares. So that is a possible vehicle. They get 
shareholder reports twice a year, and we are trying to improve 
the presentations there. This information could be presented 
there. Then typically they get quarterly account statements, 
which is another possibility. And then we could create some 
additional document.
    But I think we have to be sensitive, again going back to 
Representative Kanjorski's question, in terms of overload and 
trying to make sure we tailor this information in a way that is 
effective and useful. I think that is the benefit of rulemaking 
and disclosure proposals, and getting comment and having 
investors react in trying to figure out what is most effective.
    Chairman Baker. The gentlelady's time has expired.
    Mr. Matheson?
    Mr. Matheson. Thank you, Mr. Chairman.
    The first question I would like to ask is, it seems to me 
that our desired goal here is that we would like to move in a 
direction of having real price competition in the mutual fund 
industry. First of all, will you give me your opinion on if you 
think we have any, or to what extent we have price competition 
today in that industry? Mr. Roye?
    Mr. Roye. I think that there is evidence that there is 
competition. If you look at where the assets are in the mutual 
fund industry, about a quarter of the assets are in the three 
low-cost providers in the industry. So that, I think, tells you 
that there are investors who are paying attention to costs, 
sensitive to costs, and a huge chunk of the industry's assets 
are in those three fund groups.
    If you look at the cost of comparable funds outside the 
U.S., in Europe for example, you will see that the cost of 
comparable funds are probably one-third to one-half as great as 
they are in the U.S. So I think there is some evidence, and 
there is a fair amount of information out there about costs. 
Certainly, we can improve it, but I think you can point to 
certain factors that say, look, something is working here. Our 
whole regime is essentially based on trying to make those costs 
as transparent as we can so investors can make those kinds of 
judgments.
    Mr. Matheson. So you are saying that there is evidence that 
assets have moved to the lower-cost funds, but the fact that we 
are here, the fact that we are talking about this tells us that 
probably collectively we think there is not enough price 
competition in this industry, or we could do better. I guess 
that leads to the fundamental question of as you look at this 
legislation, is this going to get us where we want to be? Do 
you think we do not go far enough? Do you think it goes too 
far? Is this going to really affect true price competition in a 
better way?
    Mr. Roye. I think that the legislation goes a long way 
toward making a lot of these costs more transparent. There are 
certain costs that we view as not transparent enough. To the 
extent that we can surface those and enhance investor 
understanding of those, then I think we can have an impact on 
cost competition in the industry. So we view this as a 
positive.
    Mr. Matheson. One specific item in terms of disclosure that 
we talk about is portfolio manager compensation. Do you think 
that this legislation is adequate in setting up a system where 
there will be actual compensation reported to investors for 
portfolio managers?
    Mr. Roye. I think technically what the legislation calls 
for is the method of compensation, structure of compensation. I 
guess what I would say is that maybe it is not so important 
that you know the actual dollar amount. You know what the 
management company is being paid. That amount of dollars is 
being disclosed. You know what the company is being paid to 
manage the fund.
    But perhaps the more important information is, what are the 
incentives that the portfolio manager has in managing the fund? 
Is the portfolio manager compensated for short-term 
performance, long-term performance? Is the portfolio manager 
compensated on a pre-tax, after-tax basis? If you are a tax 
exempt account, you could care less about taxes, and if you 
have some information about how the portfolio manager is 
compensated, you know something about the incentives there. 
Maybe that will give you some insights into how they run the 
fund.
    Mr. Matheson. I would endorse having that information out 
there about the incentives and how they are compensated. I am 
trying to understand, and I know you did not draft the 
legislation, but I am trying to understand if there is some 
hesitancy to put in actual compensation for a portfolio 
manager. What are the arguments not to do that?
    Mr. Roye. I guess it would be privacy, issues like that. 
Again, you know what the management company is being paid. If 
they are getting paid millions of dollars to manage the fund, 
you can make an assessment about their performance and whether 
or not you are getting value for what the management company is 
being paid. Do you need to know what they are paying every 
employee in the management company to kind of make that 
assessment, probably not, at least in my view.
    Mr. Matheson. Thank you, Mr. Chairman. I yield back.
    Chairman Baker. Thank you, Mr. Matheson.
    My turn.
    Mr. Roye, there are some industry critics of this approach 
who have stated in press reports, at least, that the cost of 
conforming and implementing the bill as proposed would outweigh 
any benefit potentially to investors. Can you comment as to 
whether you think from the agency perspective, the bill is 
constituted, even though there may be a point or two over which 
there would be a differing method to achieve goals, the 
transparency provided, the reporting provided, the competitive 
environment which results coming from the flow of information. 
Isn't that more beneficial to the investor than the potential 
cost, even as the bill is currently constituted?
    Mr. Roye. I guess I would answer by saying that what the 
bill attempts to achieve in terms of goals are certainly worth 
it from a benefit standpoint. I think where we have to 
certainly spend some time thinking about is the implementation, 
the details of how we carry through on some of the directions 
from the legislation. I think that is what the Commission would 
have to be sensitive to and the direction from the Congress.
    Chairman Baker. To that end, there is discussion in your 
testimony concerning dollar disclosure versus a formula for a 
model $10,000 investment. You also stipulate in your testimony 
that the Commission has some significant concern about the 
level of understanding investors have about the real fees that 
are assessed, and their ability, even a sophisticated investor, 
to get to the bottom end conclusion of comparability.
    Is their concern that the dollar disclosure will cost more 
to fund managers and the investment world than it is worth to 
the investor side? I am a cost-benefit kind of guy. I don't 
mind spending money if the end results generates a net gain for 
us. Can you speak to that balance?
    Mr. Roye. Sure. We clearly share your concern, and your 
example in the opening statement about your son's statement and 
trying to figure out just what it means and what you are paying 
in terms of expenses is a real concern and a real problem. We 
want to address that. The ultimate question is, how do you get 
there? How do you do it? What makes sense from a cost-benefit 
standpoint?
    The Commission has an outstanding proposal that would use 
fund shareholder reports to enhance this fee disclosure. It 
would be dollar disclosure. I think one of the problems that we 
sense in the fund area is that when you look at how the fees 
are communicated, they are largely translated in terms of a 
percentage of assets, expense ratios.
    Actually, if you took that information and used it, you 
could make some good judgments about low-cost funds and high-
cost funds, but investors have difficulty understanding the 
concept. So can we turn it into a dollars and cents analysis so 
investors can make sense of it?
    So you want to enhance competition. You want investors to 
understand fees. In between, you have to have what you alluded 
to, which is some means to compare one fund to another. What we 
tried to do in the proposal with the $10,000 example was using 
the fund's actual expenses, using the fund's actual return on a 
$10,000 investment, translating that into dollars. So you could 
estimate what it costs you to be invested in the fund over, 
say, a six-month period.
    We proposed a second number which would use the actual 
expenses of the fund and an assumed rate of return, so you 
could take that number and compare it to another fund. So if 
you got your semi-annual report and you looked at the number 
there, and it showed that it cost you $98 to be invested in 
that fund, you could take the number, get a report from another 
fund, and figure out whether your fund was comparable to that 
from a fee standpoint high or low.
    So we were trying to do that in a way that minimized the 
burden and the cost, and do it in a way that we thought 
investors could understand. I think the GAO has recommended we 
use account statements to do that, and some of the other folks 
who are testifying have recommended different ways to 
accomplish that. This is a proposal we want to obviously step 
back and look at what the GAO has recommended and what others 
have recommended.
    Chairman Baker. Let me bring Mr. Hillman in at that point. 
Mr. Hillman, what is your view with regard to real-dollar 
versus a formula disclosure? What is the take that you have?
    Mr. Hillman. We have endorsed what the SEC is proposing by 
placing additional information in specific dollar amounts on a 
$10,000 investment. We think it will provide additional 
information to investors and it will also help ensure 
comparability looking across funds of what these expenses are. 
The main issue that we seem to have, as Mr. Roye alluded to, is 
really the placement of some of this information, Mr. Chairman. 
Our view is in order for these disclosures to be of real 
benefit, they have to be read by the investor.
    Studies conducted by the ICI and others suggest that the 
information of most interest to investors is disclosed in the 
account statement. That is where investors go regularly to 
determine what their account value is. If disclosures on fees 
were placed in that statement, we feel it would have the 
maximum benefit.
    Putting disclosures in a prospectus or putting them in a 
semi-annual or annual report, or putting them in a statement of 
additional information which can be requested by the investor 
to look at, are also important measures, but they are probably 
not going to give you the same benefit as coming from an 
account statement.
    Chairman Baker. Thank you very much. My time has expired.
    Mr. Capuano?
    Mr. Capuano. Thank you, Mr. Chairman.
    I just have a few basic questions. I have not heard anyone 
anywhere ever tell me that they opposed enhanced disclosure. I 
would just like to hear from Mr. Roye and Mr. Hillman, have you 
heard from anyone in a professional manner that they would 
oppose some form of enhanced disclosure?
    Mr. Roye. In the context of this bill?
    Mr. Capuano. Yes.
    Mr. Roye. Not yet.
    Mr. Capuano. Okay. Mr. Hillman?
    Mr. Hillman. Disclosure is one of the less-costly options 
to ensure that investors have a good understanding of the fees 
and costs associated with their funds.
    Mr. Capuano. So you have not heard anybody oppose the 
concept of enhanced disclosure?
    Mr. Hillman. No.
    Mr. Capuano. Because I haven't either, and I was kind of 
wondering why we are doing this so quickly if no one opposes 
it. We are all for it. It strikes me that I have two very 
professional gentlemen in front of me and I have 60-odd 
professional people here with me, and we are not 100 percent 
sure yet exactly what is the best way to go and how to get this 
done in a manner that is not going to overburden the industry, 
not going to do anything other than help the consumers. 
Personally from my end of it, I say, well, this is a great 
idea, let's do it, but let's talk this out. Let's get this 
right so that we don't have to go back and forth like a ping-
pong ball.
    Even as I sit here today, I hear two very valid different 
viewpoints on an important issue. My expectation is that nobody 
at the GAO and nobody at the SEC is trying to find ways to say 
they are for disclosure, but yet really not be. I assume that 
you are being honest about it, on a personal basis and on a 
professional basis, for your agency.
    I would also like to know, as I understand it, under 
current law the SEC theoretically has the ability to do this if 
they wanted to do it just willy-nilly. Am I wrong in my 
understanding, Mr. Roye?
    Mr. Roye. We clearly have the ability to effect a lot of 
disclosure changes. In some of these areas, we are already 
working toward that. There are other aspects of the bill that 
we would not have authority to achieve on our own.
    Mr. Capuano. Then I just want to close by expressing my 
appreciation for the fact that you are not just knee-jerking, 
coming up with something that though you have your opinions, 
you have been willing to listen to other people and to take all 
that into consideration before rushing to judgment. I would 
hope and I would assume that the Congress will do the same.
    Thank you.
    Chairman Baker. I thank the gentleman.
    Chairman Oxley?
    Mr. Oxley. Thank you, Mr. Chairman, and welcome to our 
witnesses.
    Mr. Roye, in your prepared remarks you state that the 
bill's disclosure requirements, quote, ``should help to address 
ongoing concerns that fund investors do not understand the 
nature and long-term effect of recurring mutual fund fees.'' 
Would you discuss that a little bit further and indicate how 
the SEC has cited the lack of investor understanding of fund 
fees? In that context, how would this legislation and 
subsequent regulation help in that regard?
    Mr. Roye. Sure. There are really two categories of fund 
fees. There are transactional-type fees; sales loads that 
investors pay. They see those, they feel those. Then there are 
ongoing expenses and fees that are coming out of fund assets. 
These are typically again expressed in terms of percentages of 
net assets and disclosed in that way.
    I think to some extent it is hard for investors to 
understand what that means in terms of dollars and cents. One 
of the goals here of the bill is to translate a lot of these 
ongoing expenses and expenses that are not readily apparent to 
the investor, to surface those and make them more transparent, 
again with the goal of enhancing their understanding and 
hopefully leading to greater competition.
    Mr. Oxley. Mr. Hillman, do you have any comments in that 
regard?
    Mr. Hillman. Yes, I would agree that right now, given the 
fact that investors receive fund performance data net of fees, 
that is a problem in having investors better understand the 
fact that their mutual funds incur fees. The legislation 
requiring more specific dollar disclosure of fees would 
eliminate this ambiguity over how much an investor is actually 
paying, and we hope then potentially spur increased competition 
to ensure that fees are kept to a minimum.
    Mr. Oxley. In both of your works, did you actually take a 
look at some of these statements and fee schedules and compare 
and contrast some of those?
    Mr. Hillman. A lot of that fee information that you are 
alluding to currently is done on a net basis of performance. 
Therefore, the investor really does not have an opportunity to 
evaluate how much the fee is and what implications that has 
across funds.
    Mr. Oxley. But were you able to discern that by your work 
that you did in background in preparation for the hearing? 
Obviously, you are not the average investor. I am just 
wondering how you came to that conclusion, and indeed how you 
were able to perhaps break through some of that information.
    Mr. Hillman. As part of our study, we did for you and this 
committee and subcommittee, we did compare the types of 
disclosures required by mutual funds compared to other types of 
specific financial products, where they do disclose actual 
dollar amounts and fees, and where it becomes much more clear 
to the consumer what those costs are. Those same types of 
disclosures currently are not available to the same extent in 
the mutual fund environment.
    Mr. Oxley. Would you have any other comments, Mr. Roye?
    Mr. Roye. Yes, what I would add to that is, of course, we 
write the disclosure documents. We are in charge of the rules 
so we know what they require, and we know what is in the 
reports and we know what is in the statements. Again, I think 
that we look at the existing regime and believe it can be made 
better.
    If some of the additional practices have grown, like 
revenue sharing, we think that the disclosures clearly should 
be surfaced and made clear to investors so they understand some 
of the incentives and conflicts associated with some of these 
payments. So clearly there is work to be done here, and the 
bill addresses those concerns.
    Mr. Oxley. Mr. Hillman, as you know and I am sure Mr. Roye 
obviously knows, the SEC currently has pending a rule proposal 
that would require mutual funds to disclose in annual and semi-
annual reports new disclosure regarding mutual fund fees. Mr. 
Bullard, who will testify in the next panel, states that the 
SEC's rule proposal would require disclosure not in a document 
that less price-sensitive shareholders are likely to review, 
but in a semi-annual report. Why would the quarterly statement 
be more useful than the semi-annual report in a prospectus?
    Mr. Hillman. In a survey performed by ICI about how 
investors obtain information about their funds, the Investment 
Company Institute found that account statements is probably the 
most important communication to investors. Nearly all 
shareholders use such statements to monitor their funds. The 
point here is, for disclosures to be beneficial, you want them 
to be read. The document that is most read is the quarterly 
account statement.
    Mr. Oxley. Thank you.
    Mr. Chairman, thank you very much.
    Chairman Baker. Thank you, Mr. Chairman.
    Mr. Emanuel?
    Mr. Emanuel. I apologize for missing the earlier parts. I 
was at another hearing at the Budget Committee on waste, fraud 
and abuse.
    On the two approaches that SEC is studying and GAO is 
studying, my question is a general question on this approach. I 
am trying to get relevant information and not confuse the words 
between ``relevant'' versus ``more.'' They are not the same, 
and for investors to get relevant information that allows them 
to compare fund to fund, what is your sense of how we should 
approach that and how we make the distinction between 
``relevant'' versus just ``more'' information?
    I think everybody has a sense that they are overloaded with 
information. Really, what we are trying to get at, and root 
kind of problem is, how do we get the individual investor 
information that is important to them so they can compare fund 
to fund as it relates to cost?
    Mr. Roye. That is a question that we struggle with 
continually at the Commission. Where we have a disclosure 
regime, obviously we want the disclosure to be effective. We 
want it to be the information that investors need to make that 
investment decision, and how can we present that information so 
they can make use out of it, and make intelligent investment 
decisions.
    I think the debate here is how to get really fee 
information to investors in a way that they can understand it. 
We think the notion of dollars and cents disclosure is very 
sensible and that will demystify expense ratios and percentages 
of assets. If we can communicate to investors expenses in a 
dollars and cents common sense way, that will go a long way 
toward making sure they understand mutual fund fees and 
expenses.
    The question is, what vehicle, what document would be most 
effective in getting that information and the cost of doing 
that. We have a proposal outstanding. It is not final. 
Obviously, we want to step back and look at what our colleagues 
at GAO have recommended and suggested and others have 
suggested.
    We are digesting the comments in this area. But the 
Commission's initial thought on this was again to be able to 
take a $10,000 investment, use the actual expenses of the fund, 
and use the actual return of the fund and translate that into a 
dollar number. So you can understand what it costs you to be 
invested in that fund.
    Mr. Emanuel. Can I interrupt for one second? From the GAO's 
perspective, if we were to adopt what the SEC has recommended, 
would you see that as an improvement over the present 
situation?
    Mr. Hillman. Absolutely.
    Mr. Emanuel. A marked improvement? Significant?
    Mr. Hillman. It would be a significant improvement. It 
would provide investors with increased information to compare 
fees across funds. It goes the added step of providing the 
specific dollar disclosure that you are looking for to reduce 
the ambiguity; to demystify the net assets. Our concern would 
be more about the placement of that information than the 
recommendations that SEC is making.
    Mr. Emanuel. And what would you do, then, if you were just 
to tweak it, just to get it over the goal line, then?
    Mr. Hillman. One possible alternative would be to use 
exactly the same information that the SEC is proposing, but to 
put that in addition to semi-annual reports, to put that within 
the account statement, so that investors have a greater 
opportunity of actually reading it.
    Mr. Emanuel. Okay.
    Mr. Chairman, no further questions. Thank you.
    Chairman Baker. Thank you, Mr. Emanuel.
    We have no further members for questions at this time, am I 
correct? Okay, I am correct.
    Mr. Roye, I would like to just make a request for the 
benefit of the committee. It was the hope that we could move 
toward subcommittee consideration of the proposal sometime in 
mid-July as a goal. Given the comments of the agencies this 
morning, we would very much request some closure on opinions 
perhaps on our return after the July Fourth recess for the 
members to have time to adequately assess any modifications 
that may be suggested, so that we can move as much as is 
practicable to a mid-month consideration of this proposal. If 
the agency does not find that an unreasonable request, we would 
certainly appreciate it.
    Mr. Roye. We will try to accommodate you.
    Chairman Baker. We thank both of you for your 
participation. It has been most helpful to the committee, and 
thank you for your help.
    At this time, I will call up our next panel.
    I want to welcome our panelists to the hearing this 
morning. As is the usual custom, we will request that if 
possible make your statement within a 5-minute constrain. Of 
course, your official testimony will be made part of the 
record. I am advised that we will have a series of votes 
interrupt our consideration at some time within the next 15 or 
20 minutes, but we will proceed to receive as much testimony as 
we can, and then recess the committee briefly for members to 
make those votes.
    I would like to welcome back to the committee, certainly no 
stranger here, Mr. John C. Bogle, who is the founder of the 
Vanguard Group. Welcome, Mr. Bogle.

    STATEMENT OF JOHN C. BOGLE, FOUNDER, THE VANGUARD GROUP

    Mr. Bogle. Thank you Chairman Baker and Ranking Member 
Kanjorski and members of the committee. I am delighted to be 
back with you again to talk about your proposed amendments on 
the Integrity and Fee Transparency Act of 2003.
    And particularly on disclosure, I compliment you on the 
disclosure and the call for reporting of costs, the annual 
operating expenses borne by each shareholder, I will come back 
to that in a moment, and especially the requirement which has 
profound consequences, to have an independent Director serve as 
Chairman of the funds.
    I want to say right at the outset, however, that I hope the 
final legislation you draft will go further, because I do not 
believe that this industry has adequately measured up to its 
responsibilities to mutual fund investors. The express language 
of the preamble to the Investment Company Act of 1940, which 
the Investment Company Institute in its testimony correctly 
called ``our common legacy,'' calls for mutual funds to ``be 
organized, operated and managed'' in the interests of 
shareholders, rather than the interests of ``Directors, 
officers, investment advisers and underwriters.'' I believe it 
is impossible to argue that that has been the case in this 
industry.
    Consider, for example, how fund expenses have soared over 
the past quarter-century. I am in a little bit of trouble here 
with the industry for saying that expenses rose 120-fold, from 
$523 million in 1979 to $64 billion in 2001. Even in 2002, with 
our equity fund shareholders having lost 34 percent of their 
money from the markets deck, the total fund expenses amounted 
to $62 billion. That 120-fold increase is far higher than the 
increase in fund assets during that period, which went from $70 
billion to $6.5 trillion, or about 90-times over. The net 
result, the expense ratio of the average mutual fund rose from 
about nine-tenths of 1 percent to 1.36 percent. So to be fair, 
the unit expenses are up only, if that is a word one can apply 
to such an increase, 51 percent.
    In my direct personal hands-on experience in being in this 
business and running a company for more than 2 decades, the 
economies of scale in this industry are staggering, and they 
simply are not being shared with mutual fund investors. 
Specifically, Vanguard expense ratios, and I don't mean to plug 
Vanguard here, but we operate at-cost so we know what the costs 
are, are down 60 percent in that period, compared to the 
industry rise of 51 percent.
    Expense disclosure will help. Further strengthening the 
board of Directors will help. But I also think we need an 
express standard of fiduciary duty playing off the language in 
the preamble to the 1940 Act, specifically a fiduciary duty 
that Directors place the interests of fund shareholders ahead 
of the interests of fund managers and distributors.
    I want to emphasize how crucially important costs are in 
shaping investment returns. The impact is enormous. For 
example, if we assume a future market return of 8 percent and 
assume, on the low side, for costs are actually higher, 2.5 
percent cost of mutual funds, the compound return of the stock 
market at 8 percent would produce a $58,000 profit on that 
$10,000 investment over 25 years. The return on the same 
investment after costs of 2.5 percent would produce a $28,000 
profit, less than half as much as the profit on the market's 
return. More than half is confiscated by expenses. 2.5 percent 
is a huge, huge cost to the long-term investor, staggering in 
its dimension.
    Disclosing the dollar amount of costs invest incur would be 
very helpful to investors, and it would be virtually cost-free. 
I want to put that to rest. We do not need to make any 
estimates. All we need to do is take the fund's expense ratio 
during the prior 12 months, apply it to the dollar value of the 
assets that the investor has at the end of the period, and say 
these are your annualized expenses, period. It would cost so 
far from $265 million, the absurd estimate I have read, that 
you would not be able to see it. The cost would be virtually 
zero.
    I want to emphasize something we have not talked about in 
these hearings. Think of the impact of that disclosure not on 
equity fund shareholders, but on money market shareholders. 
Consider a shareholder with $10,000 in a money market fund. The 
money market fund would yield about 1.25 percent and the 
investor received net income of $25, a quarter of 1 percent, 
after fees of perhaps $100; $100 to the manager out of $125 and 
$25 to the investor. If that would not open an investor's eyes, 
I do not know what would.
    I am going to skip a couple of things over here, but I do 
want to get to my final point and do not want to run over my 
time too badly. I want to comment on the conventional industry 
allegation that the industry must be good because it has never 
had a major scandal. If a scandal is described as a ``grossly 
discreditable condition of things,'' it is not clear that this 
statement is accurate.
    Consider the returns of mutual fund shareholders versus the 
stock market. For the last 20 years, the U.S. stock market has 
averaged a return of 13 percent. The average mutual fund 
investor, believe this or not, has averaged a return of a 
little bit over 2 percent a year. An investor in the stock 
market, $105,000 profit on $10,000; the average mutual fund 
investor, $5,000. Is that a scandal or is it not?
    That lag is important to the responsibility of this 
business. During the years leading up to the peak of the stock 
market bubble, we offered the public. 494 new technology, 
telecom, Internet and aggressive growth funds favoring those 
sectors. It is not conceivable that those funds were organized, 
operated and managed in the interests of investors, rather than 
the interests of fund managers. Is that a scandal or not?
    These new funds, these high-risk funds, believe this or 
not, took in $500 billion in that period, as the investor greed 
of that era drew the money into funds. But we helped them. We 
advertised in Money magazine in March, 2000, right at the peak, 
an average return of 85.6 percent in the previous year. We 
lured the sheep into this terrible market. Is that a scandal or 
not? You can decide.
    I have been in this business for 52 years and I think we 
are suffering from a severe case of the emperor's clothes 
syndrome. What is all too obvious to anyone who opens their 
eyes, from Warren Buffett to the respected Morningstar Advisory 
Service, seems invisible to the industry. I want to emphasize, 
that every person I have ever met in this industry over my long 
career has not been other than a good, capable, honest human 
being. But I believe the powerful financial interests of 
investment executives and the companies that manage the funds 
blind them to the realities of today's investments and the 
terrible penalty of cost.
    That is why I am here today. I believe that this industry 
can only survive if investors are given a fair shake, with 
managers focusing not on salesmanship, but on stewardship. 
Progress is being made, but I think we have got to go further 
if we are going to live up to the promise of the 1940 Act, 
which is to serve the national public interest and the interest 
of investors.
    Thank you, Mr. Chairman.
    [The prepared statement of John C. Bogle can be found on 
page 60 in the appendix.]
    Chairman Baker. Thank you, Mr. Bogle.
    Our next participant is the founder and President of the 
Fund Democracy, Mr. Mercer Bullard. Welcome, Mr. Bullard.

   STATEMENT OF MERCER BULLARD, FOUNDER AND PRESIDENT, FUND 
                           DEMOCRACY

    Mr. Bullard. Thank you, Chairman Baker, Ranking Member 
Kanjorski, members of the subcommittee. Thank you for the 
opportunity to appear before you today to discuss H.R. 2420, 
the Mutual Funds Integrity and Fee Transparency Act of 2003. It 
is an honor and a privilege to appear before the subcommittee 
today.
    I am the founder of Fund Democracy, a nonprofit advocacy 
group for mutual fund shareholders and an assistant professor 
of law at the University of Mississippi. I founded Fund 
Democracy in January 2000 to provide a voice and information 
source for mutual fund shareholders on operational regulatory 
issues that affect their fund investments. I have previously 
counseled mutual funds and investment advisers in private 
practice, served as an assistant chief counsel in the Division 
of Management at the SEC, published an industry newsletter for 
mutual fund lawyers, and published and written a column on 
mutual fund operational issues for Thestreet.com.
    More than 95 million Americans are shareholders in mutual 
funds, making mutual funds America's investment vehicle of 
choice. These shareholders, I believe, have made the right 
decision. For the overwhelming majority of Americans, mutual 
funds offer the best available investment alternative. This 
will continue to be true, however, only as long as mutual fund 
rules keep pace with changes in the fund industry. In 
significant respects, fund rules have not kept pace with 
developments in the fund industry. H.R. 2420 is necessary to 
update rules to ensure that mutual funds remain the best 
possible alternative for investors.
    The fund industry owes much of its success to the 
requirements of the Investment Company Act of 1940 and the body 
of law that has grown up around it. The Act provides liquidity 
by requiring that mutual funds be redeemable on demand at a 
price based on their net assets. Fund rules provide safety by 
prohibiting transactions between funds and their affiliates, 
and by limiting the amount of leverage that funds can use. 
Transparency and standardization are assured by rules regarding 
the use of standardized investment performance and fee 
disclosure. These rules are buttressed by the presence of an 
independent board of Directors that oversees fund operations to 
ensure that funds are operated in the best interests of their 
shareholders, and not fund affiliates.
    Mutual funds offer liquidity, safety, transparency and 
standardization at a reasonable price, again partly as a result 
of effective regulation. The fee information provided in the 
prospectus provides investors with standardized costs that can 
be used to compare different funds. This information can also 
be easily disseminated through the information channels that 
investors use when making investment decisions. The 
transparency of fund fees promotes price competition and has 
resulted in the availability of a wide variety of low-cost fund 
options.
    Fund regulation has also been successful in adapting to 
changing business practices. Many of the fundamental 
characteristics of mutual funds owe their existence to 
regulatory reforms, including the fee table, standardized 
investment performance, 12b-1 plans, and multi-class funds. As 
Mr. Bogle can attest, The Vanguard Group itself, America's 
second-largest fund complex, exists and operates only by reason 
of the series of exemptions that Mr. Bogle obtained from the 
SEC in the 1970s.
    In some respects, however, fund regulation has failed to 
adapt to changing business practices. Fund distribution and 
brokerage practices have changed dramatically over the last 20 
years. The rules governing fund disclosure and fund Directors's 
responsibilities have not kept pace. The true cost of investing 
in mutual funds has become obscured by fee disclosures that 
fail to reflect accurately how and how much shareholders pay 
for fund-related services. Fund governance rules need to be 
improved to give independent Directors the authority and tools 
they need to oversee funds' increasingly complex distribution 
and brokerage practices.
    H.R. 2420 takes an important first step in modernizing fund 
rules to reflect the way that funds operate today. H.R. 2420 
will update fund disclosure rules to provide investors with 
needed information about fund costs. It will provide investors 
with a clearer understanding of the impact of fees by requiring 
that they be disclosed in dollar amounts. Fee disclosure will 
be required to incorporate all fees, including portfolio 
transaction costs, and to identify all distribution expenses, 
including those paid outside of 12b-1 plans. Improved 
disclosure of compensation to portfolio managers and to retail 
brokers will enable shareholders to evaluate the extent to 
which these persons' economic interests are aligned with their 
own.
    In addition, H.R. 2420 will strengthen the role of 
independent Directors and further focus their energies where 
conflicts of interest between the fund adviser and fund 
shareholders are greatest. Recent scandals have reminded us of 
the importance of proactive leadership in the boardroom. H.R. 
2420's requirement that a fund board's Chairman be an 
independent Director will ensure that the leadership of 
America's funds is independent.
    That concludes my statement.
    [The prepared statement of Mercer Bullard can be found on 
page 66 in the appendix.]
    Chairman Baker. Thank you, Mr. Bullard.
    For the introduction of our next witness, I would like to 
turn to Mr. Ford for a comment.
    Mr. Ford. Thank you, Mr. Chairman.
    In the interests of keeping the next witness in good 
standing with her own congressman, I would defer to her own 
congressman first and I would love to say a few words once he 
finishes. So I defer to Mr. Emanuel, Ms. Hobson's congressman.
    Mr. Emanuel. We have been having this fight for six months 
on who likes Mellody more.
    I understand, but we have 15 minutes before votes, so I am 
letting Mellody go. She is an impressive person who, if you do 
not have an opportunity to hear her today, you can always watch 
her on Good Morning America giving advice. So we are very 
fortunate to have her here.
    Chairman Baker. Welcome, Ms. Hobson.
    Mr. Ford. She also raised some important points about the 
size of fund that she manages, in a lot of ways ensuring some 
of the things that the University of Mississippi law professor 
just raised, ensuring that those kind of things do not impact 
small funds disproportionately. So it is a delight to see her 
and I am glad to welcome her to Washington again.
    Chairman Baker. Just for the sake of our process here, we 
have had votes announced. We would like to proceed to receive 
Ms. Hobson's testimony. In order to give you time where you 
will not be rushed, I would suggest at that point we then 
recess for votes and come back to hear Mr. Haaga's testimony at 
that time.
    Ms. Hobson?

   STATEMENT OF MELLODY HOBSON, PRESIDENT, ARIEL MUTUAL FUNDS

    Ms. Hobson. Okay. Thank you very much, Chairman Baker, 
Ranking Member Kanjorski, and members of the subcommittee.
    Testifying about investor confidence when the issue is more 
important to our economy and a more relevant event to the 
destinies of average Americans than ever before is a great 
honor and even greater responsibility. I am President of Ariel 
Mutual Funds. Ariel is a small investment firm and a small 
business. We offer four mutual funds. More than 100,000 
individuals have given $3.7 billion to us to invest. Ariel is 
based in Chicago and we have 67 employees.
    In addition to my work at our firm, I also contribute a 
weekly segment on personal finance and investment issues for a 
network television program. My colleague John Rogers founded 
Ariel 20 years ago. At the time, we were the first minority-
owned money management firm in the nation. He was 24 years old. 
John discovered the stock market at the age of 12 when instead 
of toys, his father bought him stocks every birthday and every 
Christmas. That childhood interest evolved into his life's work 
and ultimately created the passion that led to the creation of 
Ariel.
    This story tells you about the heart and soul of one small 
mutual fund company in America. Some have suggested to the 
subcommittee that the mutual fund industry is dominated by 
firms who have forgotten their fiduciary obligations, lost 
their connection to individual shareholders, abandoned the 
basic principles of sound investment management, and repudiated 
the industry's proud history. Nothing could be further from the 
truth. As a mutual fund executive, my future, my credibility 
and my integrity are inextricably linked to Ariel's 
shareholders's success.
    Moreover, Ariel takes enormous pride in being part of a 
great industry. We work hard to reach out to those who have not 
seen first-hand the wonders of long-term investing, compounded 
growth, and the creation of enduring wealth. One important 
aspect of our work is the unique mission to make the stock 
market a subject of dinner table conservation in the black 
community.
    It is therefore heartening to come to Washington and see 
policymakers who care so much about investors. We applaud your 
efforts. When you find effective ways to reinforce investor 
protections and support the integrity of our markets, you help 
our business and you help our shareholders.
    I am aware that four major government reports on mutual 
funds have been published in the last 36 months, two by the SEC 
and two by the GAO. Taken as a whole, the reports reaffirm the 
health of the fund industry and the continued effectiveness of 
the regulatory regime that governs it. It would be logical to 
think that the SEC had put other fund initiatives on hold while 
these studies were completed, but that has not been the case. 
Since 1998, the SEC appears to have adopted at least 20 new 
mutual fund regulatory initiatives, averaging one every 12 
weeks. This appears to be the fastest rate in SEC history.
    Of course, each initiative can include multiple forms, 
rules, requirements and mandatory filings. I will attach a more 
extensive list for the record, but recent SEC mutual fund 
regulations have included new requirements in areas ranging 
from consumer privacy to proxy voting to after-tax return 
performance. In addition, at least four new major initiatives 
are now pending.
    The sheer number and range of these regulations 
demonstrates the vitality of the SEC's efforts to help 95 
million fund investors. I also think it bears noting that the 
ICI has worked constructively with the SEC on virtually all of 
these matters, and has endorsed the overwhelming majority of 
them.
    We should, however, remember that these new regulations 
invariably lead to significant costs. The SEC deserves credit 
for several efforts that reduced fund regulatory costs, but 
those initiatives are dwarfed by regulations that have added 
far larger cost burdens. Reviewing the SEC's own cost estimates 
for these rules is striking. The net impact of SEC mutual fund 
rulemakings since 1998 appears to have increased the fund 
industry's regulatory costs by at least several hundred million 
dollars annually.
    I am worried that the impact of all of this on small mutual 
fund companies could ultimately contribute to making the fund 
industry less hospitable to innovative startups and perhaps 
even less competitive. I am not certain that in good faith I 
would advise a 24-year-old today to take on the costs and 
burdens of starting a mutual fund family, as John Rogers did 
when Ariel was started.
    Let me turn to some general observations about the bill. 
Section 2 of H.R. 2420 directs the SEC to initiate expedited 
rulemaking on six broad new mutual fund disclosure mandates. As 
the subcommittee considers whether to support this directive, 
as I have stated, I am hopeful that the inevitable impact on 
smaller fund companies will be carefully thought out. It would 
be deeply regrettable if attempts to heighten shareholder 
disclosure eroded the competitive position of the most dynamic 
and entrepreneurial parts of the fund business. For that 
reason, I urge you to provide sufficient time so that a 
consensus approach to these issues can be embraced.
    Fed Chairman Alan Greenspan recently observed that in our 
laudable efforts to improve public disclosure, we too often 
appear to be mistaking more extensive disclosure for greater 
transparency. He said that improved transparency is more 
important, but harder to achieve than improved disclosure. 
Former SEC Chairman Leavitt once expressed a similar concern, 
stating that the law of unintended results has come into play. 
Our passion for full disclosure has created fact-full reports 
and prospectuses that are more redundant than revealing.
    The possibility that disclosures might impede, rather than 
enhance, decisionmaking is a real concern. For that reason, it 
is worth noting that the SEC, when they made changes to their 
own prospectus reform five years ago, they mentioned that 
learning too much information discourages investors from 
further reading or obscures essential information about the 
funds.
    After reading the SEC and GAO reports and reviewing the 
transcript of the subcommittee's March hearing, it is obvious 
that a substantial effort has been undertaken to explore the 
ways to bolster mutual fund investors' understanding of fund 
fees and expenses. Fortunately, recent ICI data about 
investors's actual behavior supports the message that fund fees 
has broken through.
    The ICI looked at all equity fund sales over a 5-year 
period ending in 2001 and found that, first, 83 percent of all 
equity funds bought by investors had expense ratios below the 
1.62 percent average charged by the average fund; and secondly, 
that the average investor holds equity funds with a total 
operating expense of .99 percent, about 39 percent lower than 
the fee level charged by the average fund.
    These findings indicate convincingly that very large 
majorities of fund shareholders own funds with lower than 
average costs. I hope the subcommittee will bear this data in 
mind as it further considers these issues.
    Lastly, I mentioned earlier that I conduct personal finance 
features on a television network news program and author a bi-
monthly column. I have received literally thousands of 
questions and requests for guidance in this role, and hear one 
refrain more than any other: people feel overwhelmed by 
information. Young, old, married, single, black, white, 
working, retired, investors want insight in ways to cut through 
the noise so they can get to the most important information 
that will help them make the best investment decisions. I never 
hear complaints about having too little information. It is 
always the opposite.
    Interestingly, I have received many fairly sophisticated 
inquiries, but never have I received one single question about 
soft dollars, directed brokerage, rule 12b-1, or many of the 
other mutual fund issues that we have discussed today. Perhaps 
there can be a small insight gleaned from that.
    Again, many thanks for the privilege of testifying. I look 
forward to your questions.
    [The prepared statement of Mellody Hobson can be found on 
page 135 in the appendix.]
    Chairman Baker. Thank you, Ms. Hobson.
    We are now down to 5 minutes on votes. We will stand in 
recess for approximately 20 minutes. Thank you.
    [RECESS]
    Chairman Baker. Just to proceed, certainly within the time 
frame allocated for Mr. Haaga's testimony, we should have a 
member return. I am advised they are on their way.
    The Chairman of the Investment Company Institute, Mr. Paul 
Haaga, please proceed, sir.

STATEMENT OF PAUL HAAGA, CHAIRMAN, INVESTMENT COMPANY INSTITUTE

    Mr. Haaga. Great. Thank you very much, Chairman Baker and 
members of the subcommittee. It is actually not a problem that 
they will miss a lot of my testimony, because we are in very 
substantial agreement with the SEC and the GAO. So if they were 
here this morning, this may be largely a replay.
    I am very pleased to be appearing before you today, as I 
did in March, and again I am doing so as Chairman of the 
Investment Company Institute's Board of Governors. H.R. 2420 
was introduced shortly after the release of a detailed report 
by the staff of the Securities and Exchange Commission. The SEC 
report, we are happy to say, found no significant shortcomings 
in mutual fund regulation. However, the report does recommend a 
series of policy changes and also identifies areas warranting 
further study.
    In large part, the industry agrees with the SEC staff's 
recommendations and we are committed to working with the 
Commission on these issues. Since then, we have also, of 
course, received the GAO report and we are in very substantial 
agreement with the GAO recommendations.
    I will discuss the provisions of H.R. 2420 in three parts. 
The first part consists of those provisions that we believe 
would be beneficial to mutual fund investors and could be 
implemented through SEC regulation. We call upon the SEC to 
proceed expeditiously in these areas and we pledge our full 
cooperation.
    The second are those which would also be beneficial to fund 
investors and in which voluntary industry practices could be 
initiated. As Chairman of the ICI, I pledge to move forward in 
these areas. The third are several provisions that we 
respectfully submit would not be advisable.
    To begin with we believe the SEC should take action in four 
areas. First, we call upon the SEC to adopt as soon as 
practicable the rules it has already proposed that would 
require fund shareholder reports to disclose the cost in 
dollars of a $10,000 investment in the fund, based on the 
fund's actual expenses and the return for the period of the 
report. We believe this proposal is superior to alternatives 
that have been suggested, as it will enhance investors' 
understanding of fees and most importantly, will permit them to 
compare the expenses of different funds.
    Second, we recommend that the SEC address the other areas 
of disclosure identified in H.R. 2420, including portfolio 
transaction costs, revenue sharing arrangements, fund brokerage 
practices, and the structure of portfolio manager compensation. 
The SEC report makes several suggestions in these areas, each 
of which is worthy of serious consideration.
    Third, we recommend that the SEC clarify the roles of fund 
advisers and fund Directors in connection with soft-dollar and 
directed brokerage arrangements as the legislation proposes. 
This is a good idea and the SEC does not need to wait for 
legislation to take this step. In fact, I would point out this 
has been a very important part of the SEC's regulatory agenda 
for a long time now. Back in 1998, they did a sweep of advisers 
and found a number of problems, but none of those were with 
respect to advisers managing mutual funds.
    Fourth, the legislation requires the SEC to undertake a 
thorough review of soft-dollar practices. We believe this is 
one of the most important issues addressed by the bill. We 
recognize the SEC has been actively reviewing soft-dollar 
practices for some time, especially through its inspection 
program. We believe it is time now for a review of the rules 
governing soft dollars.
    There are also areas in which the mutual fund industry can 
and should take voluntary steps to enhance investor confidence 
in our own system of corporate governance. First, we support 
applying the standards for audit committees established in the 
Sarbanes-Oxley Act to mutual funds. The audit committee 
standards are one of the few provisions of the Sarbanes-Oxley 
Act not applicable to mutual funds. H.R. 2420 would require 
mutual funds to adopt these standards. However, we do not need 
to wait for legislation, and I will recommend to the ICI board 
of governors that the standards proposed in H.R. 2420 be 
adopted as a best practice.
    Second, we agree with the SEC report and H.R. 2420 that it 
is inappropriate for certain relatives and persons with 
material business or professional relationships with management 
to serve as independent Directors of a mutual fund. I will also 
recommend to the ICI board of governors that it adopt a best 
practice under which these individuals would not serve as 
mutual fund independent Directors, as the industry has already 
done with respect to former employees of fund management 
companies.
    Third, I wish to point out that the ICI has adopted 
corporate governance best practices relevant to many of the 
issues addressed in the legislation. These include having 
independent Directors constitute at least two-thirds of fund 
boards, having a lead independent Director, and having 
independent Directors regularly meet in executive session. 
Because independent Directors meet and vote separately on the 
most important governance matters, annual renewal of the 
management, and distribution contracts, the latter two 
accomplish the objectives behind the proposal that funds have 
an independent chair.
    Our understanding is that the vast majority of fund groups 
follow all of these best practices. However, in order to ensure 
that their adoption is as close to universal as possible, I 
will also recommend to the ICI board that it take further steps 
to urge each individual member of the ICI to adopt them. I 
believe that the above SEC and industry actions will accomplish 
the primary objectives of H.R. 2420, and will send a message to 
investors that we, Congress, the SEC, the GAO and the industry, 
intend that their interests come first.
    There are also some parts of the legislation that we just 
do not think would be a good idea. I would like to briefly 
mention three of them. First, as I stated, we believe that 
existing practices in the fund industry, such as lead Directors 
and regular meetings of independent Directors in executive 
session, make it unnecessary to require mutual funds to have an 
independent Chairman of the Board.
    I might add to that the requirement that two-thirds of the 
Directors be independent. Not only is it unnecessary, but 
having an independent Chairman could actually result in a less 
effective board. Most matters that come before a fund board do 
not involve conflicts of interest, but are matters on which 
board oversight is facilitated by having a chair be intimately 
familiar with the operations of the fund. A management 
representative is usually in the best position to do this. As I 
stated, for those matters that do involve potential conflicts 
or would benefit from a separate discussion among independent 
Directors, the existing practice of an executive session 
chaired by a lead independent Director would suffice. We note 
that none of the self-regulatory organizations have proposed 
that operating companies be required to have an independent 
chair as part of their recommended corporate governance 
standard. We think that mutual funds are not any different in 
this regard and should not be singled out for this requirement.
    Second, we believe it would be a mistake for the 
legislation to dictate the specifics of how certain items 
should be disclosed and in which document they should appear. 
The SEC is the agency charged with administering the securities 
laws and it has the experience and expertise to make these 
determinations. Moreover, the regulatory process allows input 
from the public and a careful weighing of costs and benefits. 
It also provides maximum flexibility to adjust thereafter to 
changing circumstances. We are particularly concerned with the 
legislation's presupposition that prospectus disclosure is not 
sufficient for any of the items covered. Under the securities 
laws, the prospectus is the legal document required to include 
all of the important information that is necessary to assist an 
investor in making an investment decision. Congress should not 
inadvertently discourage investors from viewing the prospectus 
as the most important disclosure document.
    Third, to the extent H.R. 2420 would require disclosure of 
individualized operating expenses, we believe this would not be 
the most effective way of providing disclosure of fund expenses 
to investors. Unlike the SEC's proposal, this approach would 
not provide investors with cost information that permits 
comparisons because costs would not be based on a standardized 
amount.
    In addition, as the SEC report notes, this type of 
disclosure would impose enormous costs and burdens on funds and 
intermediaries. Funds in my group are sold through independent 
dealers and because of this, my fund company does not send out 
account statements to most investors. Instead, most investors 
receive those from brokers or 401(k) plans, so it would be 
others who would have to implement that.
    For these and other reasons, we recommend that once the SEC 
adopts its new rules on expense disclosure, which we hope will 
be soon, Congress study their effectiveness before mandating 
another costly and in our view far less effective form of 
disclosure.
    I would also note that the GAO's report which was released 
this week discussed several different ways in which fee 
disclosure could be included in account statements. I was 
pleased to hear the discussion this morning that seemed to 
offer some flexibility there to include it in another document 
and to include it on a standardized basis. We would be happy to 
work with both agencies in that regard.
    I will close by noting that beyond any of the specific 
matters I have touched upon, the mutual fund industry is 
committed to working with this subcommittee and others to 
continue to pursue reforms that will meaningfully benefit 
mutual fund investors.
    Thank you very much.
    [The prepared statement of Paul Haaga can be found on page 
90 in the appendix.]
    Chairman Baker. Thank you, Mr. Haaga.
    I think it is important just to reflect a bit on how we 
came to where we are this morning with the Capital Market 
Subcommittee review. This really is another component of our 
market-sector-by-market-sector analysis of arms length 
oversight which is frankly appropriate in light of the 
significant time that has passed since the committee has had a 
mutual fund discussion, and coupled with the enormity of growth 
we have seen, not only in notional dollar amount, but in 
numbers of investors. This is no longer an activity that is 
relegated to sophisticated financial individuals. Working 
families in everybody's community have some stake or interest 
in the performance and understanding of their mutual fund 
investments.
    Secondly, we are really here to help, we hope, with 
restoration of investor confidence. It had a measurable 
economic effect when working families made a conscious decision 
to withdraw their money from the capital markets and park it on 
the sideline for whatever the reason, whether a corporate 
misgovernance issue, whether disappointment in the performance 
of a particular fund. To ensure individuals that there is a 
third party looking at this matters, I think ultimately is 
helpful.
    Ms. Hobson, you indicated specifically with regard to 
concern of a smaller-managed fund, the impact that disclosure 
may have on the viability of the fund and on net return to 
individuals who are investors. I share those concerns. But in 
your further explanation, you indicated that very few investors 
talk to you about soft-dollar arrangements or 12b-1.
    Frankly, if I went back home to Baton Rouge and talked 
about 12b-1, most of my constituents would think I was talking 
about a nutritional program. They don't know about these 
things. They don't have enough information to propound the 
question.
    Are there provisions that are now applicable to the 
operation of your fund that you feel do not provide any 
significant measure of benefit to the consumer that we could 
repeal? This is not about just adding on pages, but in your 
statement, you indicated the number of regulatory steps that 
had been taken that now require the pronouncement of any number 
of forms. Help us out. We ought to be able to do both. We ought 
to be able to facilitate better disclosure, which in my opinion 
is not adequate, while at the same time helping the industry 
from the burden of unwarranted reporting. Do you wish to 
respond?
    Ms. Hobson. That is a very good question. I would have to 
think about the specifics of some of the regulatory issues that 
we confront on a daily, monthly, weekly basis at our board 
meetings, et cetera, that have become onerous, and bring those 
back to you. What I can tell you is that there is a lot of 
lawyering going on in our board meetings. There is a lot of 
discussion in every meeting that I am in now, from everything 
from the investment process to the marketing of the mutual 
funds around what the rules, laws and legal issues are, and 
often legal obstacles are to certain things that we would like 
to get done.
    So I will make sure to think about that and come back to 
you. But it is everything from the amount of hedge that we put 
on the bottom of an ad or reprint is so dense that I would 
argue that very few people actually read that hedge copy with 
all the disclosure. It obviously goes through lots of forms of 
review before it is approved to be able to go out. That is just 
one of many, many examples that we have. I can come back with 
specifics.
    Chairman Baker. Terrific. If you could do so for, say, 
early in July, just take a couple of weeks or so and get us 
something back, it would be helpful because the goal is not to 
just throw more stuff inside the door and say ``figure it 
out.'' It is to get something that is useful, while getting rid 
of that which is not helpful.
    Mr. Haaga, the same point. I note in your statement you 
indicate that disclosure of these matters is best left to the 
prospectus. I turn to Ms. Hobson's comments where she 
acknowledges even as a critic of the bill that a lot of this 
stuff does not get read. I would have to say to you that most 
investors when you get to that little bottom line where it says 
``I have read and understand the conditions outlined in the 
prospectus'' before you make your investment decision, don't 
put people on the stand and ask them to answer that under oath. 
Not many people read the entire prospectus and truly understand 
either the risk or the fee structure in association with it.
    Is there a way for us, not without burdensome obligation, 
to come to some point? I mean, that is what people care about. 
When you go make a loan, a lot of people don't ask interest 
rate; they don't ask terms; what the points are. What I want to 
have is something that says what the note is. Can you help me 
there?
    Mr. Haaga. Yes. I think it is a great question. I did not 
mean to say that these things should only go in the prospectus. 
What I argued against was precluding them from going into the 
prospectus. So let the prospectus be one of the options is 
really our position. I didn't mean to misstate that.
    When I look at these things, I am kind of reminded of when 
I go to church on Sunday and I come out afterwards, there are a 
number of elderly people who know what business I am in or are 
friends of ours, and they come up to me and ask me about 
investing. Actually for them, it is not investing. It is taking 
money out. They are not putting any more money in. So all these 
discussions of shelf-space and distribution channels do not 
apply to them. It is how much can I take out. And most of them, 
all of them I try to get together with an investment adviser 
because they need to do scenario analysis and find out how much 
they are going to move.
    I guess with them, when I talk to them about what kinds of 
funds they ought to be looking at, I am always aware of the 
fact that they are sitting down with an adviser, and that the 
adviser is interpreting a lot of this stuff. So the burden on 
us to get all of the information directly in the hands of the 
investor maybe in the directly sold funds may be important, but 
where there is an adviser or a 401(k) plan trustee, whose is 
reading this and selecting the funds that are going to be in 
the 401(k) plan, that is about 80 percent of our investors in 
the entire group. That is important.
    I am straying a little bit from your question, but when you 
come back to it, I talk to them about looking at the investment 
objectives of the fund, the investment record of the fund, 
particularly volatility, not just the total return over a 
period. When I talk to them, it is a two-way conversation 
because you have to talk to them about their investment needs, 
and sometimes we look at these things as though investors are 
all the same person with the same time horizon and the same 
risk-reward structure, and they are not.
    I do tell them that expenses are important, but it is also 
important to measure expenses against what you receive. The 
cheaper funds generally don't pay for you to have an investment 
adviser, so you want to think about whether you need an adviser 
or not. If you get an adviser, that person needs to be paid and 
how they are paid needs to be disclosed. That is kind of the 
discussion. Translating that into a document, I think frankly 
that the first few pages of the prospectus, which were at one 
time adopted as the profile prospectus, do a pretty good job of 
that. If we could get the profiles out there with people, it 
had a bar chart that showed the annual returns over the last 10 
years, which gives you a good idea of the volatility, as well 
as the rewards. It summarized the fees and it did it in a way 
that was exactly comparable with other funds. Morningstar makes 
a lot of money doing one-page profiles about funds. It is 
basically the same thing. So I would put it on that.
    Chairman Baker. Thank you, Mr. Haaga.
    I am reminded, since you gave us the church analogy, there 
was a Sunday School class during the summer and they had a 
little day-school thing. The kid gets in line in front of the 
tray where the fruit is, the preacher put up a sign that says, 
``Take one apple, God is watching.'' He gets to the end of the 
line where the desserts are, and another kid has scribbled out 
a note that says in front of the cookies, ``Take all you want; 
God is watching the apples.''
    [LAUGHTER]
    I think that is my problem. We have got to watch both ends 
of the line here.
    Mr. Bogle, did you want to comment?
    Mr. Bogle. Yes. I think first of all it seems to me 
critically important that we have much more disclosure than the 
bill asks for. It is not a matter of disclosing, I don't think, 
just the methodology about how portfolio managers are paid. I 
think that is the Investment Company Institute's argument. But 
what is important is not only the amount of compensation the 
portfolio manager is paid, but how much the management company 
gets and where the management company spends its money. Does it 
spend it mostly on marketing? Does it spend it on 
administration? And how much is profit to the management 
company? All of that needs to be disclosed.
    We need to pierce this sort of corporate veil that keeps 
the fund shareholders from knowing what the management company 
is doing, even though the fund is the only client that 
management company has. So we need to put that in shareholder 
reports, at least the annual report, rather than the 
prospectus. Visualize a situation where a fund has a million 
investors and no new buyers for whatever reason. Well, it is in 
a prospectus that nobody uses and you are depriving a million 
investors of the information.
    So it seems to me absolute that the shareholders of the 
fund, the ongoing owners who maybe got a prospectus 10 years 
ago must be informed of that. So that is, I think, an extremely 
important thing to show.
    Mr. Haaga. May I add something to my answer, sir? I was 
worried that we read the intermediaries out of the equation. I 
am also worried that we may be reading the Directors out of the 
equation here. The Directors do know about profitability. They 
know about all of these things that we are saying ought to go 
to the shareholders.
    The difference between them and the shareholders is that 
the Directors can sit down and discuss it with us. They have a 
fiduciary duty and they can ask us follow-up questions. So I 
worry that we are saying that everything that ought to go to a 
Director needs to go right through to a shareholder because 
that is transparency. That example is just one of them.
    Mr. Bogle. If I could add to that direct point, if I may. 
Vanguard reports all those costs to our investors, fund by 
fund, item by item, how much goes to investment management, how 
much to distribution, how much to operations and 
administration, how much to the custodian, to every fund, every 
investor and the aggregate if anybody wants to add them up. It 
is not troublesome. It is not burdensome. It is out there for 
everybody to see.
    I am not arguing that the cost matters so much to the 
investor, because they clearly do not pay a lot of attention to 
that. I am arguing that the simple act of disclosure puts 
something out in the public limelight and changes the behavior 
of those who are disclosing.
    Chairman Baker. Ms. Hobson?
    Ms. Hobson. Yes, if I could add one point to that, 
respectfully disagreeing with Mr. Bogle. This would be the only 
industry where your profitability would be mandated to be 
disclosed. So for example, the way that I have thought about 
this when I heard this argument was that it would be as if you 
went to buy a jar of peanut butter; you get your Skippy off the 
shelf. And every item of that peanut butter is detailed for 
you. Peanuts cost this much; the oil cost this much; the jar 
cost this much. That is not material to the person picking the 
peanut butter off the shelf who wants to know, is it $1.29 or 
$1.19?
    The idea of having to then disclose on top of that, we have 
built up this much profit into the peanuts after we shipped 
them and paid for all the labor et cetera. There is no other 
example in business of that kind of disclosure.
    Chairman Baker. Let me make the observation, though. If it 
is a peanut butter company that is publicly traded, I can find 
out all that information.
    Ms. Hobson. You can find out information about cost of 
labor; you can find out certain information about components of 
the business, but all the profitability numbers you can back 
out of a financial document for a public company, but they are 
not explicitly stated to you because of competitive 
considerations.
    Chairman Baker. I don't want to be argumentative, because I 
have gone way over my allotted time, but I just think there are 
some parallels between publicly traded reporting standards and 
what you can find out about a company's operations.
    Mr. Haaga. I think Mellody's point is that you can find 
that out, but you don't find it out when you decide whether to 
buy a jar of peanut butter.
    Chairman Baker. Right, not when you are picking up the 
peanut butter. Right.
    Mr. Bogle. I like to think that mutual funds are more 
important to the investor's financial future than peanut butter 
is.
    Chairman Baker. Even in that case, you have a bunch of jars 
and you can pick the lowest price or the crunchiest, whatever 
you want, but you have a choice.
    Mr. Kanjorski?
    Mr. Kanjorski. We don't have peanuts in Pennsylvania, Mr. 
Chairman.
    [LAUGHTER]
    It is interesting listening to the four viewpoints given. 
It seems we almost have a philosophical difference. Mr. Bogle, 
you are equating mutual funds with almost the credit union-type 
movement in banking. You want to see the least expenditure on 
experts on investment, on management, and the most advantage to 
go to the investor. That is a very good concept. I tend to 
agree with it.
    I think Ms. Hobson addresses another problem, though, 
allowing the field to be open to new competition, small mutual 
funds. And then an overall prevailing issue is, if you take 
your argument and you show such a small portion of expense for 
the operation of your fund, that is all well and good. But 
suppose Ms. Hobson's fund shows 10 times as much expense but 30 
times as much profit? I mean, that is significant, too.
    So I don't think we here in the Congress or the regulator 
or the marketplace is asking us to set up some measurement of 
certainty of success of investment. That is not our role. There 
used to be a principle in the law, caveat emptor, but we seem 
to have forgotten that altogether.
    What I am most interested in is the question I asked Mr. 
Roye earlier. Has anybody done a cost analysis of this? I just 
did a back of the envelope with 30,000 funds, obviously every 
one of them if we pass a new statute has to have legal advice. 
I have nothing against lawyers. In another life, I was one. But 
if the minimum fee or the average fee were $10,000 per fund, we 
are talking about an expenditure here of $300 million to come 
up with some numbers.
    We all probably agree, and I will confess to it, anyway, 
when I make a bank loan, the omnipotence of the Congress 
determines that they have to give us disclosure sheets that you 
end up signing and never reading. Quite frankly, my eyesight is 
not worthwhile with the small print anymore to read it. I just 
know I would not enjoy it, and I don't think 95 percent or 99 
percent of borrowers do read those disclosure documents. I tend 
to agree, it is where it is placed, how it is placed and the 
simplicity.
    I am not arguing against some simple, easy formula that 
sets out to give some basis of comparison. But hopefully, it is 
only a recognized basis. It is not the holy grail that we are 
putting out here. Much more thought, analysis and insight by 
the investor is necessary to participate in equity capital 
markets, whether they use a private broker or whether they use 
a mutual fund.
    Quite frankly, I am not one of these people that believe 
100 percent of the American people are eventually capable of 
becoming equity investors. I think we make a mistake, as 
sometimes my thoughts on real estate and ever pushing for 
higher ownership just can't be handled by some people.
    But if we are going to spend $300 million here, somebody 
should convince us that that expenditure is going to save more 
than that. And yet, I heard the SEC said there are only five 
problems that they have had this last year, and the losses 
incurred to the investors in their estimation were under $100 
million. So we are talking about a regulation here that is 
going to cost us three times as much in legal fees as the total 
money saved to the investors. If that is the case, let's take 
$100 million and put it in a fund and pay the losses to those 
five groups that lost. Now, quite frankly, I am going to run 
out and make an investment in a plane company and a paper 
company, because I think the stock is about to go up if we do 
this.
    Chairman Baker. That would be insider trading. Be careful.
    [LAUGHTER]
    Mr. Kanjorski. You know, I think I have listened to 
everybody's argument here correctly. I think I come up with the 
sense that we would like to have a more open capital market. We 
would like to have less potential for abuse and not necessarily 
any proved abuse. We would like to have some standard of 
comparison. I think all those elements are good. I tend to 
favor if it can be done reasonably, that to happen.
    But if we get very burdened down with passing some law 
empowering another regulator when they have nothing else to do, 
to go out and get involved in this, when I think there are many 
other things. I mean, if we are going to spend a lot of time in 
regulation, I could give a list of another 10 or 20 
corporations that probably should be looked into that are 
probably in very serious condition, and yet haven't even been 
disclosed.
    That all being said, why don't we look at investor 
education? Why wouldn't the mutual fund industry be the ideal 
industry to get together? We require brokers to be licensed, to 
have a measure of ability and capacity. Maybe we ought to 
license investors.
    I don't agree with that. I am being facetious when I say 
that, but in reality, that is what we are talking about. We are 
saying there are a lot of people who are probably subject to 
being hoodwinked or scammed or taken advantage of, even in the 
mutual fund market, because they lack the financial capacity to 
make comparisons, involve themselves in the profit-loss 
statements of the fund, and to understand what is to their best 
advantage.
    I am convinced that rather than the government thinking 
about ensuring and anticipating the inadequacies or 
incapacities of every investor in America, I think that is 
impossible. Maybe what we ought to do is invest the $300 
million in some way with the SEC or NASD or somebody, to more 
highly educate investors as to how to compare or how to look 
and how to read, and then encourage a simple disclosure in the 
statement that people can look at and make a comparison.
    But I am not sure that we should be in the make work 
posture of putting a federal regulator empowered with a lot 
more power than they would have now, to get involved in what I 
consider a relatively successful fund market. Now, you can make 
the argument, Mr. Bogle, that a lot more money is taken out 
than should be, and I agree with you. But at least they are 
allowing people to get into the equity markets. I don't think 
you are arguing that all advice is of the same value. If I get 
a brain surgeon, he is going to be high priced. I am not going 
to price him and bid it. I think with investment advice, you 
just don't bid the market and get the cheapest price. If you 
are smart, you pick the best expertise you can and generally it 
costs a little bit more.
    Sometimes there is fluffing of the price. Sometimes there 
are add-ons that should not be there. We should find some way 
to have the transparency to see that simplistically, not with 
horrendous expense. I am just worried about what we are on a 
roll here is to start down that road.
    May I make a suggestion? Assuming we want to get to 
transparency and the capacity to compare, I think Ms. Hobson 
came up with a very good idea, and I analogize it to the CRAs. 
When I first came to Congress when we have the Community 
Reinvestment Act, the major difficulty with the Act was that 
all banks were treated the same, and they had to comply with 
the rules and regulations of CRA.
    A big bank like Citicorp, they spent maybe $100,000 to fill 
out their report to comply. But a little bank like Ajax 
National Bank in Paducah had to spend $55,000, $60,000, $65,000 
to fill out the same report to show compliance. It was an 
unusually heavy burden on banks under $100 million, $200 
million, $300 million.
    We struggled here. We thought of a three-tier system and 
having different requirements for disclosure. We thought about 
taking the lawyers out and shooting them, but that didn't work. 
A few district attorneys and others did not like that idea.
    Finally, it was resolved. A good friend of mine, Gene 
Ludwig, became Comptroller of the Currency. He sat down and 
wrote out a computer program and offered it to every bank in 
America, that if you file in accordance with and use this 
computer program, you comply. Rather than $55,000 for lawyers, 
suddenly they did not have to hire a lawyer because they merely 
took the comptroller's program, complied with it, and filed.
    Now, why can't we do that with the mutual fund industry? 
Have the regulator take the responsibility of coming up with 
whatever that disclosure figure is, where it should appear, and 
how it should appear; get everybody agree to do it; then put a 
program together; send it out so everybody can comply without 
going through $300,000 in legal fees. And we have accomplished 
something. We have given transparency. We have given a standard 
of comparison. And we have not shamed an industry or assaulted 
an industry at a very weak moment in the American economy.
    If we keep questioning the integrity of every financial 
market and company in this country, we may improve some, and 
there are some losers, but some bad ones are always going to be 
out there. But one thing we will have a tremendous impact on, 
we are going to drive people out of the trust and faith of the 
capitalistic system. Again, I say on my side of the aisle to be 
arguing for that probably is a shame to some of my colleagues. 
But the fact of the matter is, let's not hammer it into the 
ground, so either the Congress or the regulators can look good 
and be able to say to our constituents, we did something; we 
put a new rule in; and we made the mutual fund industry comply, 
even though it cost $300 million to save $100 million.
    Let's be practical and respond to all the questions raised 
and all the testimony given, that if the regulator takes it 
upon themselves, working with the associations, comes up with a 
simple formula or simple computer program that will be made 
available free of charge to the mutual fund industry, this 
affords the opportunity to protect everybody, to get the 
transparency, but most of all not to shut off the opportunity 
that Ms. Hobson testifies about.
    We are not here as the protectors of the giants and the big 
ones. They are going to take care of themselves. They are going 
to survive. What we want to do is encourage a real egalitarian 
capitalist market. It is only through the successes of 
organizations that Ms. Hobson represents that that is going to 
happen. We can, in our haste to look good, in our haste to work 
responsive, can poison the well of the future opportunity of 
those types of organizations. I think that would be the worst 
of all.
    Chairman Baker. Can the gentleman conclude?
    Mr. Kanjorski. Mr. Chairman, I conclude. I have given you 
all the best thoughts I have had this morning.
    Chairman Baker. Thank you, Mr. Kanjorski.
    Is there comment from the panel?
    Mr. Bogle. Could I respond to that? At least on the cost 
side. The way I suggest that we estimate the investor's 
expenses is just take the current expense ratio, it is easily 
ascertainable, and multiply it by the shareholder's asset 
value. It has a cost very close to zero. The $300 million cost 
is simply not relevant. It is a simple thing. Whether smaller 
companies should be relieved of other regulatory burdens is I 
think a separate issue and a reasonable one.
    Now let me talk about the impact of costs on mutual funds.
    Mr. Kanjorski. Just one second. On that, you mean if you 
managed a fund and this new regulation came down, you would not 
feel compelled to call your attorney and get an opinion as to 
what you should do to comply with the law, and whether in fact 
when you decided what to do you were complying with the law?
    Mr. Bogle. I would just do it. I would comply with the law. 
The attorneys would probably get in there somewhere, but I 
think we can spend too much time with them. There is such a 
thing as just doing what is right.
    I would rather tackle the bigger issue, if I may, of how 
much expenses cost investors? This is a truism, it ought to be 
stated before this committee, that all mutual funds investors, 
stock investors, bond investors, money market investors, get 
essentially the total return generated by those markets, less 
the cost of operating and trading the securities and mutual 
funds. That number is approximately $100 billion a year; about 
$65 billion of mutual fund expenses, dollar expenses, multiply 
the weighted expense ratios of the funds times the assets. It 
is not a complicated calculation. The other $35 billion more or 
less, probably more, can be made up of portfolio turnover 
costs, sales charges, and out-of-pocket costs. So every year 
American investors as a group lose to the returns of the stock 
market by $100 billion a year. That is a staggering cost, a 
huge cost over time.
    So the way to get them aware of that is to give them their 
expenses and also to have somebody stand up and look at those 
expenses, in this case the board of Directors, and say, whoa, 
this has gotten out of hand; we should not be costing 
investors; all the fund Directors together, $100 billion a 
year, it is too much. We could run this industry on half that. 
That is why Vanguard's expense ratio is so much lower than 
everybody else, because so many of those items are minimized.
    So it is a staggeringly large number and gives some idea of 
the dimension of what we have to get across to the investors 
relative to the tiny cost of some of these improvements.
    Chairman Baker. Any response to that?
    Mr. Haaga. I would just say, supporting Mr. Kanjorski's 
argument, we did not make a big deal about the cost of the 
individualized expense disclosure because it also happens that 
the cheaper solution is the better solution; the thing that 
costs a lot of money is the thing that destroys comparability, 
and we think comparability is very important. So that is why we 
did not argue. But I absolutely support that we need to have a 
very thorough cost-benefit analysis of any regulation that the 
SEC should pursue.
    Chairman Baker. Mr. Tiberi?
    Mr. Tiberi. Thank you, Mr. Chairman.
    Let me pursue this in a little bit different tack. As a 
former realtor, when I negotiated with a client for their 
services, I negotiated and disclosed a percentage that I would 
charge them. And then when I was successful in selling their 
house, I would then be forced to disclose to the client, to the 
world, how much I charged for my services.
    Ms. Hobson, you made a passionate case that was very 
coherent on peanut butter. Can you tell me why or what would be 
the reason that you would oppose, if you would oppose, maybe 
you would support, some sort of simplified fee disclosure in 
actual dollars to me as your client, the cost of me investing 
with your fund?
    Ms. Hobson. I can answer that question in two ways. I in no 
way oppose people knowing what they are paying. It is like that 
saying with the commercial on TV, it is all in there, the one 
with the spaghetti sauce. In this situation, the fees are 
stated very prominently in the first pages of the prospectus.
    Mr. Tiberi. In actual dollars?
    Ms. Hobson. They are actually stated. They say, if it is a 
fund, Ariel Fund, that this fund costs 1.25 percent a year. If 
you invested $1,000, you will pay $12.50, and then it states 
what that will be for three years, and it will state what that 
estimate will be for five years. That information is there. I 
am for anything that helps educate the investor, because long 
term, that means they will understand what they have bought and 
stick with it, and I want our customers to stick with us. So 
anything that helps educate them, I am absolutely for.
    Mr. Tiberi. I have not seen very nice prospectuses. I have 
seen wonderful annual reports. Would you be opposed to putting 
that in an annual report or putting that in quarterly or semi-
annual statements?
    Ms. Hobson. We have said we are not opposed to moving that 
information to another document. The question is how 
personalized that information gets, where it becomes onerous 
for mutual fund companies, particularly smaller companies like 
ourselves, to be able to provide that information.
    Ultimately for me, the question that I am asking myself, 
when mom and pop are sitting at the kitchen table making their 
fund choice investment decisions, either for their 401(k) plan, 
their retirement, or Susie's college education, is this 
information materially helping them to make a better investment 
decisions? That is the critical issue for me.
    Mr. Tiberi. I agree. The interesting thing is, and I would 
like Mr. Haaga to maybe talk about this, I got into a 
discussion at church, maybe that is why you should answer this, 
on Sunday with a group of individuals who are discussing with 
me the fact that mutual fund fees only came out of profit. I 
tried to tell them that was not the case. They argued with me 
that it was the case.
    I think it goes to the point of disclosure, again, that 
these mutual fund investors happen to believe because of maybe 
a lack of information or a lack of detail, that on their 
monthly statements there wasn't anything like that. Can you 
expand on that?
    Mr. Haaga. Actually, that is a really good point. I would 
like to comment a little bit if I could first on the realtor 
example, because the GAO also had some examples. We are using 
the terms ``fees and expenses'' interchangeably here. Mutual 
funds charge both. If it is a fee, it is paid by the 
shareholder. So when we charge you a sales charge, you get the 
exact dollars, you get it on the confirm, you know exactly what 
you paid, and you paid it, so we can tell you that. That is the 
one that is analogous to a realtor and that is the one where we 
disclose exactly the same as you do, just as quickly and just 
as accurately.
    What we are arguing about here is how to disclose operating 
expenses of the fund that fluctuates and are really borne 
indirectly by the shareholder because they are taken out of, as 
you said, returns, if there are returns, and assets if there 
aren't returns, but they are basically taken out of the 
returns. They end up affecting the value of the account, even 
though they are not paid directly. That is the thing that is 
hard to disclose and hard to be exact about because they are 
indirect.
    Mr. Tiberi. Mr. Bogle, do you have a view on that at all?
    Mr. Bogle. Help me out with the original question.
    Mr. Tiberi. Do you have a view on the cost of personalizing 
expenses?
    Mr. Bogle. Yes, I think it is something that should 
absolutely be done, and I think the cost is trivial.
    Mr. Tiberi. The cost to the fund?
    Mr. Bogle. The cost to the funds would be trivial if you do 
it the simple way. There is a complicated way of doing it, you 
know, trying to go back and show how many shares he owned each 
day when he goes in and out of the fund. But all you have to do 
is take the year-end value and multiply it by the expense ratio 
of the previous year, and it is a simple one extra line or two 
extra lines in the statement.
    Mr. Tiberi. And you don't believe it will be onerous to a 
small mom-and-pop shop like Ms. Hobson's?
    Mr. Bogle. It is a simple shareholder statement. It is a 
line on the shareholder statement. It is not complicated. I 
don't know why it gets portrayed as being complicated. I think 
we ask the wrong question to give a simple answer. I think it 
would be very helpful, particularly to the investor, 
particularly in the money market example I gave where the cost 
in money markets are today consuming something like 80 percent 
of the return on money market funds.
    Mr. Haaga. Jack, you say it would be free. When we did the 
cost study, the cost of doing the estimate that you describe 
was 90 percent of the cost of doing the exact thing. What you 
are saying is ``free,'' just is not free. It is 90 percent of 
the original cost.
    Mr. Bogle. And how do you define that original cost?
    Mr. Haaga. It is the cost of programming at brokers and all 
the intermediaries to provide information and then following 
through on it to provide information. We will show you the 
study.
    Mr. Bogle. I am very dubious that the simple thing and the 
way I am talking about doing it would cost that much, but we 
will take a look at it.
    Mr. Tiberi. Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Tiberi.
    Mr. Royce?
    Mr. Royce. Thank you, Mr. Chairman.
    Just to allow you each to recap in terms of how you feel 
about the SEC proposal and why their proposal to disclose fees 
in a shareholder report is better than or worse than disclosing 
these costs on an individualized basis, I would like to ask you 
that. In terms of disclosing the operating expenses, getting 
back to Mellody's example of the peanut butter, I just wanted 
to make the observation that probably the government should 
impose how much of the cost of that peanut butter is a 
component of our policy of not allowing anybody to grow peanuts 
unless you had a farm in 1933.
    In other words, there are government-imposed costs in all 
of this, too. Mr. Kanjorski's point, you know, do we mandate 
the government-imposed costs on some of these. There are 
consequences, but we also have evidence here that in this case 
the government-imposed cost would be very minimal. So maybe we 
can just kind of sum up with your views. Which approach, the 
SEC or the Chairman of the committee's bill, and why?
    Mr. Bogle. I opt for the individual cost disclosure, the 
number of dollars the investor pays, because it brings home 
costs relative to the value of his account.
    Mr. Royce. But you say this is yearly. As I understand the 
SEC proposal and the Chairman's bill, wouldn't it presume that 
it was semi-annual?
    Mr. Bogle. Honestly, I don't have a strong opinion between 
semi-annual, quarterly and annual. I think any one of those is 
pretty much the same thing.
    Mr. Royce. Yes.
    Mr. Bogle. I think it will bring home the cost to the 
shareholder in a way that he can compare it to the income the 
fund has earned. He can compare to the profits he got from the 
fund. He can compare it with the electric utility bill. He has 
got to understand it is costing him money. Anytime someone 
compares dealing with people's financial futures with peanut 
butter or toothpaste or beer or anything else, the financial 
service that we provide investors is basically a sacred trust 
to the investors. It is not a consumer product.
    As in the $100 billion that I mentioned, cost means 
everything in terms of those returns and we have to make people 
aware of it. We have to make boards stand up and defend fund 
shareholders against the interests of the management company 
which conflict with that. So we need to do this whole program 
of greater independence.
    I believe an independent Chairman is crucial. And much 
better cost disclosure, and I would add cost disclosure not 
only in the shareholder statement, but cost disclosure of all 
the items that the management company spends its money on, 
including its profits, are the right of a shareholder to know. 
Mr. Haaga said that his Directors already know that. Well, his 
Directors are there to represent the shareholders, so I don't 
see that it is but one small step.
    Mr. Royce. And you are going to take a look, you said, at 
Mr. Haaga's study if he offers that, to see if that $300 
million cost is in your estimate a wild estimation.
    Mr. Bogle. We work directly with investors. We do not have 
broker-dealers out there selling our funds. We are a no-load 
fund group and people come to us. We don't take it through the 
broker level, so it is probably a little bit easier for us.
    Mr. Royce. That is one of the concerns here. You have a 
certain methodology that you have developed and they do have a 
different means, a different way of providing products that are 
more individualized. As a consequence, I guess you would grant 
that there might be additional costs in that.
    Mr. Bogle. Somebody testified that the cost was .000038 or 
something. I may have gotten a zero wrong.
    Mr. Royce. Yes.
    Mr. Bogle. But fairly trivial in light of the assets of the 
industry, although I don't think we should be throwing money 
away on costs. When you realize the profitability of the 
management company and the management company's net profits in 
this business after they take the net fees, they take the 
advisory fees they get, and subtract their expenses and make a 
net profit that I estimate to be something like $25 billion, I 
don't think it is a serious cost relative to that profit.
    Mr. Royce. One of the comments that I think I heard Fed 
Chairman Greenspan once make is that there is a tremendous 
benefit in terms of where someone has specific expertise and 
can engineer above-average returns. In terms of the results for 
the overall economy, this is one of the reasons the United 
States presumably does so well. But you essentially debunk that 
thesis. Your argument is that over the long haul, no matter how 
good the expertise, these funds don't necessarily out-perform 
the market.
    Go ahead. I will let you state your position.
    Mr. Bogle. I would agree with something even more profound 
than that.
    Mr. Royce. Yes?
    Mr. Bogle. I would argue it is not just over the long haul, 
it is every single day, absolutely. That is to say, investors 
fall behind the return of the market by the amount of the cost 
of our system of financial intermediation. This is not an 
arguable proposition. So investors lose to the market, 
investors as a group, not just fund investors, by roughly $1 
billion a day. That is a simple fact. So it is daily. It does 
not always show up, and we look at returns of funds that are 
unweighed and all that kind of thing, but for every good 
adviser who is buying all the right stocks, there is a bad 
advisor who is selling the stocks to him.
    It is a closed system. One investor's gain is another 
investor's loss. It has nothing to do with the expertise of a 
brain surgeon. I have an expert over here; he is going to be 
good for a while, someone else is going to be bad. But within 
the system, it is gross return on the market, the amount of 
financial intermediation costs taken out is the net return 
investors get. For that, there is no argument.
    Mr. Royce. Can we have a response? Paul or Mellody?
    Mr. Haaga. Let me start. I would like to point out the 
irony of Jack waving off three-tenths of a basis point as 
irrelevant. If we had proposed to raise our fees by three-
tenths of a basis point, I am sure he would have strung it out 
25 years, present valued it, and made it into a big number.
    Mr. Bogle. I think the number was three one-hundredths of a 
basis point.
    Mr. Haaga. Well, even three one-hundredths.
    Mr. Bogle. Maybe it was three one-thousandth.
    Mr. Haaga. First of all, the question was posed as a 
preference for the SEC approach or the Chairman's bill. It is a 
matter of interpretation, but I think the Chairman's bill 
accommodates the SEC's approach. It depends on how you read the 
words ``each shareholder.'' So they may not be incompatible, 
and therefore it may not be something you have to decide 
between the two.
    Mr. Royce. The Chairman's bill would also ostensibly allow 
Jack's interpretation.
    Mr. Haaga. It could. We just have to clarify that. I just 
wanted to point out that they are not necessarily inconsistent.
    I think what we have here is a trade-off. The more specific 
you get with the exact dollar amount of the shareholder's fees 
or expenses, the less comparability you have and the more it 
costs. I think what we need to do is look for a compromise 
here. We think the happy medium here is the SEC's approach that 
does use the standardized amount. People can interpolate from 
that what their exact cost is; saving them from the 
interpolation costs the industry and ultimately shareholders a 
lot of money, and worse than that destroys comparability. That 
is really our position. There are two problems. If it were only 
three one-hundredths of a basis point and it were better, we 
would be in favor of it. It happens to be three one-hundredths 
or some number of basis points and it is worse. That is why we 
are arguing against it because we think it goes too far in the 
direction of exactitude and gives up on the other two 
considerations.
    Ms. Hobson. The other thing to note is just to underscore 
Mr. Bogle noted that in the Vanguard situation specifically, 
they do not have the intermediary concern that perhaps lots of 
other fund companies have who distribute their funds through 
others. In the situation of Ariel where we have $3.7 billion 
under management and about 100,000 shareholders, we have over 
2,000 selling agreements with different distributors around the 
country.
    So this isn't us just flicking a switch to change how we 
send out a statement. There is a lot of interface that would 
have to occur, not only at the individual levels of those 
distributors, but also in our own organization, which is where 
these costs are meaningful.
    And then the one other point that I don't want us to forget 
is that I strongly believe our interests, contrary to what 
others might think, are squarely aligned with those of our 
shareholders, because every single day our performance is in 
the newspaper. Every single day the expenses of our fund get 
deducted out of our performance and therefore affect our 
competitive standing.
    Portfolio managers in this business are very competitive 
and they understand to the extent that they out-perform, more 
investors will come, so we will grow. So to the extent that we 
do well for our investors, we will grow. So it does put us at 
odds with them. When any fee discussion comes up in our board 
room, I can tell you the first person who is the most concerned 
is the portfolio manager who knows he has to give up 
performance for that.
    Mr. Royce. Thank you.
    Mr. Bullard. May I add something to that? I am concerned 
about the disclosure of actual dollar amounts, but to some 
extent this discussion is making me more concerned that the 
bill will be viewed as being about that, when at least in my 
mind there are more significant aspects of the bill that will 
have a much greater, more positive impact. One of those that is 
being overlooked is the fact that the simple number, the 
expense ratio, that if any investor looks at anything other 
than performance, will be what they look at, does not include 
all the expenses of funds.
    In fact, the SEC report shows us that portfolio transaction 
costs can be a substantial part of fund expenses. It varies 
across different funds. It depends on their strategies, and 
that is not being shown to investors. They are prevented 
effectively from consuming that information. It dampens price 
competition. The day you include commissions, for example, in 
expense ratios, I believe you would see a substantial reduction 
in the amount of turnover in funds portfolios.
    Mr. Royce. Thank you.
    Mr. Chairman, thank you for this hearing and for your 
leadership on so many issues in this Congress.
    Chairman Baker. I thank the gentleman for his kind remarks.
    I want to express my appreciation to each of you. Our goal 
here is not to bring about unwarranted, unneeded regulatory 
burdens. That helps no one. It is adding simply to the expense 
bottom line. We do, however, want to examine the way in which 
information is delivered to investors. Ultimately, an enhanced 
disclosure regime will bring investors back to the market in 
greater number and both perspectives can win.
    We don't yet have a perfect remedy, but in our business we 
have timelines and we will have to act at some point. So I 
encourage each of you in further written comments if you so 
choose to get it to the committee's attention within the next 
couple of weeks. We would be most appreciative.
    If there are no further comments, then we stand adjourned.
    Thank you very much.
    [Whereupon, at 1:15 p.m., the subcommittee was adjourned.]


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