August 12, 1993
TO: BOARD OF GOVERNORS NO. 72-93
RE: TRANSCRIPT OF RECENT MUTUAL FUND HEARING
__________________________________________________________
As we recently informed you, SEC Chairman Levitt testified on August 5
before the Telecommunications and Finance Subcommittee of the House Energy and
Commerce Committee on the state of the mutual fund industry. (See Memorandum to
Board of Governors No. 71-93, dated August 10, 1993). Attached is a copy of the
transcript of the hearing.
Set forth below is a summary of the significant points addressed at the
hearing.
1. SEC Resources - In his opening statement, Chairman Levitt stressed the
need for additional resources for the SEC to regulate the mutual fund industry.
He testified that while the assets under management have increased by over 430
percent since 1982, the SEC's investment company staff had increased only 74
percent. Levitt warned that the inspection program has been the "hardest hit"
and that if additional examiners are not hired, the inspection program will not
be able "to provide any real measure of deterrence or of investor protection."
(See p. 14-15)
2. Sales Loads and Fund Expenses - In response to Chairman Markey's remark
that sales loads and fund expenses are the "single greatest cause of confusion
and frustration for most mutual fund investors", Chairman Levitt stated that
clarity and uniformity in the disclosure of fees is important and that the fee
table in the front of the prospectus has been a constructive step in this regard.
(See pp. 19-22)
With respect to the level of fees and expenses, Chairman Markey observed
that mutual fund expense ratios have not decreased, even though assets in mutual
funds have increased significantly. Chairman Levitt explained that part of the
reason is due to the development of new services and products. (See pp. 22-24)
In response to questions on 12b-1 fees, Chairman Levitt expressed
skepticism about the collection of 12b-1 fees in certain circumstances, such as
when a fund closes to new investors. He also expressed concern about the use of
the term "no load" under the NASD rule for a fund that collects a 12b-1 fee of
25 basis points or less. Chairman Levitt stated that these issues require
careful consideration and that he would work with the Subcommittee and the
industry on them. (See pp. 50-53)
3. Section 22(d) - In expressing opposition to the recommendation in the
SEC staff's study on investment company regulation to repeal Section 22(d) of the
Investment Company Act, Chairman Levitt stated that "the removal of 22(d) might
have unintended consequences." (See pp. 34-35)
4. SEC Review of Advertising - In response to an inquiry about the
adequacy of the SEC's review of advertising materials of funds whose shares are
not sold through NASD member firms and therefore file their advertising materials
with the SEC, Chairman Levitt stated that the SEC is understaffed in this area
and that it does not do as detailed an evaluation of these materials as the NASD
does. When asked whether a SECO-like entity for overseeing those funds that are
not sold through NASD broker-dealers should be established to address this
problem, he responded that it is an issue that just recently came to his
attention and one that the SEC will consider. (See pp. 33-34)
5. Marketing Practices - Chairman Levitt stated in response to a question
about the use of fee waivers and funds guaranteeing investors a stated return for
a specified period that he thought these practices were a form of "gimmickry" and
that aggressive marketing techniques needed to be watched very carefully.
However, he stated that he did not want to generalize about marketing techniques
and noted that the American consumer is better informed than ever before in
history. (See pp. 37-38.)
6. Summary Pospectus Proposal - Chairman Levitt strongly supported the
SEC's proposal to allow investors to purchase mutual fund shares directly in
response to a summary prospectus. (See pp. 57-64)
Chairman Markey questioned how the NASD would be able to handle reviewing
the new summary prospectus, since it now has only 13 people assigned to review
advertising and sales material. Chairman Levitt responded that the NASD will
clearly need additional resources to ensure that mutual fund advertisements are
properly reviewed and that "the NASD must be encouraged to beef up their
resources in that connection." (See p. 64)
7. Bank Sold Mutual Funds - In response to inquiries about the unique
investor protection issues raised when mutual funds are distributed through
banks, Chairman Levitt stressed the importance of ensuring that investors
understand that funds are not federally insured like bank deposits. He also
stated that there is a need for banks to "erect the kinds of firewalls to prevent
abuses in terms of using their corporate business as an offset to what they are
doing in the fund business," but that he was not prepared to make a specific
proposal at that time. (See p. 55)
In addition, Chairman Levitt was asked about the oversight of bank sales
practices, especially in light of the New York City's Consumer Affairs report on
mutual fund sales practices in which it was reported that only two out of five
bank representatives contacted stated that the funds were not FDIC insured. He
responded that bank funds that are not sold through registered broker-dealers are
not subject to the NASD sales practice rules and that it is a very important area
that should be addressed. (See pp. 55-56)
8. Unified Fee Fund - Chairman Levitt stated that while he believes that
a unified fee structure would be desirable from the investor's point of view, it
is very complex and he is not sure how to implement it at this time. (See page
41.)
9. Derivatives - Chairman Markey inquired about the propriety of mutual
funds investing in derivative products, citing recent press articles that focused
on the risks presented by these instruments. Chairman Levitt responded that
mutual funds primarily use derivatives to hedge risks and that he does not
believe that the extent to which mutual funds are using derivatives presents a
danger. He cautioned against legislation to prohibit the use of derivatives,
since "it would be taking away from the funds a legitimate device for protecting
against unnecessary risk." (See pp. 65-68)
10. Disclosure in the Retirement Market - Chairman Markey and Chairman
Levitt agreed that participants in employee-directed defined contribution plans
need to receive all of the information necessary, in an understandable format,
in order to make an informed investment decision. (See pp. 73-74)
* * *
We will keep you informed as developments occur.
Matthew P. Fink
President
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