shareholder protections” and that “there is no consensus
as to the optimal percentage of independent directors
of a fund board.” In its letter, the ICI letter reiterates its
concern that “the costs of the board independence
requirements will disproportionately affect small fund
organizations, potentially increasing barriers to entry to the
mutual fund industry.” The ICI letter requests that the SEC
“conclude [its] rulemaking without further action.”
Like the ICI letter, the IDC letter also believes that the
OEA studies “do not provide economic support for the
position that the independent chair provision should be
adopted.” Unlike the ICI, the “IDC continues to support
the proposal to require a 75% majority of independent
directors.”
ICI Voices Concerns about NYSE Proxy Voting
Proposal
In a recent letter to SEC Chairman Christopher Cox, the
ICI urged the SEC to reject the NYSE’s proposal to
eliminate discretionary broker voting in uncontested
elections of directors. Referring to the significant costs
for funds under the proposed rule, the ICI recommended
that the SEC “take into account fully and carefully the cost
implications for the nation’s 94 million fund investors.”
Under current proxy voting rules, brokers are allowed
to vote shares on behalf of their clients on certain
“routine” proposals when the clients do not provide voting
instructions. In a recent NYSE newsletter, NYSE President
and Co-COO Catherine Kinney explained: “The goal of
the NYSE has been to not allow the broker to vote on any
proposal that substantially affects the rights of shareholders.
Today, the election of directors is just too important to
ever be considered routine, even when the election is
uncontested.”
While noting that the ICI has a long-standing policy of
supporting strong corporate governance, the ICI suggested
that the current proposal as applied to funds has “no
demonstrable benefits, and certainly none that come
close to off-setting its cost.” Specifically, the ICI asserted
that:
•
the proposal would cause “difficulties and
unnecessary costs … in achieving quorums” and
“related delays in electing fund directors,”
•
when directors seeking election are uncontested,
the “same directors in virtually every case will
be elected whether or not funds and their
shareholders bear these steep additional costs,”
•
•
the ICI “is aware of no fund shareholders who
voiced dissatisfaction of the current proxy voting
process as it relates to the uncontested election of
directors,” and
© 2007 Bell, Boyd & Lloyd LLP. All rights reserved.
A service to our clients.
the ICI does not believe the current process “entails
any detrimental effects on funds or fund governance.
As the old adage goes—if it ain’t broke, don’t fix it.”
In a related report on the costs of eliminating discretionary
broker voting, the ICI highlighted the difficulties investment
companies would face as a result of the proposed rule.
The NYSE proposal is subject to SEC comment and
approval. In its letter, the ICI urged the SEC to require
that all self-regulatory organizations, including the NYSE,
“perform an appropriate cost/benefit analysis prior to
submitting any regulatory proposal to the Commission.”
Investment Management and
financial MARKETS Group
Cameron S. Avery
312-807-4302
cavery@bellboyd.com
Alicia A. Perla
312-807-4318
aperla@bellboyd.com
Kevin R. Bettsteller
312-807-4226
kbettsteller@bellboyd.com
Andrew T. Pfau
312-807-4386
apfau@bellboyd.com
Kelly R. Bowers
202-955-7081
kbowers@bellboyd.com
Paulita A. Pike
312-781-6027
ppike@bellboyd.com
Paul H. Dykstra
312-781-6029
pdykstra@bellboyd.com
Bruce A. Rosenblum
202-955-7087
brosenblum@bellboyd.com
Jennifer C. Esquibel
312-807-4262
jesquibel@bellboyd.com
Laura E. Simpson
312-807-4219
lsimpson@bellboyd.com
Alan Goldberg
312-807-4227
agoldberg@bellboyd.com
Donald S. Weiss
312-807-4303
dweiss@bellboyd.com
Veena Jain
312-807-4287
vjain@bellboyd.com
Stacy H. Winick
202-955-7040
swinick@bellboyd.com
May 2007
Inside This Issue
Director Donohue
Reaches out to Fund
Directors and Makes
Rule 12b-1 a High
Priority - page 3
SEC Proposes Rules
Expanding Use of
Interactive Data page 3
ICI and IDC Comment
on SEC Economic
Papers Relating to
Fund Governance page 3
ICI Voices Concerns
about NYSE Proxy
Voting Proposal page 4
American Enterprise Institute Publishes Proposal to Eliminate Mutual
Fund Boards
Background
The American Enterprise Institute recently published Competitive Equity: A Better Way
to Organize Mutual Funds, a long-awaited study by Peter Wallison and Robert Litan that
proposes dramatic changes in the organization and governance of mutual funds. The
authors argue that the industry is in need of a major overhaul because price competition
among U.S. mutual funds is “weak and mutual funds are likely to be operating very
inefficiently.” The authors assert that “a primary goal of public policy should be to
ensure that nothing unnecessarily hinders fund managers from offering the lowest
possible costs to investors.”
The authors believe that the lack of competitive pricing among U.S. mutual funds is a
result of the current legal and regulatory framework. Pointing to the role of fund boards
in setting advisers’ fees, the authors assert that “the rate regulation by a board of
directors impairs the incentives of investment advisers to compete on price and
thus keeps expense ratios of mutual funds higher than they would be in a fully
competitive environment.”
To address the problem, the authors recommend a complete overhaul of the existing
framework: “the way to address the lack of price competition in mutual funds is
to abandon the current corporate structure and the role of the board in approving
the investment adviser’s fees and expenses….” The authors advocate eliminating
boards—their responsibilities for monitoring conflicts of interest would shift to a bank
trustee. The authors contend that “a more effective system than a part-time board of
directors can be put in place to address the conflicts of interest that may remain.”
Lack of Price Competition
Deborah M. Connor • Group Coordinator • 312-578-6034
dconnor@bellboyd.com
The authors assert that the mutual fund industry in the U.S. has not produced vigorous
price competition, claiming that “the expense ratios of funds that ostensibly compete
with one another vary widely.” The authors found that the expense ratios of class A
shares of 811 actively managed U.S. equity funds ranged from approximately 60 basis
points to 170 basis points, which represents a cost difference of almost 300%. In
comparison, a similar review of 456 funds in the U.K. showed a range in expense ratios of
127 basis points to 196 basis points, a difference of 54%.
Gwen C. Cooney • Paralegal • 312-558-7826
gcooney@bellboyd.com
Role of Boards in Price Regulation
Anna Paglia
312-781-7163
apaglia@bellboyd.com
IN TOUCH. IN SYNC. INVOLVED.
www.bellboyd.com
Investment Management Update
70 West Madison Street
Chicago, Illinois 60602
t. 312-372-1121
f. 312-827-8000
1615 L Street, N.W.
Washington, D.C. 20036
t. 202-466-6300
f. 202-463-0678
Investment Management Update is published by Bell, Boyd & Lloyd LLP for clients and friends of the firm and is for information only. It is not a substitute for legal advice or
individual analysis of a particular legal matter. Readers should not act without seeking professional legal counsel. Transmission and receipt of this publication does not create
an attorney-client relationship.
The authors contend that in the U.S. “mutual fund pricing bears a strong resemblance
to the way rates are established by electric and other utilities.” They contend that
fund boards, as watchdogs for fund shareholders, function like utility rate commissions
in that they regulate the profits of advisers. A consequence of that practice, the authors
argue, is that “price competition and price convergence have not occurred in the
mutual fund industry because there is little incentive for investment advisers
to reduce costs.” The authors explain that if an investment adviser takes the risk of
lowering prices to attract new shareholders, and then succeeds in doing so, “part of
the profit associated with that risk—if the board of directors is diligent on behalf of the
shareholders—will be promptly taken away in the form of new breakpoints…” Therefore,
Investment Management Update
•
they maintain, investment advisers have little incentive to
reduce costs and operate more efficiently for the benefit of
fund shareholders.
Both the adviser and the bank trustee would have fiduciary
obligations to investors. All fees, including those of the
bank trustee and legal counsel, would be paid out of
the adviser’s fee. The authors believe that this would
“eliminate the adviser’s temptation to structure its activities
so as to place some of the costs of operating the fund on
the fund itself—the source of the most serious potential
conflicts.” In addition, there would be little to no restriction
on an investor’s ability to redeem units and Rule 12b-1 fees
would be eliminated.
In their study, the authors highlight the difficulties boards
face in evaluating fund expenses. Even though an
investment adviser often jointly manages multiple funds, the
evaluation process, they believe, is “based on the fiction
that the board and the adviser have fiduciary responsibilities
to the shareholders of each fund separately, and thus the
board must review the adviser’s compensation for each
fund apart from the others.” They claim that the allocation
of costs among funds is arbitrary, noting that “there is no
right or rational way for any organization engaged in a joint
enterprise—such as managing two or more mutual funds—to
allocate certain costs between them.” The authors conclude
that “the best, if not the only, way to bring competition,
risk taking, and lower fees and expenses to the mutual
fund industry is to eliminate the rate regulation now
carried on by the boards of directors of mutual funds.”
Under the proposal, the bank trustee would perform the
oversight function that fund boards currently perform.
The authors believe that “use of a bank to monitor and
oversee the adviser’s activities, and in appropriate
cases to address the adviser’s potential conflicts of
interest, not only will be less expensive than a board of
directors, thus permitting a higher return for investors,
but also has the potential to perform the oversight and
monitoring function more effectively.” In support of that
position, the authors note that the bank would have:
Role of Boards in Monitoring Conflicts of Interest
The authors also argue that fund boards cannot prevent
improper activities involving investment advisers and
are “simply not equipped to discover anything about the
adviser’s activities that the adviser does not choose to tell
them.” The authors criticize the SEC’s efforts to increase
the independence of fund boards in response to recent
industry scandals, noting that the “late-trading and market
timing scandals had nothing to do with the existence or
absence of board independence, because the scandals
stemmed from decisions by investment advisers that
would never have come to a board’s attention.” The
authors maintain that by increasing board independence,
the SEC has missed the point and “made the real problem
worse by driving the industry even further from a competitive
model.”
The authors propose permitting the development of
an “alternative, competing system” for collective
investment funds in which investors would “contract
directly with the investment adviser without the
intercession of a corporation or a board of directors.”
The authors note that the contract structure is the dominant
form of collective investment in most developed countries,
including Canada, Japan, the U.K., and most other countries
in the European Union. Under the framework of a so-called
“Managed Investment Trust,” the investment adviser would:
establish a trust arrangement with a bank under an
indenture,
•
offer subscriptions to redeemable units of the
investment trust, and
•
a “full-time, professional staff, continuously in contact
with the fund and aware of how it is being managed,”
and
•
“strong incentive to be diligent in overseeing the
adviser” since the bank would have the fiduciary
responsibilities of a trustee under U.S. trust law and
“failure to perform adequately could endanger a line
of business.”
Comparing the proposal to the deregulation of the
brokerage, air travel, trucking and telecommunications
industries, the authors conclude that U.S. investors would
benefit from deregulation of the fund industry through “lower
prices, greater efficiency, and more innovation.”
Proposal for New Structure
•
agree to manage the trust’s investments for a single,
all-inclusive fee.
Authors Address Questions
The authors participated in a panel discussion regarding
their study at a recent Mutual Fund Directors Forum
conference and addressed questions. The authors
acknowledged that in developed countries expense
ratios generally were higher than those in the U.S., but
the authors were unable to explain why these higher
fees existed in markets that they believed exhibited
greater price competition than the U.S. market. The
authors also noted that the U.S. mutual fund industry
generally was very competitive, but stressed that their
proposal could result in even lower expense ratios in the
U.S.
2
Director Donohue Reaches out to Fund
Directors and Makes Rule 12b-1 a High Priority
SEC Proposes Rules Expanding Use of
Interactive Data
In a recent speech at the ICI Mutual Funds and Investment
Management Conference, Andrew “Buddy” Donohue,
Director of the SEC’s Division of Investment Management,
expressed his commitment to undertake “a review of fund
director responsibilities under the Investment Company
Act” and his intention to “reconsider Rule 12b-1, both
the rule itself and the factors that fund boards must
consider when considering approval or renewal of a
Rule 12b-1 plan.”
The SEC recently proposed rule amendments that would
allow mutual funds, on a voluntary basis, to file with
the SEC risk/return summary information from their
prospectuses through the SEC’s interactive data
program using technology developed by the ICI. The
proposed rule amendments would allow mutual fund
risk/return information to be “data tagged” so that it
could become interactive and available to be searched
and analyzed through interactive means. In 2005, the
SEC adopted rules permitting filers, on a voluntary
basis, to submit certain interactive tagged data through
EDGAR. Under current rules, mutual funds are allowed
to file interactive data exhibits only in connection with
Form N‑CSR.
Revisiting Certain Director Responsibilities
Mr. Donohue, calling on the industry and regulators to
“get back to basics,” stated that he wants “to make sure
that we have not so overloaded fund boards that it is
difficult for them to effectively perform their oversight
role.” As a result, he noted that 2007 would be dedicated
“to undertaking a review of fund director responsibilities”
and to “reaching out to fund directors to hear from them
what the Commission can do to enable directors to be more
effective.” Specifically, Mr. Donohue expressed his interest
in exploring rule revisions “that are easy to do—i.e., quick
fixes—and important to do—i.e., not necessarily easy, but
could have significant impact.” He also asked directors
to help identify “areas in which fund directors could
benefit from additional guidance, in addition to fair
valuation and soft dollars.”
Interactive data submissions would be filed as
supplemental exhibits only and would not replace
current filing requirements. The proposed amendments
would extend the limited protection from liability for the
tagged risk/return information that currently is provided
for interactive data submissions. (Liability would remain
for official filings.) The release notes that, as with current
tagged data submissions, “participating in the voluntary
program would not create a continuing obligation for
a volunteer to submit tagged risk/return summary
information.” In addition to risk/return information, the
proposed amendments allow for the submission of tagged
financial highlights or condensed financial information. In
the SEC’s release, it states that increased use of interactive
data could (1) assist investors and others in analyzing
and comparing fund information, (2) help to further
automate filings, reducing fund costs, and (3) minimize
the potential for human error in data processing.
Rethinking 12b-1
Mr. Donohue also addressed Rule 12b-1 and identified
the rule as one of the matters that he “worries about.” He
observed that the fund industry is in a very different state
now than when the rule was adopted in 1980. He explained
that at that time, a period of net redemptions, prompted fears
that funds might not survive if they “were not permitted to
use a small portion of their assets to facilitate distribution.”
Today, he noted, “the primary use of 12b-1 fees has
shifted from the limited marketing and advertising
purposes that were originally envisioned,” with 12b-1
fees now used “primarily as a substitute for a sales load
or for servicing.”
Comments on the proposed rule amendments were due on
March 14.
ICI and IDC Comment on SEC Economic Papers
Relating to Fund Governance
The SEC’s Office of Economic Analysis (OEA) has
prepared studies relating to the SEC’s proposed rule
amendments on mutual fund board independence that
would require fund boards to appoint an independent chair
and be comprised of 75% independent directors. The
Investment Company Institute and the Independent
Directors Council (which is affiliated with the ICI) each has
issued a comment letter in response to these studies.
Stopping short of offering a concrete proposal for revising
Rule 12b-1, Mr. Donohue declared, “[w]hile I have previously
stated that this is something I would like to address during
my tenure with the Division of Investment Management, I
am announcing today that this is something that we will
address. This is now a high priority for the Division this
year.”
The ICI letter notes that “neither OEA study finds any
compelling evidence that independent chairs enhance
3
Investment Management Update
•
they maintain, investment advisers have little incentive to
reduce costs and operate more efficiently for the benefit of
fund shareholders.
Both the adviser and the bank trustee would have fiduciary
obligations to investors. All fees, including those of the
bank trustee and legal counsel, would be paid out of
the adviser’s fee. The authors believe that this would
“eliminate the adviser’s temptation to structure its activities
so as to place some of the costs of operating the fund on
the fund itself—the source of the most serious potential
conflicts.” In addition, there would be little to no restriction
on an investor’s ability to redeem units and Rule 12b-1 fees
would be eliminated.
In their study, the authors highlight the difficulties boards
face in evaluating fund expenses. Even though an
investment adviser often jointly manages multiple funds, the
evaluation process, they believe, is “based on the fiction
that the board and the adviser have fiduciary responsibilities
to the shareholders of each fund separately, and thus the
board must review the adviser’s compensation for each
fund apart from the others.” They claim that the allocation
of costs among funds is arbitrary, noting that “there is no
right or rational way for any organization engaged in a joint
enterprise—such as managing two or more mutual funds—to
allocate certain costs between them.” The authors conclude
that “the best, if not the only, way to bring competition,
risk taking, and lower fees and expenses to the mutual
fund industry is to eliminate the rate regulation now
carried on by the boards of directors of mutual funds.”
Under the proposal, the bank trustee would perform the
oversight function that fund boards currently perform.
The authors believe that “use of a bank to monitor and
oversee the adviser’s activities, and in appropriate
cases to address the adviser’s potential conflicts of
interest, not only will be less expensive than a board of
directors, thus permitting a higher return for investors,
but also has the potential to perform the oversight and
monitoring function more effectively.” In support of that
position, the authors note that the bank would have:
Role of Boards in Monitoring Conflicts of Interest
The authors also argue that fund boards cannot prevent
improper activities involving investment advisers and
are “simply not equipped to discover anything about the
adviser’s activities that the adviser does not choose to tell
them.” The authors criticize the SEC’s efforts to increase
the independence of fund boards in response to recent
industry scandals, noting that the “late-trading and market
timing scandals had nothing to do with the existence or
absence of board independence, because the scandals
stemmed from decisions by investment advisers that
would never have come to a board’s attention.” The
authors maintain that by increasing board independence,
the SEC has missed the point and “made the real problem
worse by driving the industry even further from a competitive
model.”
The authors propose permitting the development of
an “alternative, competing system” for collective
investment funds in which investors would “contract
directly with the investment adviser without the
intercession of a corporation or a board of directors.”
The authors note that the contract structure is the dominant
form of collective investment in most developed countries,
including Canada, Japan, the U.K., and most other countries
in the European Union. Under the framework of a so-called
“Managed Investment Trust,” the investment adviser would:
establish a trust arrangement with a bank under an
indenture,
•
offer subscriptions to redeemable units of the
investment trust, and
•
a “full-time, professional staff, continuously in contact
with the fund and aware of how it is being managed,”
and
•
“strong incentive to be diligent in overseeing the
adviser” since the bank would have the fiduciary
responsibilities of a trustee under U.S. trust law and
“failure to perform adequately could endanger a line
of business.”
Comparing the proposal to the deregulation of the
brokerage, air travel, trucking and telecommunications
industries, the authors conclude that U.S. investors would
benefit from deregulation of the fund industry through “lower
prices, greater efficiency, and more innovation.”
Proposal for New Structure
•
agree to manage the trust’s investments for a single,
all-inclusive fee.
Authors Address Questions
The authors participated in a panel discussion regarding
their study at a recent Mutual Fund Directors Forum
conference and addressed questions. The authors
acknowledged that in developed countries expense
ratios generally were higher than those in the U.S., but
the authors were unable to explain why these higher
fees existed in markets that they believed exhibited
greater price competition than the U.S. market. The
authors also noted that, the U.S. mutual fund industry
generally was very competitive but stressed that their
proposal could result in even lower expense ratios in the
U.S.
2
Director Donohue Reaches out to Fund
Directors and Makes Rule 12b-1 a High Priority
SEC Proposes Rules Expanding Use of
Interactive Data
In a recent speech at the ICI Mutual Funds and Investment
Management Conference, Andrew “Buddy” Donohue,
Director of the SEC’s Division of Investment Management,
expressed his commitment to undertake “a review of fund
director responsibilities under the Investment Company
Act” and his intention to “reconsider Rule 12b-1, both
the rule itself and the factors that fund boards must
consider when considering approval or renewal of a
Rule 12b-1 plan.”
The SEC recently proposed rule amendments that would
allow mutual funds, on a voluntary basis, to file with
the SEC risk/return summary information from their
prospectuses through the SEC’s interactive data
program using technology developed by the ICI. The
proposed rule amendments would allow mutual fund
risk/return information to be “data tagged” so that it
could become interactive and available to be searched
and analyzed through interactive means. In 2005, the
SEC adopted rules permitting filers, on a voluntary
basis, to submit certain interactive tagged data through
EDGAR. Under current rules, mutual funds are allowed
to file interactive data exhibits only in connection with
Form N‑CSR.
Revisiting Certain Director Responsibilities
Mr. Donohue, calling on the industry and regulators to
“get back to basics,” stated that he wants “to make sure
that we have not so overloaded fund boards that it is
difficult for them to effectively perform their oversight
role.” As a result, he noted that 2007 would be dedicated
“to undertaking a review of fund director responsibilities”
and to “reaching out to fund directors to hear from them
what the Commission can do to enable directors to be more
effective.” Specifically, Mr. Donohue expressed his interest
in exploring rule revisions “that are easy to do—i.e., quick
fixes—and important to do—i.e., not necessarily easy, but
could have significant impact.” He also asked directors
to help identify “areas in which fund directors could
benefit from additional guidance, in addition to fair
valuation and soft dollars.”
Interactive data submissions would be filed as
supplemental exhibits only and would not replace
current filing requirements. The proposed amendments
would extend the limited protection from liability for the
tagged risk/return information that currently is provided
for interactive data submissions. (Liability would remain
for official filings.) The release notes that, as with current
tagged data submissions, “participating in the voluntary
program would not create a continuing obligation for
a volunteer to submit tagged risk/return summary
information.” In addition to risk/return information, the
proposed amendments allow for the submission of tagged
financial highlights or condensed financial information. In
the SEC’s release, it states that increased use of interactive
data could (1) assist investors and others in analyzing
and comparing fund information, (2) help to further
automate filings, reducing fund costs, and (3) minimize
the potential for human error in data processing.
Rethinking 12b-1
Mr. Donohue also addressed Rule 12b-1 and identified
the rule as one of the matters that he “worries about.” He
observed that the fund industry is in a very different state
now than when the rule was adopted in 1980. He explained
that at that time, a period of net redemptions, prompted fears
that funds might not survive if they “were not permitted to
use a small portion of their assets to facilitate distribution.”
Today, he noted, “the primary use of 12b-1 fees has
shifted from the limited marketing and advertising
purposes that were originally envisioned,” with 12b-1
fees now used “primarily as a substitute for a sales load
or for servicing.”
Comments on the proposed rule amendments were due on
March 14.
ICI and IDC Comment on SEC Economic Papers
Relating to Fund Governance
The SEC’s Office of Economic Analysis (OEA) has
prepared studies relating to the SEC’s proposed rule
amendments on mutual fund board independence that
would require fund boards to appoint an independent chair
and be comprised of 75% independent directors. The
Investment Company Institute and the Independent
Directors Council (which is affiliated with the ICI) each has
issued a comment letter in response to these studies.
Stopping short of offering a concrete proposal for revising
Rule 12b-1, Mr. Donohue declared, “[w]hile I have previously
stated that this is something I would like to address during
my tenure with the Division of Investment Management, I
am announcing today that this is something that we will
address. This is now a high priority for the Division this
year.”
The ICI letter notes that “neither OEA study finds any
compelling evidence that independent chairs enhance
3
shareholder protections” and that “there is no consensus
as to the optimal percentage of independent directors
of a fund board.” In its letter, the ICI reiterates its concern
that “the costs of the board independence requirements
will disproportionately affect small fund organizations,
potentially increasing barriers to entry to the mutual fund
industry.” The ICI requests that the SEC “conclude [its]
rulemaking without further action.”
Like the ICI letter, the IDC letter also believes that the
OEA studies “do not provide economic support for the
position that the independent chair provision should be
adopted.” Unlike the ICI, the “IDC continues to support
the proposal to require a 75% majority of independent
directors.”
ICI Voices Concerns about NYSE Proxy Voting
Proposal
In a recent letter to SEC Chairman Christopher Cox, the
ICI urged the SEC to reject the NYSE’s proposal to
eliminate discretionary broker voting in uncontested
elections of directors. Referring to the significant costs
for funds under the proposed rule, the ICI recommended
that the SEC “take into account fully and carefully the cost
implications for the nation’s 94 million fund investors.”
Under current proxy voting rules, brokers are allowed
to vote shares on behalf of their clients on certain
“routine” proposals when the clients do not provide voting
instructions. In a recent NYSE newsletter, NYSE President
and Co-COO Catherine Kinney explained: “The goal of
the NYSE has been to not allow the broker to vote on any
proposal that substantially affects the rights of shareholders.
Today, the election of directors is just too important to
ever be considered routine, even when the election is
uncontested.”
While noting that the ICI has a long-standing policy of
supporting strong corporate governance, the ICI suggested
that the current proposal as applied to funds has “no
demonstrable benefits, and certainly none that come
close to off-setting its cost.” Specifically, the ICI asserted
that:
•
the proposal would cause “difficulties and
unnecessary costs … in achieving quorums” and
“related delays in electing fund directors,”
•
when directors seeking election are uncontested,
the “same directors in virtually every case will
be elected whether or not funds and their
shareholders bear these steep additional costs,”
•
•
the ICI “is aware of no fund shareholders who
voiced dissatisfaction of the current proxy voting
process as it relates to the uncontested election of
directors,” and
© 2007 Bell, Boyd & Lloyd LLP. All rights reserved.
A service to our clients.
the ICI does not believe the current process “entails
any detrimental effects on funds or fund governance.
As the old adage goes—if it ain’t broke, don’t fix it.”
In a related report on the costs of eliminating discretionary
broker voting, the ICI highlighted the difficulties investment
companies would face as a result of the proposed rule.
The NYSE proposal is subject to SEC comment and
approval. In its letter, the ICI urged the SEC to require
that all self-regulatory organizations, including the NYSE,
“perform an appropriate cost/benefit analysis prior to
submitting any regulatory proposal to the Commission.”
Investment Management and
financial MARKETS Group
Cameron S. Avery
312-807-4302
cavery@bellboyd.com
Alicia A. Perla
312-807-4318
aperla@bellboyd.com
Kevin R. Bettsteller
312-807-4226
kbettsteller@bellboyd.com
Andrew T. Pfau
312-807-4386
apfau@bellboyd.com
Kelly R. Bowers
202-955-7081
kbowers@bellboyd.com
Paulita A. Pike
312-781-6027
ppike@bellboyd.com
Paul H. Dykstra
312-781-6029
pdykstra@bellboyd.com
Bruce A. Rosenblum
202-955-7087
brosenblum@bellboyd.com
Jennifer C. Esquibel
312-807-4262
jesquibel@bellboyd.com
Laura E. Simpson
312-807-4219
lsimpson@bellboyd.com
Alan Goldberg
312-807-4227
agoldberg@bellboyd.com
Donald S. Weiss
312-807-4303
dweiss@bellboyd.com
Veena Jain
312-807-4287
vjain@bellboyd.com
Stacy H. Winick
202-955-7040
swinick@bellboyd.com
May 2007
Inside This Issue
Director Donohue
Reaches out to Fund
Directors and Makes
Rule 12b-1 a High
Priority - page 3
SEC Proposes Rules
Expanding Use of
Interactive Data page 3
ICI and IDC Comment
on SEC Economic
Papers Relating to
Fund Governance page 3
ICI Voices Concerns
about NYSE Proxy
Voting Proposal page 4
American Enterprise Institute Publishes Proposal to Eliminate Mutual
Fund Boards
Background
The American Enterprise Institute recently published Competitive Equity: A Better Way
to Organize Mutual Funds, a long-awaited study by Peter Wallison and Robert Litan that
proposes dramatic changes in the organization and governance of mutual funds. The
authors argue that the industry is in need of a major overhaul because price competition
among U.S. mutual funds is “weak and mutual funds are likely to be operating very
inefficiently.” The authors assert that “a primary goal of public policy should be to
ensure that nothing unnecessarily hinders fund managers from offering the lowest
possible costs to investors.”
The authors believe that the lack of competitive pricing among U.S. mutual funds is a
result of the current legal and regulatory framework. Pointing to the role of fund boards
in setting advisers’ fees, the authors assert that “the rate regulation by a board of
directors impairs the incentives of investment advisers to compete on price and
thus keeps expense ratios of mutual funds higher than they would be in a fully
competitive environment.”
To address the problem, the authors recommend a complete overhaul of the existing
framework: “the way to address the lack of price competition in mutual funds is
to abandon the current corporate structure and the role of the board in approving
the investment adviser’s fees and expenses….” The authors advocate eliminating
boards—their responsibilities for monitoring conflicts of interest would shift to a bank
trustee. The authors contend that “a more effective system than a part-time board of
directors can be put in place to address the conflicts of interest that may remain.”
Lack of Price Competition
Deborah M. Connor • Group Coordinator • 312-578-6034
dconnor@bellboyd.com
The authors assert that the mutual fund industry in the U.S. has not produced vigorous
price competition, claiming that “the expense ratios of funds that ostensibly compete
with one another vary widely.” The authors found that the expense ratios of class A
shares of 811 actively managed U.S. equity funds ranged from approximately 60 basis
points to 170 basis points, which represents a cost difference of almost 300%. In
comparison, a similar review of 456 funds in the U.K. showed a range in expense ratios of
127 basis points to 196 basis points, a difference of 54%.
Gwen C. Cooney • Paralegal • 312-558-7826
gcooney@bellboyd.com
Role of Boards in Price Regulation
Anna Paglia
312-781-7163
apaglia@bellboyd.com
IN TOUCH. IN SYNC. INVOLVED.
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The authors contend that in the U.S. “mutual fund pricing bears a strong resemblance
to the way rates are established by electric and other utilities.” They contend that
fund boards, as watchdogs for fund shareholders, function like utility rate commissions
in that they regulate the profits of advisers. A consequence of that practice, the authors
argue, is that “price competition and price convergence have not occurred in the
mutual fund industry because there is little incentive for investment advisers
to reduce costs.” The authors explain that if an investment adviser takes the risk of
lowering prices to attract new shareholders, and then succeeds in doing so, “part of
the profit associated with that risk—if the board of directors is diligent on behalf of the
shareholders—will be promptly taken away in the form of new breakpoints…” Therefore,