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Rating:SEC Hones in on Fund POS, Disclosure Not Rated 0.0 Email Routing List Email & Route  Print Print
Thursday, February 17, 2005

SEC Hones in on Fund POS, Disclosure

Reported by Theresa Sim

In addition to outstanding redemption fee and late trading proposals, the SEC is focusing on revising fund point of sale disclosure. SEC Chairman William H. Donaldson, addressing the Mutual Fund Directors Forum on Wednesday evening, highlighted "straightforward, simple disclosure" as an important priority at the commission.

Part of that disclosure also includes informing investors of how funds are sold and how brokers are compensated for sales, said Donaldson. "As an initial matter, we intend to complete our point of sale initiative and take up an initiative to better inform investors about mutual fund transaction costs," said Donaldson.

The SEC staff is currently also engaged in a "comprehensive review of the mutual fund disclosure regime," said Donaldson. "Few would disagree that many mutual fund disclosure documents are too long and complicated. Investors need disclosure that is clear, understandable, and in a usable format in order to make informed investment decisions," he added.

For the full text of Donaldson's remarks, see below.

Remarks by William H. Donaldson
Chairman of the Securities & Exchange Commission
before the Mutual Fund Directors Forum
February 16, 2005

Good evening. Let me begin by thanking the Mutual Fund Directors Forum for giving me an opportunity to speak tonight. In a very short time, the Forum has come to occupy an important place in the mutual fund world - helping to focus independent directors on their role in protecting fund investors, while also providing a forum for communication among independent directors and many valuable opportunities for professional development and educational advancement. David Ruder and Allan Mostoff, in particular, have done superb work in ensuring that the Forum has hit the ground running. Their success in bringing together so many leading figures from the fund community for this conference underscores their ongoing commitment to improving mutual fund governance.

In addition, the Forum played a critical and high-profile role last year providing support for the SEC's mutual fund reform efforts. As you know, our reforms were not always welcomed by everyone in the fund industry, but the support you gave as independent fund directors lent credibility to the need for reform and the importance of strengthening the internal fund governance and oversight system. In the period ahead, fund investors will be better off because many of your members were willing to take a stand on investors' behalf and support much-needed reforms.

Tonight, I would like to discuss the Commission's mutual fund agenda and the role that you, as independent directors, can continue to play in reinforcing that agenda. I will keep my prepared remarks short, so that I can take your questions and hear your comments. Before going any further, however, let me issue the standard disclaimer that the views I express here tonight are my own and do not necessarily represent those of the Commission or its staff.

Recent Commission Actions

As you all know so well, the past 18 months have been a difficult and troubling period for the mutual fund industry. One indicator of the industry's troubles has been the Commission's enforcement actions. During this period, the Commission has brought 61 cases related to mutual funds and levied approximately $1.4 billion in disgorgements and $1 billion in penalties. Unfortunately, these numbers demonstrate how mutual fund managers violated the trust handed to them by the individuals who invest in mutual funds.

Investors are unlikely to forget this period - nor should they. "Capital will always go where it is welcome," said my old friend Walter Wriston, former Chairman of Citigroup, "and stay where it is well treated." Sadly, Walt Wriston passed away recently, but his timeless observation will live on. In the months and years ahead I hope the Commission and independent directors can cooperate to help the fund industry regain investors' trust and confidence. Let me give a quick review of what we have accomplished so far.

A centerpiece of our efforts has been fund governance reform and enhanced internal oversight of fund activities. As you all know, last year the Commission approved reforms requiring that funds, relying on certain exemptive rules, must have an independent chairman, and 75 percent of board members must be independent. These reforms will enhance the critical independent oversight of the transactions permitted by these exemptive rules.

As I have said before, I believe that a management company executive who sits as chair of a fund's board is asked to do the impossible-serve two masters. There are times when the executive's duties to the management company and its shareholders simply conflict with what is in the best interest of fund investors. This is the case, for instance, when fund boards review many of the transactions permitted by our exemptive rules. I believe that an independent chairman and a 75% majority of independent directors level the playing field on behalf of fund investors and blunt the control and dominance that many management companies historically have exerted in fund boardrooms. Our fund governance reforms serve as a capstone to our reform agenda and will facilitate the effective implementation of other mutual fund initiatives the SEC has adopted and will put forward.

One of these reforms is the new compliance policies and procedures rule, and the chief compliance officer requirement. I encourage you to work closely with your chief compliance officers and highlight for them - and for all of fund management - the compliance-oriented atmosphere that you expect fund management firms to foster.

We are committed to working closely with chief compliance officers and enhancing their ability to oversee compliance at fund firms. You can be sure that we will be working hard to come up with systems to work with and enhance the efforts of these compliance officers. CCOs perform a critical oversight function, and we want to support them in their efforts.

It is in this spirit that I have asked the leadership of our Division of Investment Management and our Office of Compliance Inspections and Examinations to explore ways that we can enhance our communication and outreach with CCOs. As independent directors, you must work very closely with CCOs, and I welcome any ideas you may have as we develop and expand on our outreach efforts.

Another of our recent reform initiatives will help to foster an ethical, compliance-oriented atmosphere by requiring that all registered investment advisers, including advisers to funds, adopt a code of ethics. As directors, you should be reviewing the ethical limits that advisory firms place on their employees. In addition, you should consider whether fund investors' interests are taken into account when advisers establish their internal standards of ethical behavior.

As you are aware, our reform agenda has also focused on improving the information fund investors receive, so that they can meaningfully examine the operations of a fund and its board. Recent initiatives include enhanced disclosure of market timing; disclosures regarding fair value pricing and selective disclosure policies and procedures; dollars-and-cents expense disclosure in shareholder reports; and improved disclosure regarding portfolio managers and their potential conflicts of interest.

The new disclosure that most directly affects you is the requirement that a fund's annual report include a discussion of the considerations a fund board took into account when voting to approve or renew a management contract. We are expecting that a report on your discussions, in shareholder reports, will bring clarity to your deliberations and the factors you considered when voting.

As part of our reform agenda, we have also revamped the SEC's oversight function. With limited resources, in an expanding world of responsibilities and challenges, we are seeking to create an enhanced oversight regime that will equip the Commission to better anticipate, find, and mitigate areas of financial risk, potential fraud, and malfeasance.

The effort is designed around our Office of Risk Assessment, which brings together professionals experienced in seeking out potential areas of concern. We want our efforts and oversight to be more anticipatory and preventative in nature - to look over the hills and around the corners of the securities markets.

A prime example of this forward-thinking approach was the SEC's hedge fund adviser registration initiative. It will enable the Commission to gain greater insight into the activities of hedge fund advisers, at a time when hedge funds are growing in size and influence in the securities markets. We need to know more about the activities of hedge fund managers and the impact their trades have on the "other side of the transaction."

More generally, we need smarter, more efficient oversight of mutual funds, hedge fund managers, and other investment advisers. A Commission task force is examining how we can strengthen oversight, and as this work continues we will welcome your input.

The Road Ahead

Turning to issues that the Commission may be taking up in the months ahead, the staff is preparing a recommendation regarding the pending 2 percent redemption fee proposal, to help curb market timing. Specifically under consideration is whether a voluntary, or mandatory, approach would be more effective and more equitable.

The Commission staff is also continuing to review how we can combat late trading, perhaps through a mix of technological controls and third-party audits. Our goal is to find an effective solution that does not penalize everyday investors.

There are several other issues which the Commission has under review, including soft dollars and potential revisions to rule 12b-1. On both of these issues, we welcome observations and suggestions from independent directors.

The final issue I'd like to mention is mutual fund disclosure reform. As part of the Commission's ongoing point of sale initiative, we have received helpful input from investor focus groups. These focus groups have delivered one unmistakable message: investors want straightforward, simple disclosure about their mutual fund investments. We continue to search for the best method of informing investors about broker conflicts and compensation. Ideally, we'd like to minimize the costs to the broker-dealer and fund industries, and prevent investors from receiving so much information that they end up ignoring all of it.

We will strive to use input from investors to fashion a mutual fund disclosure regime that better serves the needs of fund investors. As an initial matter, we intend to complete our point of sale initiative and take up an initiative to better inform investors about mutual fund transaction costs.

From a broader perspective, I have asked the staff to carry out a comprehensive review of the mutual fund disclosure regime and how we can maximize its effectiveness on behalf of fund investors. Few would disagree that many mutual fund disclosure documents are too long and complicated. Investors need disclosure that is clear, understandable, and in a usable format in order to make informed investment decisions.

We also need to examine ways that we can make better use of technology, including the Internet, in our disclosure regime. In this regard, nothing will be off the table--and we welcome your input and ideas. As fund directors, you have an appreciation of the needs of mutual fund investors and an understanding of how best to communicate with them. I hope that mutual fund directors can be active participants in the mutual fund disclosure reform process, and we look forward to working with you on this critical initiative.

The Role of Independent Directors

Having touched on a number of important Commission initiatives, let me turn to your role as independent directors. There are at least four vital principles for fund directors: first, to enhance your oversight functions; second, to always serve as investor advocates in the boardroom; third, to stand up to management as appropriate; and finally, to help shape mutual fund regulatory policy.

Starting with oversight, independent directors must be committed to their watchdog role, particularly given your position as frontline gatekeepers. All of you, as fund directors, have a critical role to play in helping to restore investor confidence, and you are responsible for overseeing implementation of many of our new rules. These new rules are but the latest reminder that the job of an independent fund director is not for the inattentive. It requires time, commitment, and dedication.

The independent director role also is not for the faint of heart. Mutual fund investors rely on your vigilant oversight to ensure the responsible management of their assets. Your responsibility is significant - and the consequences if you fail can be severe, especially for the investors you are charged with protecting.

Second, you must serve as investor advocates. I am pleased to see the work of the mutual fund industry to rebuild its reputation for integrity, but it is really you, the independent directors, who are intimately involved in overseeing the workings of the industry - from the inside. You are well-positioned to protect investors, and have a unique opportunity to do so because of your boardroom access. You can guide decisions and promote a focus on investors' interests.

This leads into my third point, regarding your relations with management. As you focus your board discussions on the needs and interests of investors, remember that you have more than the power of words. You also have the power of your vote. Use it wisely, and withhold it or vote "no," if necessary. Don't support an initiative for the sake of expedience or efficiency if you believe there could be negative implications for fund investors.

In addition, it is your job to hold management accountable for fund performance. You should actively review the investment performance of the funds you oversee and compare their performance to appropriate benchmarks and groups of peer funds. If a fund is accumulating new assets at a rate that impedes the orderly and effective management of those assets, you may need to re-focus management's attention from asset gathering to portfolio management. It may even necessitate closing a fund to new investors. Such an action can represent a conflict for fund managers who may have a continuing desire to increase assets and thereby increase their management fees. This is precisely the kind of situation that requires independent directors to step in and take decisive action for the benefit of investors.

Fourth, I urge you to continue to help shape mutual fund regulatory policy and further these policies. The report published by the Forum last July on best practices and practical guidance for mutual fund directors provided a great service to both fund directors and fund investors who benefit from effective director oversight. By addressing a number of critical areas of director responsibility, the report complements the Commission's regulatory agenda. I would again like to thank the leaders of the Forum and all of the independent directors who fashioned the recommendations contained in the report for your willingness to take on this important task.

I encourage Forum members to continue to identify areas where additional best practices or industry standards should be established. The mutual fund industry is constantly evolving, and you are ideally suited to help identify new trends and practices. In this regard, I have been pleased to see the recent work of the ICI's Independent Directors Council in developing guidance for boards as they implement the new independent chairman requirement and address the issue of board self assessments. It is my expectation that these guidelines will complement the Forum's own best practice recommendations in these areas.

From my perspective, fund directors and fund investors benefit greatly from these efforts and I encourage you and your fellow independent directors to continue your impressive record of developing best practices and other guidelines for yourselves.

Of course, independent directors and the groups that represent them may have differences of opinion from time to time on the proper course for mutual fund regulatory policy or the appropriate guidance that should be provided to fund directors. It is my hope that at all times these differences will be grounded in a desire to promote what is best for America's investors-and that the existence of two fund directors groups will result in a healthy and constructive dialogue.

Finally, director education programs such as this one are more important than ever, and I hope the education function of the Forum will continue to be one of your core missions, especially as directors work to implement the Commission's recent reform initiatives. Hopefully you will also work to hone director oversight skills so that we can avoid a repeat of the anti-investor activities that have been uncovered over the past 18 months.


I recognize that significant changes have been ushered in since I addressed the Forum last year, and that there is an increased focus on director responsibilities. I hope and believe that the most troubling revelations about the mutual fund industry are behind us. Yet we must remain vigilant, and as the Commission moves forward with its reform agenda we look forward to working with the Forum to reach our common goals.

Going forward, we all must be mindful of the vital role mutual funds play as the primary investment vehicle of average Americans. When looking to prepare for retirement, save for educational expenses or meet other investment goals, investors increasingly turn to mutual funds. As new investment programs are developed, including IRAs, 401(k) plans and so-called section 529 college savings plans, mutual funds often serve as core components. The trust that investors have placed in funds makes it all the more important that managers operate them in an ethical manner, for the sole benefit of fund investors. This places a heavy burden on fund directors to oversee fund service providers, manage conflicts of interest and inculcate a boardroom culture where investor interests are paramount. While admittedly not easy, I believe you are up to this important challenge.

Thank you very much. I would be glad to take your questions and hear your observations.

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