[Congressional Record Volume 149, Number 159 (Wednesday, November 5, 2003)]
[Senate]
[Pages S14038-S14043]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]
By Mr. AKAKA (for himself, Mr. Fitzgerald, and Mr. Lieberman):
S. 1822. A bill to require disclosure of financial relationships
between brokers and mutual fund companies and of certain brokerage
commissions paid by mutual fund companies; to the Committee on Banking,
Housing, and Urban Affairs.
Mr. AKAKA. Mr. President, I rise today to introduce legislation
intended to restore public trust in mutual funds, the Mutual Fund
Transparency Act of 2003. I thank Senator Fitzgerald and Senator
Lieberman for cosponsoring my bill. I greatly appreciate the efforts of
Senator Fitzgerald to address this issue. Our Financial Management,
Budget, and International Security Subcommittee held a very thorough
hearing on mutual fund trading abuses on Monday. I applaud the efforts
of Representative Richard Baker for his leadership and his efforts to
improve mutual fund governance. I also commend the efforts of New York
Attorney General Eliot Spitzer and the Secretary of Massachusetts
William Galvin for their efforts to pursue individuals that have harmed
mutual fund investors.
Mr. President, 95 million people have placed a significant portion of
their future financial security into mutual funds. Mutual funds provide
middle-income Americans, blue and white collar workers and their
families, with an investment vehicle that offers diversification and
professional money management. Mutual funds are what average investors
rely on for retirement, savings for children's college education, or
other financial goals and dreams.
My legislation will bring about structural reform of mutual fund
governance and increase disclosures in order to provide useful and
relevant information to mutual fund investors. I ask unanimous consent
that a letter of support for my bill from the Consumer Federation of
America, Fund Democracy, Consumer Action, U.S. Public Interest Research
Group, and Consumers Union be printed in the Record.
There being no objection, the material was ordered to be printed in
the Record, as follows:
Consumer Federation of America, Fund Democracy, Inc.,
Consumer Action, U.S. Public Interest Research Group,
Consumers Union,
October 31, 2003.
Hon. Daniel K. Akaka,
U.S. Senate, Washington, DC.
Dear Senator Akaka: We are writing to express our
enthusiastic support for your draft legislation to increase
the transparency of mutual disclosures and enhance the
independence of fund oversight. Over the last two decades,
mutual funds have become firmly established as average
Americans' investment vehicle of choice, and investors have
for the most part benefitted greatly from the ability mutual
funds have offered even those of modest means to diversify
their portfolios and obtain professional management. However,
fund rules in some areas have not kept pace with industry
practices, and the recent scandals embroiling the mutual fund
industry have raised serious questions about the quality of
corporate governance in this industry.
Given the importance of mutual funds in the financial
portfolios of average Americans and the heavy reliance of the
least sophisticated investors on these investment vehicles,
we applaud your efforts to address key weaknesses in the
regulatory structure for mutual funds. Your proposed reforms
to improve disclosures about fund costs and strengthen the
independence of mutual fund boards, if adopted, should help
the fund industry to regain the investor trust that has been
the key to its success over the years but has been so
severely undermined by recent revelations.
1. We support requiring disclosure of broker compensation for
mutual fund transactions
The legislation would require disclosure of the
compensation brokers receive for selling funds. While funds
are currently required to disclose the existence of such
payments in fund prospectuses, the actual amount of the
broker's compensation for a particular mutual
fund transaction does not currently have to be disclosed.
This from of compensation creates a conflict of interest
between the broker, who may be inclined to recommend the
fund that offers him or her the highest compensation, and
the investor, whose interest is in obtaining the highest
quality fund at the lowest cost. By requiring timely
disclosure to investors of the actual dollar amount of
these commissions, your bill should help to increase
investors' awareness of the existence and extent of this
conflict of interest and its potential to induce their
broker to place his or her interests ahead of theirs.
Ample evidence that brokers do not always put investors'
interests first can be found in the allegations of improper
sale of fund B shares at some fund companies. In addition, a
recent Consumer Federation of America-Fund Democracy study of
excess costs paid by investors in S&P 500 Index funds found
that many of the funds with unjustifiably high expense ratios
were funds that brokers sold on commission. Since costs
subtract directly from fund performance, investors in these
funds end up paying a premium for sub-par performance. Had
these investors been made aware of the often substantial
payments their brokers received on the sale, they might have
been encouraged to look more closely at whether the fund or
share type being sold was really the best for them.
2. We support requiring improved disclosure of portfolio
transaction costs
The legislation would also require mutual funds to
disclosure in the prospectus the brokerage commissions they
pay on portfolio transactions and to include this cost in the
fund expense ratio. Portfolio transaction costs vary greatly
among funds and can be the single largest fund expense,
exceeding all other fund expenses combined. These costs are
not, however, currently included in fee information provided
in the prospectus. The only public disclosure of portfolio
transaction costs is a statement of the dollar amount of the
fund's commissions in the Statement of Additional
Information, a document never reviewed by the vast majority
of mutual fund investors.
Fuller disclosure of portfolio transaction costs would help
investors to hold fund advisers accountable for their trading
practices. It also would provide a collateral benefit in
connection with funds' soft dollar practices. Commissions
paid by funds typically pay for both execution and research
services. Since soft dollars pay for research that fund
advisers would otherwise have to pay for themselves, this
creates a significant conflict of interest for fund advisers.
Requiring brokerage commission cost disclosure would subject
these fund expenditures, including expenditures on soft
dollar services, to market forces, and in the process provide
a practical solution to the problem of regulating soft dollar
practices.
3. We support reforms to enhance the independence of mutual
fund boards.
The legislation contains a number of provisions to
strengthen the independence of fund boards. It would require
that 75 percent of board members, including the board
chairman, be independent. It would substantially strengthen
the definition of independent director by excluding
individuals who had served as directors, officers, or
employees within the past 10 years of the fund's manager,
principal underwriter, or other significant service
provider. It would delegate selection of new independent
directors exclusively to existing independent directors.
And it would establish qualification standards for board
members that must be publicly disclosed.
The recent investigation into market timing and late
trading at certain mutual funds has raised serious questions
about the quality of oversight provided by fund boards. Of
particular concern are the allegations that some Putnam fund
managers and the CEO of the Strong fund family were timing
their own funds--essentially picking the pockets of their own
shareholders to the tune of several hundred thousand dollars
in each instance. This is an unconscionable violation
[[Page S14039]]
of these fund managers' fiduciary duty to their shareholders.
It is also strong evidence of the need to end the domination
of fund boards by the fund manager. Increasing the
representation of independent members on boards, making sure
that independent members are truly independent, and ensuring
that the boards are led by independent members should go a
long way toward advancing that goal.
4. Other bill provisions would also benefit investors
The recent mutual fund scandals are not just a corporate
governance failure--though they certainly are that. They are
also a regulatory failure. The fact is that the SEC was
apparently aware of problems related to market timing for
years and had drifted along without doing anything about it.
Given the lack of clear direction from the SEC, it is hardly
surprising that fund boards failed to closely supervise the
trading practices at funds they oversaw. Your bill offers an
innovative approach to enhancing the quality of fund board
oversight. It would direct the SEC to study the benefits of
creating a Mutual Fund Oversight Board, generally modeled
after the Public Company Accounting Oversight Board, with
authority to examine and bring enforcement actions against
mutual fund boards of directors. Under this approach, the SEC
would retain responsibility for direct oversight of
investment adviser, but that responsibility would be
supplemented by the new independent agency's supervision of
fund boards. We believe this approach is well worth studying.
We also support the bill's provisions requiring disclosure
of portfolio managers' compensation and ownership of fund
shares (something that might have discouraged market timing
by fund managers), as well as its proposed GAO study of
mutual fund advertising practices and SEC study of financial
literacy. Such a study should look at innovative disclosure
methods designed to reach unsophisticated investors--those
who fail to take costs into account, for example--with
information they understand and act on.
conclusion
Recent events have provided a rude awakening to those who
have long trusted mutual funds as the one place where the
needs of average investors are generally well protected. Your
bill offers a reasonable approach--one that recognizes the
continued benefits of mutual fund investing for millions of
Americans but also recognizes that reforms are needed to
restore investor confidence in the integrity of this
industry. Please let us know what we can do to assist in its
passage.
Respectfully submitted,
Barbara Roper,
Director of Investor Protection, Consumer Federation of
America.
Mercer Bullard,
Executive Director, Fund Democracy.
Kenneth McEldowney,
Executive Director, Consumer Action.
Edmund Mierzwinski,
Consumer Program Director, U.S. Public Interest Research
Group.
Sally Greenberg,
Senior Counsel, Consumers Union.
Mr. AKAKA. I also ask unanimous consent that a letter of support for
the legislation from AARP be printed in the Record.
There being no objection, the material was ordered to be printed in
the Record, as follows:
AARP,
Washington, DC, November 4, 2003.
Hon. Daniel K. Akaka,
U.S. Senate,
Washington, DC.
Dear Senator Akaka: AARP supports your effort to improve
investor awareness of mutual fund costs, and to improve the
independent oversight and governance functions of fund boards
of directors. The legislation you have introduced, ``the
Mutual Fund Transparency Act of 2003,'' would put into effect
an overdue upgrade in investor protection for the ordinary
saver-investor. These reforms are already warranted by the
continuing evolution in market practices and the growth in
market choices. They are now more urgently required.
Mounting allegations of illegal--at best unethical--
practices by mutual fund management companies, executives and
brokers highlight the need for prompt action. We are
concerned that lay investor confidence in the mutual fund
industry not be allowed to deteriorate further--specifically
in its ability to reliably provide fairly priced benefits of
investment diversification and expert management.
With regard to initiatives designed to increase fund
transparency, we strongly support the bill's provisions to
require that: fees be disclosed in dollar amounts; fee
disclosures incorporate all fees, including portfolio
transaction costs; fee disclosures identify all distribution
expenses; and compensation paid to portfolio managers and
retail brokers be fully disclosed.
While greater transparency is essential to fair competition
among funds for investors, we believe it does not provide a
sufficient check on the cost of fund governance. Mutual funds
allow investors to share the costs of professional money
managers--who under the 1940 Investment Company Act are
called ``advisers.'' However, most funds are not established
by investors but rather are incorporated by advisory firms,
who then contractually provide research, trading, money
management and customer support services, and also have some
representation on the fund's board. The advisory firms have
their own corporate charters and are accountable to their own
boards of directors, posing--as we are seeing--a range of
potential conflicts of interest in the costs of services
provided to the fund.
We support the provisions in the proposal to strengthen the
role and independence of boards of directors, which should
reduce potential conflicts of interest. Specifically, we
support the requirement that: a super-majority (i.e., two-
thirds to three-fourths) of fund board members be
independent; the board chairman be selected from among the
independent members; and the independent directors be
responsible for establishing and disclosing the qualification
standards of independence, and for nominating and selecting
all subsequent independent board members.
We also see merit in the bill's requirements for three
separate studies of investor financial literacy, the value of
creating a mutual fund oversight board, and mutual fund
advertising.
The importance of the mutual fund market as a critical
component of the economic security of all Americans--
especially order persons--should not be underestimated.
Similar--although not identical--legislation (H.R. 2420) is
pending before the House financial Services Committee. We
look forward to working with you and with the other members
of the Senate to enact this measured and important piece of
investor protection legislation. Please feel free to contact
me, or have your staff call Roy Green of our Federal Affair
staff at (202) 434-3800, if you have any questions about our
views.
Sincerely,
David Certner,
Director, Federal Affairs.
Mr. AKAKA. Mr. President, recent revelations of widespread market-
timing and late-trading abuses demonstrate the failures of mutual fund
boards of directors to fulfill their fiduciary obligations to
shareholders. The activities of Canary Capital Partners and Putnam
Investments are two deeply troubling examples. However, it is likely
that the trading abuses are much more routine. At our hearing, Mr.
Stephen Cutler, Director, Division of Enforcement, Securities and
Exchange Commission, SEC, testified that preliminary results of an SEC
survey show that about ``50 percent of responding fund groups appear to
have one or more arrangements with certain shareholders that allow
these shareholders to engage in market timing.'' This statistic is just
one example of mutual funds having different sets of rules for large
and small investors. These differing rules allow the larger investors
to profit at the expense of average, ordinary investors who are working
toward their long-term financial goals.
The abuses that have been brought to our attention make it clear that
the boards of mutual fund companies are not providing sufficient
oversight. To be more effective, the boards must be strengthened and
more independent. Investment company boards should be required to have
an independent chairman, and independent directors must have a dominant
presence on the board. My bill strengthens the definition of who is
considered to be an independent director. It also requires that mutual
fund company boards have 75 percent of their members considered to be
independent. To be considered independent, shareholders would have to
approve them. My legislation also prohibits the board from making
decisions that require a vote of a non-independent director. In
addition, a committee of independent members would be responsible for
nominating members and adopting qualification standards for board
membership. These steps are necessary to add much needed protections to
strengthen the ability of mutual fund boards to detect and prevent
abuses of the trust of shareholders.
In addition, this bill requires the SEC to develop rules to disclose
the compensation of individuals employed by the investment advisor of
the company to manage the portfolio of the company and their ownership
interest in the company. Consumers deserve to know relevant information
about the portfolio manager's incentives and whether they are properly
aligned with those of their shareholders. Again, I am referring to
ordinary American families patiently working toward their long-term
financial goals.
[[Page S14040]]
The strengthening of boards to protect shareholders is only one
important aspect of my bill. My bill will also increase the
transparency of often complex financial relationships between brokers
and mutual funds in ways that are meaningful and easy to understand for
investors.
Shelf-space payments and revenue-sharing agreements between mutual
fund companies and brokers present conflicts of interest that must be
addressed. Brokers also compile preferred lists which highlight certain
funds, which typically generate more investment than those left off the
list. It is not clear to investors that the mutual fund company also
may pay a percentage of sales and/or an annual fee on the fund assets
held by the broker to obtain a place on the preferred list or to have
their shares sold by the broker.
Shelf-space and revenue sharing agreements present risk to investors.
Brokers have conflicts of interest, some of which are unavoidable, but
these need to be disclosed to investors. Without such disclosure,
investors cannot make informed financial decisions. Investors may
believe that brokers are recommending funds based on the expectation
for solid returns or low volatility, but the broker's recommendation
may be influenced by hidden payments.
The SEC has exempted mutual funds from Rule 10b-10, which requires
that confirmation notices of securities transactions be sent to
customers to indicate how the broker was compensated in the trade.
Mutual funds should be subject to this confirmation notice requirement.
My legislation will require brokers to disclose in writing, to those
who purchase mutual fund company shares, the amount of compensation the
broker will receive due to the transaction, instead of simply providing
a prospectus. The prospectus fails to include the detailed relevant
information that investors need to make informed decisions. Mutual fund
investors deserve to know how their broker is being paid.
My bill also will inject a measure of reality into the expenses of
mutual funds. In order to increase the transparency of the actual costs
of the fund, brokerage commissions must be counted as an expense in
filings with the SEC and included in the calculation of the expense
ratio, so that investors will have a more realistic view of the
expenses of their fund. Consumers often compare the expense ratios of
funds when making investment decisions. However, the expense ratios
fail to take into account the costs of commissions in the purchase and
sale of securities. Therefore, investors are not provided with an
accurate idea of the expenses involved. Currently, brokerage
commissions have to be disclosed to the SEC, but not to individual
investors. Brokerage commissions are only disclosed to the investor
upon request. My bill puts teeth into brokerage commission disclosure
provisions and ensures that commissions will be included in a document
that investors actually have access to and utilize.
This bill also creates a powerful incentive to reduce the use of soft
dollars. Soft dollars refer to the bundling of services or products
into commissions. Mutual fund companies often pay higher commissions in
order to obtain other products and services, typically research on
stocks. Soft dollars can be used to lower their expenses by having
services and products paid for by soft dollars. Purchases using soft
dollars do not count as expenses and are not calculated into the
expense ratio. The SEC released a study in September 1998 concluding
that soft dollars were used to pay for research, salaries, office rent,
telephone services, legal expenses, and entertainment, among other
expenses.
At the hearing, Secretary Galvin called for a prohibition of soft
dollars. This is a recommendation that needs to be examined. However,
my bill provides an immediate alternative, which is to provide an
incentive for funds to limit their use of soft dollars by calculating
them as expenses. If commissions are disclosed in this manner, the use
of soft dollars will be reflected in the higher commission fees and
overall expenses. This will make it easier for investors to see the
true cost of the fund and compare the expense ratios of funds.
Some may argue that this gives an incomplete picture and fails to
account for spreads, market impact, and opportunity costs. However, the
SEC has the authority to address the issue further if it can determine
an effective way to quantify these additional factors. This bill does
not impose an additional reporting requirement that would be burdensome
to brokers. It merely uses what is already reported and presents this
information in a manner meaningful to investors.
My legislation also directs the SEC to conduct a study to assess
financial literacy among mutual fund investors. The SEC will identify
the most useful and relevant information that investors need prior to
purchasing shares, methods to increase the transparency of expenses and
potential conflicts of interest in mutual fund transactions, and a
strategy to increase the financial literacy of investors that results
in positive change in investor behavior. None of our disclosure
provisions will truly work unless investors are effectively given the
tools they need to make smart investment decisions.
Finally, my bill requires the General Accounting Office, GAO, to
study the current marketing practices for the sale of shares of mutual
funds. GAO will provide recommendations to improve investor protections
in mutual fund advertising to ensure that investors are able make
informed financial decisions when purchasing shares.
Public confidence in mutual funds will not recover if funds continue
to employ different sets of rules for large and small investors, engage
in ethical misconduct, and enrich themselves at the expense of
shareholders. The transgressions brought to light underscore the
absence of effective oversight by the boards of mutual funds companies.
This legislation will strengthen board independence and enhance the
transparency of financial relationships. The American investing public
deserves nothing less.
Mr. President, I look forward to working with my colleagues in
enacting meaningful reform of the troubled mutual fund industry. We
must act to restore trust in this critical investment vehicle that
people rely on for their financial future and goals. I ask unanimous
consent that the text of the Mutual Fund Transparency Act of 2003 be
printed in the Record.
There being no objection, the bill was ordered to be printed in the
Record, as follows:
S. 1822
Be it enacted by the Senate and House of Representatives of
the United States of America in Congress assembled,
SECTION 1. SHORT TITLE.
This Act may be cited as the ``Mutual Fund Transparency Act
of 2003''.
SEC. 2. DISCLOSURE OF FINANCIAL RELATIONSHIPS BETWEEN BROKERS
AND MUTUAL FUND COMPANIES.
(a) In General.--Section 15(b) of the Securities Exchange
Act of 1934 (15 U.S.C. 78o(b)) is amended by adding at the
end the following:
``(11) Confirmation of transactions for mutual funds.--
``(A) In general.--Each broker shall disclose in writing to
customers that purchase the shares of an open-end company
registered under section 8 of the Investment Company Act of
1940 (15 U.S.C. 80a-8)--
``(i) the amount of any compensation received or to be
received by the broker in connection with such transaction
from any sources; and
``(ii) such other information as the Commission determines
appropriate.
``(B) Timing of disclosure.--The disclosure required under
subparagraph (A) shall be made to a customer not later than
as of the date of the completion of the transaction.
``(C) Limitation.--The disclosures required under
subparagraph (A) may not be made exclusively in--
``(i) a registration statement or prospectus of an open-end
company; or
``(ii) any other filing of an open-end company with the
Commission.
``(D) Commission authority.--
``(i) In general.--The Commission shall promulgate such
rules as are necessary to carry out this paragraph not later
than 1 year after the date of enactment of the Mutual Fund
Transparency Act of 2003.
``(ii) Form of disclosure.--Disclosures under this
paragraph shall be in such form as the Commission, by rule,
shall require.
``(E) Definition.--In this paragraph, the term `open-end
company' has the same meaning as in section 5 of the
Investment Company Act of 1940 (15 U.S.C. 80a-5).''.
(b) Disclosure of Brokerage Commissions.--Section 30 of the
Investment Company Act of 1940 (15 U.S.C. 80a-29) is amended
by adding at the end the following:
[[Page S14041]]
``(k) Disclosure of Brokerage Commissions.--The Commission,
by rule, shall require that brokerage commissions as an
aggregate dollar amount and percentage of assets paid by an
open-end company be included in any disclosure of the amount
of fees and expenses that may be payable by the holder of the
securities of such company for purposes of--
``(1) the registration statement of that open-end company;
and
``(2) any other filing of that open-end company with the
Commission, including the calculation of expense ratios.''.
SEC. 3. MUTUAL FUND GOVERNANCE.
(a) Independent Fund Boards.--Section 10(a) of the
Investment Company Act of 1940 (15 U.S.C. 80a-10(a)) is
amended--
(1) by striking ``shall have'' and inserting the following:
``shall--
``(1) have'';
(2) by striking ``60 per centum'' and inserting ``25
percent'';
(3) by striking the period at the end and inserting a
semicolon; and
(4) by adding at the end the following:
``(2) have as chairman of its board of directors an
interested person of such registered company; or
``(3) have as a member of its board of directors any person
that is an interested person of such registered investment
company--
``(A) who has served without being approved or elected by
the shareholders of such registered investment company at
least once every 5 years; and
``(B) unless such director has been found, on an annual
basis, by a majority of the directors who are not interested
persons, after reasonable inquiry by such directors, not to
have any material business or familial relationship with the
registered investment company, a significant service provider
to the company, or any entity controlling, controlled by, or
under common control with such service provider, that is
likely to impair the independence of the director.''.
(b) Action by Independent Directors.--Section 10 of the
Investment Company Act of 1940 (15 U.S.C. 80a-10) is amended
by adding at the end the following:
``(i) Action by Board of Directors.--No action taken by the
board of directors of a registered investment company may
require the vote of a director who is an interested person of
such registered investment company.
``(j) Independent Committee.--
``(1) In general.--The members of the board of directors of
a registered investment company who are not interested
persons of such registered investment company shall establish
a committee comprised solely of such members, which committee
shall be responsible for--
``(A) selecting persons to be nominated for election to the
board of directors; and
``(B) adopting qualification standards for the nomination
of directors.
``(2) Disclosure.--The standards developed under paragraph
(1)(B) shall be disclosed in the registration statement of
the registered investment company.''.
(c) Definition of Interested Person.--Section 2(a)(19) of
the Investment Company Act of 1940 (15 U.S.C. 80a-2) is
amended--
(1) in subparagraph (A)--
(A) in clause (iv), by striking ``two'' and inserting
``5''; and
(B) by striking clause (vii) and inserting the following:
``(vii) any natural person who has served as an officer or
director, or as an employee within the preceding 10 fiscal
years, of an investment adviser or principal underwriter to
such registered investment company, or of any entity
controlling, controlled by, or under common control with such
investment adviser or principal underwriter;
``(viii) any natural person who has served as an officer or
director, or as an employee within the preceding 10 fiscal
years, of any entity that has within the preceding 5 fiscal
years acted as a significant service provider to such
registered investment company, or of any entity controlling,
controlled by, or under the common control with such service
provider;
``(ix) any natural person who is a member of a class of
persons that the Commission, by rule or regulation,
determines is unlikely to exercise an appropriate degree of
independence as a result of--
``(I) a material business relationship with the investment
company or an affiliated person of such investment company;
``(II) a close familial relationship with any natural
person who is an affiliated person of such investment
company; or
``(III) any other reason determined by the Commission.'';
(2) in subparagraph (B)--
(A) in clause (iv), by striking ``two'' and inserting
``5''; and
(B) by striking clause (vii) and inserting the following:
``(vii) any natural person who is a member of a class of
persons that the Commission, by rule or regulation,
determines is unlikely to exercise an appropriate degree of
independence as a result of--
``(I) a material business relationship with such investment
adviser or principal underwriter or affiliated person of such
investment adviser or principal underwriter;
``(II) a close familial relationship with any natural
person who is an affiliated person of such investment adviser
or principal underwriter; or
``(III) any other reason as determined by the
Commission.''.
(d) Definition of Significant Service Provider.--Section
2(a) of the Investment Company Act of 1940 is amended by
adding at the end the following:
``(53) Significant service provider.--
``(A) In general.--Not later than 270 days after the date
of enactment of the Mutual Fund Transparency Act of 2003, the
Securities and Exchange Commission shall issue final rules
defining the term `significant service provider'.
``(B) Requirements.--The definition developed under
paragraph (1) shall include, at a minimum, the investment
adviser and principal underwriter of a registered investment
company for purposes of paragraph (19).''.
(e) Study.--
(1) In general.--The Securities and Exchange Commission
shall conduct a study to determine whether the best interests
of investors in mutual funds would be served by the creation
of a Mutual Fund Oversight Board that--
(A) has inspection, examination, and enforcement authority
over mutual fund boards of directors;
(B) is funded by assessments against mutual fund assets;
(C) the members of which are selected by the Securities and
Exchange Commission; and
(D) has rulemaking authority.
(2) Report.--Not later than 1 year after the date of
enactment of this Act, the Securities and Exchange Commission
shall submit a report on the study required under paragraph
(1) to--
(A) the Committee on Banking, Housing, and Urban Affairs of
the Senate; and
(B) the Committee on Financial Services of the House of
Representatives.
SEC. 4. PORTFOLIO MANAGER COMPENSATION.
Not later than 270 days after the date of enactment of this
Act, the Securities and Exchange Commission shall prescribe
rules under the Investment Company Act of 1940, requiring
that a registered investment company disclose the structure
of, or method used to determine, the compensation of--
(1) individuals employed by the investment adviser of the
company to manage the portfolio of the company; and
(2) the ownership interest of such individuals in the
securities of the registered investment company.
SEC. 5. FINANCIAL LITERACY AMONG MUTUAL FUND INVESTORS STUDY.
(a) In General.--The Securities and Exchange Commission
shall conduct a study to identify--
(1) the existing level of financial literacy among
investors that purchase shares of open-end companies, as such
term is defined under section 5 of the Investment Company Act
of 1940, that are registered under section 8 of such Act;
(2) the most useful and understandable relevant information
that investors need to make sound financial decisions prior
to purchasing such shares;
(3) methods to increase the transparency of expenses and
potential conflicts of interest in transactions involving the
shares of open-end companies;
(4) the existing private and public efforts to educate
investors; and
(5) a strategy to increase the financial literacy of
investors that results in a positive change in investor
behavior.
(b) Report.--Not later than 1 year after the date of
enactment of this Act, the Securities and Exchange Commission
shall submit a report on the study required under subsection
(a) to--
(1) the Committee on Banking, Housing, and Urban Affairs of
the Senate; and
(2) the Committee on Financial Services of the House of
Representatives.
SEC. 6. STUDY REGARDING MUTUAL FUND ADVERTISING.
(a) In General.--The Comptroller General of the United
States shall conduct a study on mutual fund advertising to
identify--
(1) existing and proposed regulatory requirements for open-
end investment company advertisements;
(2) current marketing practices for the sale of open-end
investment company shares, including the use of unsustainable
past performance data, funds that have merged, and incubator
funds;
(3) the impact of such advertising on consumers;
(4) recommendations to improve investor protections in
mutual fund advertising and additional information necessary
to ensure that investors can make informed financial
decisions when purchasing shares.
(b) Report.--Not later than 1 year after the date of
enactment of this Act, the Comptroller General of the United
States shall submit a report on the results of the study
conducted under subsection (a) to--
(1) the Committee on Banking, Housing, and Urban Affairs of
the United States Senate; and
(2) the Committee on Financial Services of the House of
Representatives.
Mr. LIEBERMAN. Mr. President, I rise today to join with my colleagues
Senator Daniel Akaka and Senator Peter Fitzgerald and cosponsor
legislation that would begin the crucial process of reforming the
mutual fund industry. In the wake of shocking revelations of abusive
trading and self-dealing in some of America's largest funds, it is
imperative that we act quickly, and I commend my friend Senator Akaka
for his leadership. We must
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do two things in order to reassure the 95 million Americans who invest
in mutual funds that they have not misplaced their trust. We must find
out how this was allowed to happen, and we must put safeguards in place
to prevent these widespread abuses from poisoning our markets again.
As the deceptions and conflicts of the Wall Street analysts were
uncovered last year in the wake of the Enron scandal, the oft-heard
advice to the average investor was to invest in mutual funds. Investors
took this advice in droves. Half of all American households own shares
in mutual funds, and of the $7 trillion invested in mutual funds, $2.1
trillion of it is invested for retirement.
Perhaps these working families felt comfortable entrusting their
precious savings with mutual funds because these funds offer one of the
most highly regulated investments available. Mutual funds, their
directors and their managers owe their investors a statutory fiduciary
duty. Mutual funds are overseen by the SEC through a prescribed
registration and reporting process as well as a regular examination and
audit process, pursuant to the Investment Company Act of 1940.
Unfortunately, the trust of these American families has been abused.
According to a just-released survey conducted by the Securities and
Exchange Commission, half of the largest 88 mutual funds have permitted
a practice called ``market-timing,'' which allows some investors to
trade quickly in and out of the funds, even though many of those funds
had explicit policies against such trading because of its detrimental
impact on other investors in the fund. Many fund companies admitted
providing portfolio information, unavailable publicly, to certain large
investors to help them make trading decisions. Also, a full one-quarter
of the brokerage firms surveyed indicated that they had allowed certain
customers to engage in late-trading, an illegal practice that allows
favored investors to execute trades based on that day's price, but
after the market close, when new information has come to light. Perhaps
most shocking, Stephen Cutler, Director of the SEC's Enforcement
Division, has said that there is evidence that officials at fund
companies profited personally at the expense of their customers by
market-timing their own funds.
The SEC didn't discover these abuses on its own initiative, however.
It acted only after the New York State Attorney General and the
Massachusetts Secretary of the Commonwealth took steps to investigate
and stop this conduct. The SEC didn't discover the abuses through the
extensive reporting process mutual funds go through; the SEC didn't
discover the abuses through the broad and regular examinations the SEC
does of these mutual funds; the SEC didn't even discover the abuses
after it received a tip from an insider, who went to the SEC with his
attorney, evidence in hand.
Yesterday, I sent a ten-page letter to SEC Chairman William
Donaldson, demanding to know how the SEC could have failed to uncover
such a sweeping problem in the mutual fund industry. I asked how the
SEC planned to change its practices in order to ensure that it is never
again caught so unaware. Congress gave the SEC the responsibility to
monitor the mutual fund industry, and we must ensure that the SEC does
its job.
This is not the first time the SEC has been caught off guard with a
scandal on Wall Street. In October 2002, the staff of the Senate
Governmental Affairs Committee, of which I was then the Chairman,
released a report, Financial Oversight of Enron: The SEC and Private-
Sector Watchdogs, detailing the ignored red flags and the missed
opportunities that kept the SEC from detecting the problems at Enron
before that company collapsed, taking with it the jobs and retirement
savings of thousands of Americans. Again, despite being fully aware of
the troubling conflicts faced by Wall Street analysts, the SEC turned a
blind eye to that problem until this Committee and others held hearings
on the issue and New York State Attorney General Eliot Spitzer exposed
how deeply deceptive many analyst recommendations truly were. I hope
this mutual fund scandal represents the last time the SEC is playing
regulatory catch-up.
In addition to holding the SEC accountable, Congress must also act to
protect investors by fixing the holes in the statutory scheme for
mutual funds. That's why I'm pleased to cosponsor the Mutual Fund
Transparency Act of 2003, which enjoys widespread support from consumer
groups. It contains many of the policy changes I urged the SEC to
consider in my letter to Chairman Donaldson. It would strengthen the
independence of mutual fund boards of directors by tightening the
definition of independence and by requiring that 75 percent of the
directors be independent. The bill would also require that mutual fund
boards have nominating committees comprised solely of independent
directors, so that directors are not chosen by management.
In my letter to the SEC, I also criticized the opaque or, in some
cases, lack of, disclosure to investors about mutual fund fees. The
Mutual Fund Transparency Act would significantly improve such
disclosure to investors, by including in the fees disclosed to
investors the costs the fund incurs when it executes trades of its
holdings. Currently, such costs are not included among these more
visible fees, which are disclosed in documents provided directly to
mutual fund shareholders. Trading costs are currently only disclosed in
filings with the SEC, but if this bill became law, trading costs would
be included among the fees provided directly to investors. Such
information is useful because it can give investors a sense of how
often their funds are buying and selling assets and at what expense.
The bill would also require funds to tell shareholders how fund
advisers are compensated. Public companies are required to tell their
shareholders how their managers are paid; mutual fund shareholders
should have the same information. Finally, the bill would require that
brokers offering mutual funds to investors inform those investors of
any fees or incentives those brokers are receiving for making those
sales in a sale confirmation.
The bill also mandates that the SEC study three initiatives to
improve mutual fund oversight and transparency. The first two ask the
SEC and the Comptroller General, respectively, to look at financial
literacy among mutual fund investors and at mutual fund advertising, to
determine how relevant information can be made clearer and more readily
understandable to the average investor. In my letter to the SEC, I
suggested the agency consider using consumer research methods in order
to achieve such a result. The third study required by the bill relates
to the formation of a Mutual Fund Oversight Board to take over the
frontline efforts of mutual fund regulation from the SEC, while
remaining under that agency's oversight. This may be a good approach,
but I have concerns about the costs of such a board being borne by
mutual fund investors, which is one of the areas suggested for study. I
hope other options would be explored.
The Mutual Fund Transparency Act is clearly an important first step
in closing some of the gaps in the laws governing these important
investment vehicles. But there is more work to do, and I look forward
to working with Senator Akaka and the other cosponsors of this bill in
making further necessary improvements. For example, we should consider
strengthening the fiduciary duties owed by mutual fund directors and
managers to their shareholders. In addition, as I indicated in my
letter to the SEC, guidelines must be developed to prevent mutual fund
directors from serving on more boards of funds than they can
effectively oversee; at some of the major funds, directors serve on a
hundred or more boards. Compliance officers at the funds must be
elevated to emphasize their role. I suggested in my letter to the SEC
that such a compliance officer should be active at each fund and should
report directly to an independent committee of the board.
Moreover, as I pointed out to the SEC in my letter to Chairman
Donaldson, we must close the loophole that allowed so many brokers and
mutual funds to circumvent the law on late trading. Imposing a hard
deadline of a time at which trades must be into the mutual fund may be
the solution to this problem. We also must provide even more, clearer
information to investors about the fees they are actually paying to
participate in mutual funds. In my letter the SEC, I asked
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the agency why investors should not receive on their monthly statements
detail about the fees they actually paid to the fund during that time
period, similar to the finance charge information that credit card
consumers get. I also suggested that funds be required to provide
comparative fee information. This would help people make better
investment decisions, and might also encourage more competition among
funds to reduce expenses.
Mutual funds hold the nest eggs, the retirement savings, and the
college funds for many of America's working families. Through those
investments in their own futures, those families are also feeding
capital into today's economy, fueling the engine that creates and
maintains American jobs. In a very real sense, these mutual fund
investments are investments in the American dream. We must act now to
protect them, and to restore the integrity to the mutual fund industry.
Once again, I thank Senator Akaka for his leadership on this issue,
and I urge my colleagues to support this important and timely
legislation.
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