SEC's Report Provides Useful Information On Mutual Fund Fees And 
Recommends Improved Fee Disclosure (03-MAY-01, GAO-01-655R).	 
								 
This correspondence (1) discusses the Securities and Exchange	 
Commission's (SEC) report on mutual fund fee disclosures and (2) 
reviews SEC's response to GAO's recommendations on improving fee 
disclosure. The results of SEC staff's comprehensive analyses and
other findings generally corroborate the findings of GAO's report
and provide considerable additional information on the trend in  
mutual fund fees. The SEC staff's report also contains several	 
recommendations to the agency's Commissioners, and the Commission
has already approved recommendations on after-tax return	 
disclosure and fund governance. In response to GAO's		 
recommendation that mutual fund investors' quarterly account	 
statements disclose the specific dollar amount of fees they paid,
SEC staff recommends that investors receive additional fee	 
information in funds' annual and semiannual reports. The SEC	 
staff's proposal would provide investors with more information on
fees in a form that allows comparison among funds. However, it	 
will not provide information specific to each investor, nor will 
it be provided in the most frequent and relevant source--the	 
quarterly statement. Therefore, it may be less likely to increase
investor awareness and spur additional price competition among	 
mutual funds to the same degree as GAO's recommendation sought to
do.								 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-655R					        
    ACCNO:   A00973						        
  TITLE:     SEC's Report Provides Useful Information On Mutual Fund  
             Fees And Recommends Improved Fee Disclosure                      
     DATE:   05/03/2001 
  SUBJECT:   Investment planning				 
	     Investments					 
	     Mutual funds					 
	     Information disclosure				 
	     Fees						 
	     Brokerage industry 				 

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GAO-01-655R
     
GAO- 01- 655R SEC's Report on Mutual Fund Fees United States General
Accounting Office

Washington, DC 20548

May 3, 2001 The Honorable John D. Dingell Ranking Minority Member Committee
on Energy and Commerce House of Representatives

Subject: SEC's Report Provides Useful Information On Mutual Fund Fees And
Recommends Improved Fee Disclosure

Dear Mr. Dingell: This letter responds to your request that we comment on
the findings and recommendations in the December 2000 Report on Mutual Fund
Fees and Expenses by the Securities and Exchange Commission's (SEC) Division
of Investment Management. In this report, the SEC staff presents the results
of its own analysis of the trend in mutual fund fees, including the results
of its statistical analyses that identified how various fund characteristics
affect fee levels. In addition, the report describes the approaches the SEC
staff proposes be taken in response to the recommendation in our report
Mutual Fund Fees: Additional Disclosure Could Improve Price Competition
(GAO/ GGD- 00- 126, June 7, 2000). In this letter, we

discuss the findings of the SEC staff's report and compare them to those of
our report. We also comment on the SEC staff's proposed response to our
recommendation calling for additional disclosure of fee information to
mutual fund investors.

Results in Brief

The results of the SEC staff's comprehensive statistical analyses and other
findings generally corroborate the findings of our own report and provide
considerable additional information regarding the trend in mutual fund fees.
The SEC staff's report also contains several staff recommendations to the
agency's Commissioners, and Commission approval has already been granted to
recommendations relating to after- tax return disclosure and fund
governance. In response to our recommendation that mutual fund investors'
quarterly account statements disclose the specific dollar amount of fees
they paid, SEC staff recommends that investors receive additional fee
information in funds' annual and semiannual reports. The SEC staff's
proposal would provide investors with additional information regarding fees
in a form that facilitates comparison among funds. However, it will not
provide information specific to each investor, nor will it be provided in
the most frequent and relevant source -the quarterly statement. Therefore,
it may be less likely to increase investor awareness

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 2 and spur additional
price competition among mutual funds to the same degree as our

recommendation sought to do.

Background

We undertook our June 2000 report on mutual fund fees as the result of
Congressional concerns that fees charged by mutual funds had not declined
despite the growth in mutual fund assets. Our report presented information
on how the growth in assets could produce cost efficiencies for funds;
however, because comprehensive cost data for mutual fund companies was not
available, we were unable to determine whether fund companies had
experienced the type of efficiencies that would have allowed them to reduce
their fees. Our report also showed that the fees charged by 77 of the
largest mutual funds 1 had generally declined but that not all had reduced
their fees. Our report also discussed various factors that are expected to
ensure that mutual fund fees are set competitively. One such factor was
direct competition among mutual funds, which we found occurs primarily on
the basis of service and other fund characteristics rather than on price. In
addition, our report found that, although mutual fund companies make
extensive disclosures of the fees they charge, these disclosures do not
include the specific dollar amount of fees each investor paid. Finally, our
report noted that funds' boards of directors are tasked with overseeing the
fees their funds charge but that opinions as to the effectiveness of these
directors' oversight were mixed.

Because of the limitations in the various factors that are relied on to
produce price competition among mutual funds, we recommended that investors
receive additional information to heighten their awareness and understanding
of the fees they pay, which could serve to spur additional price competition
in the industry. Specifically, our report recommended that SEC require that
the account statements that are provided to mutual fund investors on a
quarterly basis include the dollar amount of each investor's share of the
operating expense fees deducted from their funds. Because such calculations
could be made in various ways, we also recommended that SEC consider
alternative means of making such disclosures, taking into account the cost
and burden on investors and the industry. One alternative means of
disclosing such information was by having mutual funds produce an estimate
of an investor's individual expenses using an average of the total value of
fund shares owned multiplied by the fund's expense ratio for the period
covered by the account statement. Alternatively, mutual funds could report
to investors the dollar amount of expenses paid by fund shareholders for
preset investment amounts, such as $1,000, which could be used by investors
to estimate the amount of fees deducted from their own mutual fund shares.

1 These 77 funds included all of the largest stock, bond, and hybrid funds
in existence from 1990 to 1998. Specifically, this included the 41 stock
funds with assets over $8 billion, 31 bond funds with assets of $3 billion,
and 5 hybrid funds with assets over $8 billion. Collectively, these 77 funds
had combined assets of $1,157 billion in 1998 and represented nearly 28
percent of the $4,177 billion in total industry assets invested in these
three types of funds.

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 3

SEC Report Presents Similar Findings and Provides Additional Analyses of
Fund Fees

The SEC staff report's findings on the trend in mutual fund fees were
generally comparable to ours. Using data for all stock and bond mutual funds
in existence at the end of 7 selected years from 1979 to 1999, the staff's
report finds that the average asset- weighted expense ratio 2 of these funds
has increased from 0.73 percent in 1979 to 0.94 percent in 1999. However,
the SEC staff attributed this increase generally to funds' shift over time
from charging loads, which are not included in the expense ratio, to
charging 12b- 1 fees, 3 which are included in the ratio. Although finding
that fees had increased since the late 1970s, the SEC staff also found that
the 1999 weighted average expense ratio of 0.94 percent represented a
decline from its 1995 level of 0.99 percent. This was comparable to the
finding in our report that the average asset- weighted expense ratio of the
top 46 largest stock funds, 4 which peaked in 1994 at 0.81 percent, declined
to 0.65 by 1998.

SEC's report also presented additional analyses on the level of fees across
different fund types and how fund characteristics affect fee levels. The SEC
staff found that various fund characteristics generally correlate with fund
expense ratios, including finding that older funds had lower ratios than
newer funds 5 and that larger funds had lower ratios than smaller funds. The
staff's report also presented the results of an econometric model that
showed how various fund characteristics affect fund expense ratios. Using
this model, the SEC staff found that funds in families 6 with more assets
tended to have lower expense ratios than did funds in families with fewer
assets.

SEC also found that many large funds were already past the breakpoints in
their fee structures and, as a result, may not automatically reduce fees as
the assets in these funds grow. One way that mutual funds whose assets are
growing can pass on costsaving economies 7 to their investors is by
establishing breakpoints in their management fee structure. Such breakpoints
result in lower fees being charged as total fund assets reach various
predetermined levels. 8 However, after analyzing information for the 100
largest funds from 1997, 1998, and 1999, the SEC staff found

2 The expense ratio for a mutual fund is the cumulative total of various
fees and expenses charged to the fund during a particular period shown as a
percentage of the fund?s average net assets. 3 Rule 12b- 1 allows mutual
funds to pay marketing and distribution expenses from fund assets. These

fees are used to compensate sales professionals and others for selling fund
shares as well as for fund advertising and promotion. 4 These 46 funds
included all of the largest stock funds in existence from 1990 to 1998,
which

comprised all such stock funds with assets over $8 billion. Also included in
the 46 funds were 5 hybrid funds that also invest in bonds and other debt
securities. 5 However, SEC?s econometric model that attempted to identify
the factors affecting funds? expense

ratios found that as funds get older, their expense ratios increase.
However, their report notes that this result was largely attributed to four
older funds with higher expense ratios than their peers. 6 A fund family is
a group of individual mutual funds that frequently includes one or more
funds that

invest in stocks, bonds, money market instruments, or combinations thereof,
managed by the same firm. 7 Such economies are operational efficiencies that
arise as fund assets grow. For example, such an

economy occurs when a fund?s assets increase by 100 percent but the fund
operator must increase its staffing costs by only 10 percent to accommodate
this growth. 8 For example, a fund?s management fee could be 0.35 percent on
assets up to $5 billion, 0.30 percent

on assets between $5 billion and 10 billion, and 0. 27 percent on assets
above $10 billion.

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 4 that many of these
funds' assets are already greater than the last breakpoints in their

fee structures. As a result, if the assets in these funds grow, their
investors will not receive further automatic fee reductions. This lack of
breakpoints may result because the funds have already achieved whatever
economies of scale exist so that fees may remain stable as assets grow.
Alternatively, if economies of scale do exist, the lack of breakpoints could
be a symptom that competitive forces are not sufficient to force funds to
pass on savings to investors.

The SEC Staff Report Proposes Additional Fee Disclosure

The SEC staff's report included recommendations regarding after- tax
returns, fund governance, and 12b- 1 fees. It also made a recommendation for
additional fee disclosure that responds to the recommendation in our report.
In its report, the SEC staff recommended that investors receive information
showing standardized after- tax mutual fund returns and, on January 18,
2001, the Commission approved rule amendments requiring funds to provide
such disclosures. SEC officials told us that they viewed this as an
important new disclosure because taxes affect investor returns to a greater
degree than do fees. In their report, the SEC staff also recommended various
changes to the fund governance provisions, including changes that would
likely increase the percentage of independent directors that must be part of
a fund's board of directors. The Commission approved these changes on
January 2, 2001. The SEC staff's report also recommends that the Commission
consider reviewing the requirements of the 12b- 1 rule in light of changes
in fund marketing and distribution since the rule's adoption in 1980. We
believe that these actions should help provide important information to
investors and could enhance oversight in the mutual fund industry.

After considering the costs and benefits of the recommendation in our June
2000 report, the SEC staff's report recommends a variation of one of the
alternatives we discussed. In its report, the staff proposes that mutual
fund investors be provided with information on the dollar amount of fees
paid using preset investment amounts. In addition, the SEC staff proposed
that this information be presented to investors in the annual and semiannual
reports prepared by mutual funds. Specifically, the SEC staff proposed
requiring funds' annual reports to present a table showing the cost in
dollars associated with an investment of a standardized amount (such as
$10,000) that earned the fund's actual return and incurred the fund's actual
expenses paid during the period. In addition, the SEC staff suggested that
the Commission could require that this table also present the cost in
dollars, based on the fund's actual expenses, of a standardized investment
amount that earned a standardized return (such as 5 percent). This would
result in investors receiving additional information regarding fees.
However, the staff's proposed disclosures would not be specific to each
investor, nor would they be provided in the most relevant and frequent
source as our report recommended and, as a result, may be less likely to
increase investor awareness and improve price competition as effectively as
the disclosures we recommended.

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 5 SEC Staff's Proposed
Additional Fee Disclosure Will Not Provide Investors With

Account- Specific Information The additional disclosures the SEC staff
proposed should provide mutual fund investors with more information about
the expenses associated with owning mutual fund shares in a form that will
allow investors to compare fees across funds as they can with the current
information disclosed about fees. However, the proposed disclosures will not
provide investors with information showing, either precisely or
approximately, the dollar amount of the fees they paid on their own fund
shares. It is our view that receiving this account- specific fee information
would be more likely to increase investors' awareness of the fees they pay
and could encourage them to evaluate the relative value of the returns and
service they receive from their mutual funds. As noted in our June 2000
report, financial products and services that report their charges directly
in dollar terms to their users often have providers that attempt to compete
more explicitly on the basis of price. Examples of these include the
discount brokerage industry that developed to offer reduced charges for
commissions or banks that offer no- fee checking accounts. Such competition
is not totally absent from the mutual fund industry, as SEC officials noted
that several lowfee mutual fund families receive a significant portion of
the total of dollars invested in mutual funds.

In its report, the SEC staff noted that placing dollar amounts of fees paid
in investors' account statements entails various administrative difficulties
and additional costs to the industry and ultimately to investors. In
discussing their report with us, one of the primary difficulties the SEC
officials cited was that the quarterly statements are often prepared by
third- party broker- dealers and not the mutual funds themselves. In many
cases, only these broker- dealer firms maintain the account- specific
information for each investor. They said it would be difficult for each
mutual fund to provide these broker- dealers with fee information that could
be used to determine the specific fee paid by each investor. In a letter to
SEC, a representative of a committee working under the auspices of the
Securities Industry Association listed the various steps believed to be
needed to implement our original recommendation. For example, the letter
noted that firms' systems would not only have to calculate the fee
applicable to each investor, but also allow such amounts to be recalculated
if errors were discovered in the expense information. The committee
representative's letter also stated that firms in the industry were
concerned that the added complexity of preparing statements with such fee
information could result in firms' failing to mail such statements to
investors within the 5- day time period currently required.

Our report also discussed the costs of providing such information to
investors. Comprehensive data on the exact costs of fully implementing our
recommendation were not available. However, the preliminary estimates
provided by industry participants and presented in our report did not appear
to be prohibitive. 9 In discussing their report's recommendations with us,
SEC officials acknowledged that they were unable to assess whether the
industry's estimates of the administrative effort required to implement fee
disclosure specific to each investor were realistic or

9 For example, we determined that the cost for one broker- dealer based on
the total amounts its officials estimated they would incur to produce such
statements were less than a dollar per account for initial development costs
and less than a dollar per account each year thereafter.

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 6 reasonable. In
addition, because we recognized the possibility of such administrative

challenges and potential for additional costs, our report noted that mutual
funds could likely provide some information that would allow the fees
specific to each investor to be approximated rather than determined exactly.
Such disclosures would still serve to make investors more aware of the fees
they paid.

The SEC staff also noted that the disclosures they are proposing will allow
investors to compare fees across funds because the information will be for
comparable time periods and a standardized dollar amount invested. In
contrast, the staff said that including specific dollar amounts in quarterly
statements would generally not allow investors to compare across funds
because of likely differences in performance, type of fund, holding periods,
and the dollar amounts invested. However, for comparability purposes,
investors could use the useful fee information already provided by the
existing disclosures, which presents fees in terms of percentages of funds'
net asset value. In addition, any additional disclosures that present
investors' fees in dollar amounts could be accompanied by comparable
disclosures showing such fees in percentage terms, which would facilitate
comparison across funds.

SEC's Proposed Additional Fee Disclosure May Not Be Provided to Investors in
the Most Relevant Source

Although the SEC staff's recommendation will improve fee disclosures, we
believe that it may be less effective in increasing investor awareness and
spurring additional price competition among funds because it would be
provided to investors less frequently and in reports that may receive less
investor attention than account statements. The SEC staff's report
recommends that additional fee information be included in funds' annual and
semiannual reports rather than in investors' account statements, which are
provided at least quarterly. However, this less frequent distribution will
likely reduce the immediacy of the information to investors. Furthermore, as
part of conducting work on this letter, we contacted officials of three
industry research organizations to discuss the SEC staff's report and its
recommendations. These officials told us that investors generally pay more
attention to the quarterly statements than they do to other information
pertaining to their mutual fund investments, such as the annual and
semiannual reports, because the quarterly statements report the specific
value of the investors' account. One of the officials said that his firm's
research has shown that, when investors receive statements that specifically
show the dollar amount of the fees they are charged for other financial
services, it generally triggers actions on the part of both the investor and
the financial institution. According to this official, investors receiving
such information frequently engage in discussions regarding the services
they have received in exchange for the fees paid. Similarly, financial
institution representatives tend to be more active in contacting the
investors to review the activity in the account and how progress is being
made toward the investors' financial plans. He said that the type of
presentation that we have advocated would likely have this same beneficial
effect.

SEC officials explained that they are suggesting that this information be
included in the annual and semiannual reports because these documents
contain more information than the quarterly statements and thus will allow
investors to better understand the fee information in an appropriate
context. Although the SEC staff's

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 7 rationale has merit,
its impact on investor awareness of fees may be reduced because

such disclosures will not be in the documents that investors likely pay most
attention to- the quarterly statements. The SEC staff could expand on its
proposal, even without providing account- specific fee information, by
requiring that the brokerdealers that prepare investors' quarterly
statements periodically include in them the additional disclosures that the
SEC staff's report recommends be included in funds' annual and semiannual
reports. In doing so, SEC would increase investors' general awareness of the
fees they paid.

In addition to their proposal for increased fee disclosure, the SEC staff's
report indicated that they intend to continue to assist investors in
becoming more educated about fees and to encourage the industry to be more
active in this area as well. The SEC officials we spoke with noted that any
additional fee disclosures would have to be accompanied by an extensive and
ongoing investor education effort to ensure that investors understand and
make effective use of the new disclosures. One example noted by the staff of
their efforts to educate investors was the mutual fund cost calculator found
on the SEC Web site. The staff also pointed out that such calculators have
subsequently been added to the Web sites of several mutual fund companies.

Agency Comments

We provided a draft of this letter to the Chairman, SEC. In his letter
(reproduced in the enclosure), the Director of SEC's Division of Investment
Management noted that both the SEC staff?s and GAO?s reports had concluded
that mutual fund investors could benefit from additional information about
fees as a way of heightening investor awareness and understanding of the
fees and their effects. However, the SEC staff disagreed with several
aspects of our draft letter. First, the SEC staff took exception to our
statement that its proposal to include fund fee information in annual and
semiannual reports would not provide investors with either precise or
approximate dollar amounts of the fees paid on their mutual fund shares. We
agree that the staff's proposed disclosures, which would provide investors
with the dollar amount of fees that would have been paid on a $10,000
investment in the previous period, could be used by investors to estimate
the amount of fees they likely incurred on their own shares. However, we
believe that providing account- specific dollar amounts of fees paid- either
precisely or approximately calculated for investors- would be the most
effective means of increasing investor awareness of fees and of potentially
increasing price competition among funds. Short of that, we suggested that
providing preset fee disclosures as part of, or along with, the quarterly
statements would allow investors to calculate for themselves the fees they
paid. Although the SEC staff's proposed disclosures would also allow
investors to estimate their fees, their proposal would impose a larger
burden on investors to collect and use two separate documents to calculate
the fees they paid.

The Director's letter also discusses the SEC staff's decision to recommend
that the additional fee disclosures be placed in funds' annual and
semiannual shareholder reports rather than the quarterly statements.
Although they acknowledge that the quarterly statements are an important
source of information and are provided more frequently, they state that the
proposed fee disclosures are more appropriately placed in the shareholder
reports alongside the information about the fund's operating

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 8 results and fund
management's discussion of fund performance. This will allow, the

letter notes, investors to evaluate the costs they pay against the services
they receive. We agree that presenting investors with any new fee
disclosures in a way that explains the information and provides a context
for evaluating it is most likely to ensure that investors understand and
appropriately use it, and our report noted that explanatory and contextual
information could also be provided in quarterly statements. As previously
stated, we believe that providing the fee information in separate documents
provided at different times from the account- specific information places
more burden on investors and may reduce its impact on awareness and price
competition.

Finally, the Director's letter indicates that implementing the original
recommendation in our June 2000 report could be costly. Noting that our
report stated that the cost could be "a few dollars or less per investor,"
the SEC staff calculated that this could produce a cost of $480 million if
providing such disclosures costs $2 for each of the estimated 240 million
investor accounts. As we have stated, our original report acknowledged that
SEC should attempt to balance the cost and burden on the industry, the
burden placed on investors to calculate and estimate the fees they are
charged, and the benefits of the additional information to investors.
Although neither we nor SEC developed definitive cost estimates, we
recognize that the proposals that would likely most benefit investors may be
the most costly, and informed judgements will be needed in making decisions
about the trade- offs. The proposal advocated by the SEC staff is probably
the lowest cost option, but it may not provide as much benefit as similarly
low cost alternatives due to the placement in annual and semiannual reports.
Furthermore, we believe that factors in addition to implementation costs are
also important in determining the most appropriate disclosures. For example,
if providing account- specific fee information increases investor awareness
and encourages additional price competition in the industry, fees for
investors could be reduced overall.

Objectives, Scope, and Methodology

To complete our work, we analyzed the SEC staff's report and compared its
findings with those of our June 2000 report. To determine the rationale for
SEC's recommendations, we interviewed SEC officials. We also discussed SEC's
report and recommendation with selected industry research organization
officials. We conducted our work in Washington, D. C., from February to
March 2001 in accordance with generally accepted government auditing
standards.

_______________ As agreed with you, unless you publicly release its contents
earlier, we plan no further distribution of this letter until 30 days from
its issuance date. At that time, we will send copies to the Honorable Laura
S. Unger, Acting Chairman, SEC. We will also make copies available to others
upon request.

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 9 If you have any
further questions, please call me at (202) 512- 8678 or Cody J. Goebel,

Assistant Director, at (202) 512- 7329. Sincerely yours,

Richard J. Hillman, Director Financial Markets and

Community Investment Enclosure

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 10 Enclosure Enclosure

Comments From the Securities and Exchange Commission

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 11 Enclosure Enclosure

GAO- 01- 655R SEC's Report on Mutual Fund Fees Page 12 Enclosure Enclosure

(250026)
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