The Securities and Exchange Commission

[thepennyking]

Close Minded


To Don's dismay, the mutual fund establishment continues to run scared from more fund disclosure.


On August 31, 1999, Dave Nadig and I, and the team at MetaMarkets.com, started managing the world's first "interactive mutual fund." It was the first fund ever to display all its portfolio holdings updated in real time -- to show and explain all trades as soon as they are completed -- to publish ongoing commentary and research about stocks and the market by the fund's managers -- and to invite fund shareholders and the public to interact with the fund's managers online.

We did it because we wanted to demonstrate that there's a new and better way for mutual funds to talk to their shareholders, their shareholders' advisers, and the public. We were fed up with the fact the the mutual fund industry constantly warns you that "past performance is no guarantee of future returns" -- but then reveals virtually nothing useful or timely about funds except their past performance. Yes, our intention has always been to make money with this innovation, by recognizing an unmet need in the marketplace. But at the same time, it's a crusade for us. We think that showing people how their money is invested is the right thing to do.

So it's with more than a little bit of frustration that we read yesterday that the Investment Company Institute, the lobbying organization of the mutual fund industry, announced that it had provided the Securities and Exchange Commission "...with information demonstrating that average investors are much more likely to be harmed than helped if all mutual funds are required to reveal their portfolio holdings more than the current, twice-a-year requirement."

The ICI's submission is the latest shot fired in a war that we started in May, 2000, when we sent an open letter to the ICI's president, Matthew Fink, calling for greater mutual fund disclosure. The letter was cosigned by several others, including Mark Rekenthaler of Morningstar. When Dave Nadig went to Washington to discuss it with the ICI's SEC Rules Committee, he was given the bum's rush. But the issue wouldn't go away. And now, a little more than a year later, it's under SEC review and the ICI is scared enough to go public with the Commission to try to head it off at the pass.

The centerpiece of the ICI's submission to the SEC is a study conducted by University of Maryland finance professor Russ Wermers. The ICI summarizes the study as concluding that "...more frequent disclosure could potentially raise fund-trading costs by increasing the risk that outsiders would anticipate fund trades and trade ahead of funds. Such 'front running' can increase the price that funds pay to purchase securities and lower the price funds receive when they sell. ...abusive trading activities would become more widespread and would adversely affect fund performance."

What, are you surprised? You shouldn't be: this is neither the first nor the last time that a study performed by an academic, financed by a lobbying organization, has arrived at precisely the conclusions that the lobbying organization has already espoused.

The ICI cites a survey of the ICI's member mutual fund companies, showing that "...some mutual funds have determined that more frequent disclosure creates an unacceptable risk of facilitating abusive practices that would harm their shareholders. In addition, members responding to the survey reported virtually no demand for more portfolio holdings disclosure from their shareholders."

Yet at the same time, the same survey shows that "...many funds already disclose portfolio holdings information more than twice a year" -- twice a year being the current regulatory minimum for disclosure.

How is that possible? How can "many funds" do something that "creates an unacceptable risk" and for which there is "virtually no demand"? It can only be that -- among the thousands of mutual funds in America -- there is room for difference of opinion as to whether more frequent disclosure is risky, and as to whether there is demand for it.

Obviously, we at MetaMarkets.com believe there is demand for it -- and for more of it. We believe that based on the very positive public and media response we've gotten to our own modest initiatives in this area over the last two years. And we believe it based on two overwhelmingly conclusive Harris Polls conducted for us -- one, in 2000, of individual investors, and another, in 2001, of investment advisors. But let it never be said that the ICI let itself be confused by the facts: our polls are simply waved away by the ICI in their letter to Paul Roye, director of the SEC’s Division of Investment Management, as being "of dubious value."

On the one hand I utterly disapprove of the ICI's scorched earth approach to an idea that has great merit, and an issue that deserves nuanced consideration. But on the other hand, I respect that the ICI is doing its most important job for its members -- protecting them from new regulations, in an industry that is perhaps more regulated than any industry other than nuclear power generation.

Throughout our crusade for more mutual fund disclosure, we have never advocated that it be mandated by regulation. Quite the contrary -- we see our own efforts as a shining example of a free market response to a legitimate consumer need, a classic attempt to "do well by doing good." And ours is just one of an infinite number of ways to meet that need. There are thousands of mutual funds out there, and there should be just as many different approaches to serving the needs of shareholders, with many different levels of disclosure, and with many different forms of disclosure. As far as I'm concerned, the regulations should be relaxed to permit mutual funds to make no disclosure. Why not? Let's see if there's a market for it.

So here's hoping that the ICI's efforts will succeed in squelching new regulations -- but not in squelching new innovations!

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Don Luskin
MetaMarkets.com