Thank you, Mr. President. I rise today to introduce legislation intended to restore public trust in mutual funds, the Mutual Fund Transparency Act of 2003. I thank Senator Fitzgerald and Senator Lieberman for cosponsoring my bill. I greatly appreciate the efforts of Senator Fitzgerald to address this issue. Our Financial Management, Budget, and International Security Subcommittee held a very thorough hearing on mutual fund trading abuses on Monday. I applaud the efforts of Representative Richard Baker for his leadership and his efforts to improve mutual fund governance. I also commend the efforts of New York Attorney General Eliot Spitzer and the Secretary of Massachusetts William Galvin for their efforts to pursue individuals that have harmed mutual fund investors.
Mr. President, 95 million people have placed a significant portion of their future financial security into mutual funds. Mutual funds provide middle-income Americans, blue and white collar workers and their families, with an investment vehicle that offers diversification and professional money management. Mutual funds are what average investors rely on for retirement, savings for children's college education, or other financial goals and dreams.
My legislation will bring about structural reform of mutual fund governance and increase disclosures in order to provide useful and relevant information to mutual fund investors. I ask unanimous consent that a joint letter of support for my bill from the Consumer Federation of America, Fund Democracy, Consumer Action, U.S. Public Interest Research Group, and Consumers Union be inserted into the Record. I also ask unanimous consent that a letter of support for the legislation from AARP be inserted into the Record.
Mr. President, recent revelations of widespread market-timing and late-trading abuses demonstrate the failures of mutual fund boards of directors to fulfill their fiduciary obligations to shareholders. The activities of Canary Capital Partners and Putnam Investments are two deeply troubling examples. However, it is likely that the trading abuses are much more routine. At our hearing, Mr. Stephen Cutler, Director, Division of Enforcement, Securities and Exchange Commission (SEC), testified that preliminary results of a SEC survey show that about "50 percent of responding fund groups appear to have one or more arrangements with certain shareholders that allow these shareholders to engage in market timing." This statistic is just one example of mutual funds having different sets of rules for large and small investors. These differing rules allow the larger investors to profit at the expense of average, ordinary investors who are working toward their long-term financial goals.
The transgressions that have been brought to our attention make it clear that the boards of mutual fund companies are not providing sufficient oversight. Attorney General Spitzer stated in his testimony that "As the investigations continue, it is important for us to focus not only on what happened but also why it happened. As more details emerge, I believe that it will become clear that a large part of the problem - and thus an issue that must necessarily be addressed when formulating solutions - is the conflict of interest facing mutual fund directors." Mr. President, boards must be called on to restore trust in the mutual fund industry.
To be more effective, the boards must be strengthened and more independent. Investment company boards should be required to have an independent chairman and independent directors must have a dominant presence on the board. My bill strengthens the definition of who is considered to be an independent director. It also requires that mutual fund company boards have 75 percent of their members considered to be independent. To be considered independent, shareholders would have to approve them. My legislation also prohibits the board from making decisions that require a vote of a non-independent director. In addition, a committee of independent members would be responsible for nominating members and adopting qualification standards for board membership. These steps are necessary to add much needed protections to strengthen the ability of mutual fund boards to detect and prevent abuses of the trust of shareholders.
In addition, this bill requires the SEC to develop rules to disclose the compensation of individuals employed by the investment advisor of the company to manage the portfolio of the company and their ownership interest in the company. Consumers deserve to know relevant information about the portfolio manager's incentives and whether they are properly aligned with those of their shareholders. And again, I am referring to ordinary American families patiently working toward their long-term financial goals.
Mr. President, my legislation requires the SEC to conduct a study to determine whether the best interests of mutual fund investors would be served by the creation of a Mutual Fund Oversight Board that has inspection, examination, enforcement, and rule making authority over mutual fund boards of directors. During our hearing, Mr. Mercer Bullard, president and founder of Fund Democracy, recommended the creation of such a board that would be "charged with identifying potential problems in the fund industry and ensuring that fund boards are actively addressing these problems before they spread." I believe this is an idea with a lot of merit and needs to be explored as an option for improving the corporate governance of mutual funds.
Mr. President, the strengthening of boards to protect shareholders is only one important aspect of my bill. My bill will also increase the transparency of often complex financial relationships between brokers and mutual funds in ways that are meaningful and easy to understand for investors.
Mr. President, shelf-space payments and revenue-sharing agreements between mutual fund companies and brokers present conflicts of interest that must be addressed. Brokers also compile preferred lists which highlight certain funds, which typically generate more investment than those left off the list. It is not clear to investors that the mutual fund company also may pay a percentage of sales and or an annual fee on the fund assets held by the broker to obtain a place on the preferred list or to have their shares sold by the broker.
Shelf-space and revenue sharing agreements present risks to investors. Brokers have conflicts of interest, some of which are unavoidable, but these need to be disclosed to investors. Without such disclosure, investors cannot make informed financial decisions. Investors may believe that brokers are recommending funds based on the expectation for solid returns or low volatility, but the broker's recommendation may be influenced by hidden payments.
Mr. President, the SEC has exempted mutual funds from Rule 10b-10, which requires that confirmation notices of securities transactions be sent to customers to indicate how the broker was compensated in the trade. Mutual funds should be subject to this confirmation notice requirement. My legislation will require brokers to disclose in writing, to those who purchase mutual fund company shares, the amount of compensation the broker will receive due to the transaction, instead of simply providing a prospectus. The prospectus fails to include the detailed relevant information that investors need to make informed decisions. Mutual fund investors deserve to know how their broker is being paid.
Mr. President, my bill also will inject a measure of reality into the expenses of mutual funds. In order to increase the transparency of the actual costs of the fund, brokerage commissions must be counted as an expense in filings with the SEC and included in the calculation of the expense ratio, so that investors will have a more realistic view of the expenses of their fund. Consumers often compare the expense ratios of funds when making investment decisions. However, the expense ratios fail to take into account the costs of commissions in the purchase and sale of securities. Therefore, investors are not provided with an accurate idea of the expenses involved. Currently, brokerage commissions have to be disclosed to the SEC, but not to individual investors. Brokerage commissions are only disclosed to the investor upon request. My bill puts teeth into brokerage commission disclosure provisions and ensures that commissions will be included in a document that investors actually have access to and utilize.
This bill also creates a powerful incentive to reduce the use of soft dollars. Soft dollars refer to the bundling of services or products into commissions. Mutual fund companies often pay higher commissions in order to obtain other products and services, typically research on stocks. Soft dollars can be used to lower their expenses by having services and products paid for by soft dollars. Most purchases using soft dollars do not count as expenses and are not calculated into the expense ratio. The SEC released a study in September 1998 concluding that soft dollars were used to pay for research, salaries, office rent, telephone services, legal expenses, and entertainment, among other expenses.
At the hearing, Secretary Galvin called for a prohibition of soft dollars. This is a recommendation that needs to be examined. However, my bill provides an immediate alternative, which is to provide an incentive for funds to limit their use of soft dollars by calculating them as expenses. If commissions are disclosed in this manner, the use of soft dollars will be reflected in the higher commission fees and overall expenses. This will make it easier for investors to see the true cost of the fund and compare the expense ratios of funds.
Some may argue that this gives an incomplete picture and fails to account for spreads, market impact, and opportunity costs. However, the SEC has the authority to address the issue further if it can determine an effective way to quantify these additional factors. This bill does not impose an additional reporting requirement that would be burdensome to brokers. It merely uses what is already reported and presents this information in a manner meaningful to investors.
Mr. President, my legislation also directs the SEC to conduct a study to assess financial literacy among mutual fund investors. The SEC will identify the most useful and relevant information that investors need prior to purchasing shares, methods to increase the transparency of expenses and potential conflicts of interest in mutual fund transactions, and a strategy to increase the financial literacy of investors that results in positive change in investor behavior. None of our disclosure provisions will truly work, Mr. President, unless investors are effectively given the tools they need to make smart investment decisions.
Finally, my bill requires the General Accounting Office (GAO) to study the current marketing practices for the sale of shares of mutual funds. GAO will provide recommendations to improve investor protections in mutual fund advertising to ensure that investors are able make informed financial decisions when purchasing shares.
Public confidence in mutual funds will not recover if funds continue to employ different sets of rules for large and small investors, engage in ethical misconduct, and enrich themselves at the expense of shareholders. The transgressions brought to light underscore the absence of effective oversight by the boards of mutual fund companies. This legislation will strengthen board independence and enhance the transparency of financial relationships. The American investing public deserves nothing less.
Mr. President, I look forward to working with my colleagues in enacting meaningful reform of the troubled mutual fund industry. We must act to restore trust in this critical investment vehicle that people rely on for their financial future and goals. I ask that the text of the "Mutual Fund Transparency Act of 2003" be printed in the Record following my remarks.
Thank you, Mr. President.
