[Congressional Record Volume 150, Number 76 (Thursday, June 3, 2004)]
[Senate]
[Pages S6452-S6455]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LIEBERMAN:
  S. 2497. A bill to amend the securities laws to provide for enhanced 
mutual fund investor protections, and for other purposes; to the 
Committee on Banking, Housing, and Urban Affairs.
  Mr. LIEBERMAN. Mr. President, today I am introducing legislation that

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would bring needed changes to our financial markets so that the 
interests of America's small individual investors are protected and 
defended.
  The recent revelations about unethical and illegal practices in the 
mutual fund industry have been deeply disturbing--to me and to ordinary 
investors throughout the country. In November 2003, the Governmental 
Affairs Committee's Subcommittee on Financial Management, the Budget, 
and International Security heard testimony from the Director of the 
Securities and Exchange Commission's (SEC's) Enforcement Division about 
a survey of fund practices that the SEC had just completed. The survey 
found that half of the largest 88 mutual funds had 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. The survey also found that a full one-
quarter of the brokerage firms it looked at 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 after the market had closed, when new information had come 
to light. Perhaps most shocking, the survey found that, in some cases, 
fund company officials profited personally at the expense of their 
customers by market-timing their own funds. In a later hearing, we 
learned about the problem of excessive fees at some funds and the fact 
that such fees may not be prominently disclosed to investors or, as is 
the case with some types of fees, not disclosed at all.
  These concerns are of particular importance because, in a very real 
sense, mutual fund investments are investments in the American dream. 
They hold the nest eggs, the retirement savings, and the college funds 
for millions of America's working families. But they also feed capital 
into today's economy, fueling the engine that creates and maintains 
American jobs. Mutual funds are where so many Americans put their 
money: 95 million people, at last count, own shares in these funds. 
Indeed, in the wake of the Enron scandal, when investigators uncovered 
widespread deceptions and conflicts of Wall Street stock analysts, 
conventional wisdom said average investors would find safe haven in 
mutual funds rather than in individual stocks. It is therefore 
particularly--and--ironically disheartening to see the scandals and 
breaches of trust that have now afflicted the mutual fund industry.
  The recent revelations about mutual funds, however, provides us with 
the opportunity and the responsibility to accomplish real, structural 
reform in the fund industry. That is why I have joined with Senator 
Akaka and Senator Fitzgerald in introducing S. 1822, the Mutual Fund 
Transparency Act, and why I have also joined Senators Corzine and Dodd 
in introducing S. 1971, the Mutual Fund Investor Confidence Restoration 
Act. Both of these bills take on many of the significant mutual fund 
problems that have come to light in recent months. Together, they bar 
late trading and discourage market timing; reform mutual fund 
governance rules to require that the chairman and 75 percent of board 
members of mutual fund companies be independent and strengthen the 
definition of independent; require far more extensive disclosure of 
fund fees and expenses; and work to increase financial literacy.
  But beyond these important, basic reforms, we need to craft new 
approaches that address the changing nature of this country's investor 
class. In the last two decades, a near-revolutionary expansion in the 
number of people participating in the financial markets has occurred. 
Since 1980, we've seen the share of U.S. households owning mutual funds 
soar from less than 6 percent to nearly 50 percent in 2002. The number 
of families owning stocks, directly or indirectly through funds, has 
increased 60 percent in the last fifteen years and, as of 2001, 
exceeded half of all families. Along with this phenomenon, and 
contributing to it, we've seen individuals increasingly taking 
responsibility for investing their own retirement money--a 
responsibility that was once entrusted to professionals . It used to be 
that employees were typically enrolled in so-called ``defined benefit'' 
pension plans that guaranteed them certain income and for which the 
employer took responsibility for investing the money properly. Now 
individuals are more frequently given responsibility for investing 
their retirement savings themselves through 401(k) plans. In fact, 
since 1983, the number of defined-benefit plans has declined over 70 
percent, while participation in 401(k) plans has been increasing. 
Forty-eight million Americans now have 401(k) plans.
  Neither changes in the law, nor changes by federal regulators, 
however, have kept pace with the increasing participation and the 
increasing responsibilities of small investors. When the Investment 
Company Act was enacted in 1940, it brought sweeping changes, and, for 
the first time, Federal regulation, to the fund industry, which had 
been fraught with fraud and abuse in the 1920's. The 1940 Act and the 
other securities laws passed in the wake of the 1929 stock market crash 
were instrumental in restoring investor confidence and in establishing 
the basic disclosure regime that continues to undergird securities 
regulation today. But the 1940 Act remains much as it was when it was 
enacted, and disclosure requirements that once appeared radical now 
often result in forms of technical compliance that little serve average 
investors who have neither the time nor guidance to find their way 
through the verbiage of fund disclosures. Nor has the SEC, created in 
the same era and charged with protecting investors, adequately kept up 
with the shifting makeup and needs of contemporary investors. To its 
credit, the SEC in recent months has made a number of changes and 
proposals specifically to address the problems uncovered in the mutual 
fund industry, and in the 1990's it undertook a serious effort to 
ensure that more securities documents were written in ``plain 
English.'' The Commission, however, has not accomplished the more 
fundamental reorientation that I believe is called for--and that indeed 
I did call for in the aftermath of the Enron scandal--to an agency that 
does not merely regulate and punish the securities industry but 
affirmatively and proactively seeks ways to assist and protect ordinary 
investors.
  The Small Investor Protection Act that I am introducing today would 
bring about these needed changes by ensuring that the SEC is more 
routinely attuned to the needs of average investors. In doing so, this 
bill serves as an important complement to, though surely not a 
replacement for, the other mutual fund reform legislation I have 
cosponsored. And I am pleased that the bill has the support of the 
Consumer Federation of America, Fund Democracy, Inc., Public Citizen's 
Congress Watch, Consumer Action and Consumers Union.
  To accomplish the goal of better protecting small investors, the bill 
would take the following four steps:
  1. Create a Division of the Investor. Too often in recent years, the 
interests of ordinary investors have not seemed to be the driving force 
behind the Commission's regulatory actions. Wall Street's 
representatives regularly meet with Commission staff to comment on each 
new Commission proposal but the voice of the small investor has been 
harder to hear. To ensure that the voices of small investors are heard, 
my bill would create a separate division within the Commission--coequal 
with the other four major divisions at the SEC--to provide for a 
permanent and institutionalized advocate for the interests of ordinary 
investors. The Division of the Investor would be responsible for such 
things as providing the small investor's perspective on new rule and 
policy proposals, identifying new issues of particular concern to small 
investors, and serving as a conduit for the concerns of outside 
advocates for small investors.
  2. Establish an Office of Risk Assessment. As part of the 
Governmental Affairs Committee's investigation into the Enron scandal, 
former Senator Thompson and I released a bipartisan staff report 
concluding, among other things, that the SEC needed to move away from 
simply reacting to cases of financial fraud to actively rooting out 
fraud. In other words, the SEC needed to ``reconceptualize its role as 
a more proactive force in protecting the marketplace against financial 
fraud.'' This conclusion has only been reinforced by

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the fact that the recent and widespread problems in the mutual fund 
industry were apparently not identified by the Commission but were 
uncovered by others. I am therefore very encouraged that Chairman 
Donaldson has announced the creation of an Office of Risk Assessment to 
gather and analyze data on new trends and risks and identify new areas 
of concern for the Commission. This effort, in my view, is critical to 
protecting small investors because it will increase the likelihood that 
practices detrimental to small investors will be proactively identified 
and addressed before they reach scandalous proportions. To ensure the 
SEC continues to pursue this important function, my bill would provide 
formal legislative recognition to the Office of Risk Assessment and 
institutionalize its responsibilities.
  3. Require Consumer Research to Gauge Whether Disclosures are Easily 
Understood by Consumers. The disclosure of information to investors is 
fundamental to securities regulation in the U.S. With respect to mutual 
funds, for instance, the SEC requires a wide array of disclosures to be 
made in prospectuses, annual reports to shareholders, advertising, and 
in other media. None of these disclosures, however, is likely to serve 
its intended purpose if ordinary investors can't understand them. There 
is little empirical evidence on whether investors do in fact understand 
the disclosures being made. Although the SEC has from time-to-time 
engaged in consumer research, such as surveys, focus groups, etc., it 
does not routinely or systematically test its proposed disclosures to 
determine if they are likely to be understood by ordinary investors. My 
bill would change that by requiring that the Commission consider 
empirical consumer research to determine whether a proposed 
disclosure--including its wording, format, and the context in which it 
appears--is likely to improve the understanding of ordinary investors.
  4. Require Investment Companies to Provide Brief, Easy-to-Understand 
Disclosures of Mutual Fund Characteristics. All too often, the 
important details of a mutual fund purchase are lost among the pages 
and pages an investor receives from his or her investment company. That 
is why the Small Investor Protection Act would also require investment 
companies to provide purchasers with a brief summary that will clearly 
and succinctly outline the relevant characteristics of a mutual fund. 
Ideally, this summary would be on a single page, and it could not 
exceed four pages; it would include information such as expenses and 
risks associated with the fund, as well as the degree to which the fund 
is diversified. By providing this information in an easy-to-understand 
format, the Act would help investors make decisions about which funds 
are best suited to their particular needs and financial goals.
  If enacted, these proposals, taken as a whole, would go a long way 
towards reorienting the regulation of our financial markets to better 
address the needs of the small investors who have become such an 
integral part of our economy and for whom investments in the market 
have become such a large part of their economic security. These 
proposals would ensure that the concerns of ordinary investors receive 
as much prominence in regulatory decisions as the concerns of Wall 
Street giants, that average investors receive relevant information in a 
form they can understand, and that they are better protected from 
existing conflicts of interest.
  In short, this legislation would help level the playing field for 
small investors. That is something that we need to do to restore 
confidence to our financial markets, which have been damaged by more 
than two years of scandals, and that we must do because it is the right 
thing for the millions of Americans who are saving and investing to 
provide a better future for themselves and their children. They deserve 
nothing less.
  I ask unanimous consent that a letter in support of this legislation 
from Consumer Federation of America, Fund Democracy, Inc., Public 
Citizen's Congress Watch, Consumer Action and Consumers Union be 
printed in the Record.
  There being no objection, the letter was ordered to be printed in the 
Record, as follows:

         Consumer Federation of America, Fund Democracy, Inc., 
           Public Citizen's Congress Watch, Consumer Action, 
           Consumers Union,
                                                     May 18, 2004.
     Hon. Joseph I. Lieberman,
     U.S. Senate, Washington, DC.
       Dear Senator Lieberman: We are writing on behalf of 
     Consumer Federation of America, Fund Democracy, Public 
     Citizen, Consumer Action, and Consumers Union, to express our 
     strong support for your draft bill to give greater prominence 
     to the concerns of individual investors, particularly small 
     investors, in the policy and rulemaking of the Securities and 
     Exchange Commission.
       The last several decades have seen a dramatic expansion of 
     the investor class. Many of these new investors are middle 
     class workers with little financial sophistication and less 
     experience with the securities markets. The major laws that 
     govern our markets were not written with these investors in 
     mind. Although the laws have been continually updated and 
     revised to address changing market conditions, individual 
     investors often find it difficult to have their voices heard 
     during those policy debates.
       The recent mutual fund reform efforts offer a number of 
     examples of how policies are often developed with little 
     apparent thought to the needs of average, unsophisticated 
     investors. One such example involves the Securities and 
     Exchange Commission's efforts to improve mutual fund cost 
     disclosure. Among other reforms they advocated, investor 
     advocates argued in favor of individualized cost disclosure 
     on mutual fund account statements on the grounds that this 
     was the place where the disclosures were most likely to be 
     seen by average investors and their impact understood. The 
     SEC quickly rejected that approach, however, echoing industry 
     arguments that the disclosures would be too costly.
       In reaching its conclusion, the Commission gave little 
     apparent consideration to how the account statement 
     disclosures might be provided. In fact, one mutual fund 
     company, MFS, has since announced that it has found an 
     economical way to do so. This suggests that, had the SEC not 
     been so quick to dismiss the views of investor advocates, it 
     might have been equally successful in finding a cost-
     effective way to provide account statement cost disclosures. 
     Instead, the Commission opted for new hypothetical 
     disclosures in annual and semi-annual reports. Again, despite 
     serious questions raised by investor advocates, the 
     Commission appears to have made no effort to determine 
     whether their alternative approach would be effective in 
     reaching the unsophisticated investors who are not well 
     served by the current disclosure system.
       Your legislation would help to rectify this situation 
     through several means. First, it would create an office with 
     a formally recognized role representing the interests of 
     individual investors, and small investors in particular, in 
     identifying areas of concern or where additional protections 
     are needed, analyzing rule proposals, and serving as a 
     liaison between investor organizations and the Commission. In 
     particular, the provision requiring that the views of the 
     Director of the Division of the Investor be included, in 
     summary form, in all rule proposals should help to give real 
     clout to this office as those rule proposals are being 
     developed.
       We also support the requirement that the Commission 
     consider content, format, and placement when developing new 
     disclosure proposals to ensure that they are likely to be 
     effective. Too often, disclosures investors receive read as 
     though they had been written by lawyers to communicate with 
     other lawyers. Your legislation should help to ensure that 
     new disclosures are written with an eye toward how to convey 
     information effectively to average investors. We would like 
     to see this provision expanded, to require a review over 
     several years of all existing disclosures in light of the 
     same considerations.
       The bill's specific requirement for pre-sale disclosure 
     covering key information about mutual funds would also 
     benefit investors by giving them the bare minimum information 
     they need to make an informed decision, at a time when it is 
     useful to them in making their purchase decision, and in a 
     form they are able to understand. Investor advocates have 
     long advocated such an approach, and our organizations have 
     recently reiterated our support for simplified pre-sale 
     disclosure as part of a comprehensive mutual fund reform 
     agenda.
       Finally, our organizations have applauded Chairman 
     Donaldson for his publicly stated commitment to improving the 
     Commission's risk assessment practices. Your legislation 
     supports that goal by codifying it. This will help to ensure 
     that this important initiative does not get left by the 
     wayside once new leadership, with new priorities, takes over 
     the agency.
       Small investors play a crucial role in our markets. They 
     should be given equally prominent consideration in the 
     policies that govern those markets. Your legislation would 
     help to bring that about. We look forward to working with you 
     to win its passage.
           Respectfully submitted,
     Barbara Roper,
       Director of Investor Protection.
     Travis Plunkett,
       Legislative Director Consumer Federation of America.

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     Frank Clemente,
       Director Public Citizen's Congress Watch.
     Sally Greenberg,
       Senior Counsel Consumers Union.
     Mercer Bullard,
       Founder and President Fund Democracy, Inc.
     Kenneth McEldowney,
       Executive Director Consumer Action.
                                 ______