June 30, 2000

The Honorable Arthur Levitt, Jr.
Chairman
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Dear Chairman Levitt:

We are writing with reference to the enclosed report by the U.S. General Accounting Office (GAO), Mutual Fund Fees: Additional Disclosure Could Encourage Price Competition (GAO/GGD-00-126, June 7, 2000), which was prepared at our request. GAO conducted an exhaustive study of data and information collected from SEC, NASDR, the federal bank regulators, the Investment Company Institute, the American Association of Individual Investors, Morningstar, Lipper, Standard & Poor’s, and a broad cross section of the mutual fund industry and academia. The resulting 125-page report discusses (1) the trend in mutual fund advisers’ costs and profitability, (2) the trend in mutual fund fees, (3) how mutual funds compete, (4) how their fees are disclosed to investors, and (5) the responsibilities that mutual fund directors have regarding fees.

In sum, GAO found conflicting views as to whether the fees that funds charge investors have declined as much as they should have given the operational efficiencies that mutual fund advisers likely experience as their fund assets grow. GAO found that many large funds had reduced their operating expense ratios between 1990 and 1998, but this decline did not occur consistently over this period, and not all funds reduced their expense ratios. Furthermore, GAO found that not all of the largest funds with the greatest asset growth had reduced their fees. We have enclosed a staff summary of GAO’s principal fee findings. GAO also found limitations in the mechanisms that regulators currently rely on to influence fee levels, concluding, for example, that "competition in the mutual fund industry is not generally price-based and thus may not be strongly influencing fee levels" and that opinions about fund directors’ effectiveness as a check on fees "varied," while reforms proposed by regulators "are not likely to have a significant impact on fees because most funds already have many of the proposed reforms in place and their purpose is to generally enhance director effectiveness and did not specifically address fees" (pp. 96-97).

The major conclusion of this GAO report is that additional targeted disclosure would help increase investor awareness and understanding of mutual fund fees and promote additional competition by funds on the basis of fees, as has occurred with brokerage commissions and other financial services. The mutual fund and regulatory officials GAO contacted generally considered mutual fund disclosures to be extensive and adequate for informing prospective investors of the fees they would likely incur on their mutual fund investments. However, GAO reports that some private money managers, industry researchers, and legal experts indicate that the current fee disclosures are not making investors sufficiently aware of the fees they pay (p. 13). GAO reviewed the existing disclosures. The report concludes that "the information that is disclosed in mutual fund prospectuses and annual reports allows investors to compare the relative fees and expenses charged by differing funds. However, while mutual fund statements show the dollar amounts of any transaction fees deducted from shareholder accounts, they do not disclose the actual dollar amounts of each investor’s share of the fund’s operating expenses" (p. 96).

On the basis of these findings, GAO recommends that the SEC require that the quarterly account statements that mutual fund investors receive include information on the specific dollar amount of each investors’ share of the operating expenses that were deducted from the value of the shares they own. Because these calculations could be made various ways, GAO recommends that SEC consider the costs and burdens that various alternative means of making such disclosures would place on either (1) the industry or (2) investors as part of evaluating the most effective way of implementing this recommendation. In addition, where the form of these statements is governed by rules of the NASD, GAO recommends that SEC should ensure that NASD requires mutual funds to make such disclosures.

GAO solicited comments on a draft of this report from SEC, NASDR, and ICI and those comment letters are included in this report (see Appendices I-III, pp. 102-124). The Director of SEC’s Division of Investment Management writes that the GAO report "raises important issues concerning the impact of mutual fund fees on investors" and agrees that "investors need to be aware of and understand the fees that mutual funds charge." The letter also indicates that SEC staff "welcome the report’s recommendation and suggestions, and will consider them carefully" (p. 102). The NASDR comment letter agrees that investors should consider fees, expenses, and other issues in addition to performance in making investment decisions (p. 111). ICI commented that this report "makes a significant contribution to this important subject" (p. 117). However, to varying degrees, all three organizations raised reservations about, or, in the case of ICI, strong opposition to, GAO’s recommendation for enhanced disclosure.

We find GAO’s response to this criticism compelling and we refer it to you:

"The additional disclosure we recommend is intended to supplement, not replace, the existing disclosures, and should serve to reinforce to investors the fact that they do pay for the services they receive from their mutual funds. The specific dollar amounts we recommend that funds disclose should also have the added immediacy of being unique to each investor and his or her account. By disclosing these additional dollar amounts on investors’ quarterly account statements, funds will provide fee disclosures to investors more frequently than they currently do" (p. 110).

"Although the disclosures that mutual funds make are comprehensive and useful for investors in comparing the relative fees charged by different funds, the information in them discloses fees in percentage terms and uses hypothetical examples, which are less direct indications of the specific prices charged to any one investor. In our report, we cite five examples of other common financial services or transactions with which most mutual fund investors are also likely to be familiar, such as checking accounts, stock brokerage, or bank trust services. These services disclose in periodic statements the specific fees in dollars charged to customers. As we point out, mutual funds do not similarly provide specific dollar amounts of charges on the periodic statements they provide to individual investors" (p.124).