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June 19, 2003
TO: BOARD OF GOVERNORS No. 30-03
DIRECTOR SERVICES COMMITTEE No. 10-03
PRIMARY CONTACTS - MEMBER COMPLEX No. 49-03
PUBLIC INFORMATION COMMITTEE No. 19-03
SEC RULES MEMBERS No. 78-03
SMALL FUNDS MEMBERS No. 27-03
RE: GAO REPORT ON TRANSPARENCY OF MUTUAL FUND FEES AND CERTAIN
PRACTICES
The U.S. General Accounting Office has issued a report on the transparency of
disclosures of mutual fund fees, distribution practices and soft dollar arrangements.* The
report, entitled “Mutual Funds – Greater Transparency Needed in Disclosures to Investors,”
was in response to an earlier request from House Financial Services Committee Chairman
Michael G. Oxley and Capital Markets Subcommittee Chairman Richard H. Baker. Messrs.
Oxley and Baker had requested that the GAO “review issues relating to the transparency and
appropriateness of certain fees and practices among mutual funds.”
The GAO report focused on the impact fees and costs associated with owning mutual
fund shares may have on investment return. In order to evaluate whether the disclosure of
fund fees and other practices are sufficiently transparent to allow investors to make informed
decisions, the GAO studied four areas. A summary of the GAO’s discussion of these areas, the
SEC and ICI comments on the report and the report’s conclusions are below:
• Disclosure of Fees and Costs. The GAO looked at how mutual funds currently
disclose their fees and costs and how these disclosures may be improved. The report
noted that investors currently receive information about the amount of fees and
expenses on their mutual fund shares, expressed as a percentage of fund assets. In
addition, the report states that the SEC is considering additional disclosures that
would facilitate fee comparisons across funds.
* A copy of the full report can be found at www.gao.gov/cgi-bin/getrpt?GAO-03-763.
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The GAO report pointed out that there are additional disclosures that could further
increase the transparency of fees, such as providing investors with the specific dollar
amounts of the expenses paid in quarterly account statements. The report
acknowledged that these alternatives may be costly and their benefits are difficult to
quantify. However, the report concluded that the importance to investors of more
transparency and enhanced awareness of mutual fund fees warrant consideration of
these or less costly alternatives, including mandating the SEC-proposed disclosure
(i.e., the dollar amount of a fund’s fees based on a set investment amount) on
quarterly account statements or including a notice on account statements to remind
investors that they pay fees and to check the fund’s prospectus and with their
financial adviser for more information. The report also pointed out that this
additional disclosure might encourage greater competition among funds on the basis
of fees. The report considered disclosure of information about the brokerage
commissions and other trading costs funds incur, but found that standard
methodologies to calculate these amounts do not exist and such disclosures could be
misleading.
• Director Oversight of Fees. The GAO report examined the role of directors in
reviewing fund fees. Some industry observers have argued that the process
directors follow fails to produce sufficient actions to minimize fund fees. The
suggestion that directors seek competitive bids was not embraced by the GAO
because such a requirement may not produce lower costs and directors use other
means to seek lower fees, such as negotiating with advisers for declining fees as
assets grow. Further, the report acknowledged recent legislative and regulatory
steps that have been taken to enhance board effectiveness. Many of the reforms
being recommended for public companies, the report observed, are either already
required for funds by rule or recommended by industry best practice.
• Disclosure of Payments to Intermediaries. The GAO looked at how payments that
fund advisers make to intermediaries that sell fund shares impact investors and how
practices in this area have changed. The report looked specifically at the way Rule
12b-1 fees are used has evolved and the increased use of revenue sharing
arrangements. The report noted that some of the changes in distribution practices
have benefited investors, however, the disclosure currently required about the
various payments to intermediaries may not provide investors with sufficient
information to evaluate potential conflicts of interest. Disclosure at the time of sale
of compensation a broker-dealer receives from a fund’s adviser company may
provide investors with more complete information, the report concluded.
• Disclosure of Soft Dollar Arrangements. The GAO studied how mutual funds use
soft dollars. The report noted that, while soft dollar arrangements may provide
advisers with access to a greater range of research and other benefits, the amount of
brokerage commissions paid directly reduces the return earned by investors. The
report noted the potential conflicts of interest presented by the use of soft dollars and
the need to increase the transparency of these arrangements to enable fund directors
and investors to better evaluate their funds’ use of soft dollars. The report
acknowledged various changes proposed by the SEC staff in a 1998 report that
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would increase transparency by expanding advisers’ disclosure of their use of soft
dollar arrangements, but commented that the SEC has yet to take action on these
proposals and other recommendations relating to soft dollar recordkeeping.
SEC and ICI Comments on the Report
The GAO report includes comments received on it from the SEC and the ICI. The SEC
commented on the report’s recommendation that more disclosure be included on quarterly
account statements. The SEC staff agreed that additional disclosure may be helpful to investors
and promised to consider, as they evaluate the comments on their proposed disclosure changes,
whether some form of fee disclosure could be included on account statements. They also
indicated that they intend to consider additional disclosures concerning revenue sharing and
soft dollar arrangements.
The ICI’s letter, focused on two issues. First, the letter commented on the comparison of
disclosures of fund fees to those of other financial service firms. The ICI’s letter stated that
current mutual fund disclosures allow individuals to make much more informed and accurate
decisions about the costs of their funds than do the disclosures made by other financial services
firms. The GAO report states that, unlike mutual funds, other financial products generally
disclose their costs in specific dollar terms. It was not the GAO’s intent, however, to make a
judgment as to whether those disclosures are superior to that provided for mutual funds.
Instead, the GAO believes that supplementing existing mutual fund fee disclosure will increase
awareness of fees and prompt additional fee-based competition among funds.
Second, the ICI also commented on the GAO’s discussion of the role played by fund
directors in overseeing fund fees. The ICI was pleased that the GAO understood the
importance and seriousness with which directors approach this duty. In particular, the GAO
properly noted the critical role of independent directors in reviewing the advisory fee each year.
The ICI letter also noted, however, that independent directors are often not given credit for the
many ways in which they safeguard shareholder interests. In the report, the GAO agrees that
independent directors have played an important role in overseeing funds. The report also notes
that SEC reviews generally have found that directors have fulfilled their duties under the law.
The report comments that, given the recent scandals and the importance of funds to the
financial health and retirement security of investors, continued scrutiny of fund governance is
appropriate. The ICI letter agrees that continued scrutiny is appropriate but indicated that the
report would be strengthened if it included a description of the full range of directors’
responsibilities to protect investors in addition to their fee-related duties.
Conclusions
The GAO report includes several specific recommendations. First, the GAO
recommends that the SEC consider the benefits of additional mutual fund fee disclosure,
including requiring that more fee information be included on fund account statements about
the fees investors pay. Second, the report recommends that the SEC consider evaluating ways
to provide more disclosure relating to revenue sharing arrangements so that investors can better
evaluate potential conflicts of interest. Finally, the GAO recommends that the SEC consider
evaluating ways to provide additional disclosure concerning soft dollars to assist directors and
investors in evaluating the benefits and potential disadvantages of their fund adviser’s use of
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such arrangements. The report specifically urges the SEC to consider and implement the
recommendations in its 1998 soft dollar examinations report.
Matthew P. Fink
President