Fitzgerald, Levin, and Collins introduce bipartisan, comprehensive mutual fund reform legislation

Bogle calls bill ‘gold standard’ of reform

U.S. Sens. Peter G. Fitzgerald (R-Illinois), Carl Levin (D-Michigan), and Susan Collins (R-Maine) today announced the introduction of the most comprehensive legislation yet to reform the mutual fund industry. The bipartisan measure follows extensive hearings Fitzgerald chaired in the Governmental Affairs subcommittee on Financial Management, the Budget and International Security.

The Mutual Fund Reform Act of 2004 (“MFRA”) would enhance the appeal of mutual funds as a flexible vehicle for long-term investment. It would do so by terminating certain questionable fund industry arrangements and by simplifying and strengthening fund fee and cost disclosures.

MFRA does not seek to regulate mutual fund fees. Instead, MFRA seeks to liberate competitive market forces by making it easier for investors to compare costs between funds.

One of the most respected voices in the mutual fund industry described the bill as the “gold standard” of reform.

“I’ve spent the greater part of my career speaking out on nearly all of the important legislative issues that Senator Fitzgerald’s Mutual Fund Reform Act of 2004 addresses,” said John Bogle, founder and former CEO of The Vanguard Group. “While nothing can solve the industry’s problems overnight, I view the bill as the gold standard in putting mutual fund shareholders back in the driver’s seat, and endorse it in its entirety.”

Fitzgerald said that the bill, if enacted, would help restore the integrity of the mutual fund industry. It could save investors billions of dollars annually and would dramatically enhance the amount of retirement savings for many long term investors.

“Shareholders would be the big winners under this legislation,” Fitzgerald said. “The losers would be high cost mutual funds. The bill would require funds to disclose all of their costs, including transaction costs. By making it much easier for shareholders to compare funds on an apples-to-apples basis, the bill would unleash competitive market forces that have until now been bottled up by an obscure and misleading disclosure regime.”

Senator Levin emphasized the importance of eliminating questionable industry practices such as soft dollar arrangements, directed brokerage and revenue sharing. “Mutual funds are a $7 trillion engine of investment for the US economy, and we need to ensure investors in those funds get honest investment advice and reasonable fees if we are to keep that engine humming,” said Sen Levin. “The goal of honest advice requires ending the conflicts of interest that exist in current practices involving directed brokerage, revenue sharing and soft dollar arrangements, which too often taint mutual fund investment advice and drive up fees for average investors. Our bill is intended to end those conflicts of interest and to protect the interests of investors.”

“This legislation also would help to protect the good, hardworking, middle-income families who are doing their best to plan for retirement or pay for their children’s education by investing their savings in mutual funds that are promoted as a safe haven for small investors,” said Sen. Collins. “Of all the components of the financial industry, the mutual funds sector has perhaps the greatest responsibility to safeguard the interests of small investors.”

Directed brokerage occurs when a mutual fund agrees to use a brokerage firm to buy stock for its holdings if that brokerage firm promotes the fund’s shares to its other customers. In revenue sharing, the mutual fund gives the brokerage firm a share of its revenues if the firm’s brokers promote the mutual fund’s shares to their customers. With soft dollar arrangements, a mutual fund pays a brokerage firm for research or other services, in the expectation that the firm’s brokers will promote the fund’s products. Notably, MFRA would statutorily repeal SEC Rule 12b-1, which has been in place since 1980 and which permits funds to debit shareholders’ accounts to pay distribution expenses. The original theory behind Rule 12b-1 was that it would help funds to increase their size so that cost savings from economies of scale could be passed along to investors. Testimony at the subcommittee’s hearings showed, however, that Rule 12b-1 has been a bonanza for brokers and advisors but has not succeeded in lowering fund costs for shareholders. Since 1980, the fund industry’s total assets have increased by some 60 times, but costs have increased even more – by some 90 times.

Further testimony revealed that nearly two-thirds of 12b-1 fees are paid to brokers. In other words, 12b-1 fees have largely degenerated into disguised loads. Some 12b-1 fees are as high as 1 percentage point per year. Over the life of a retirement plan, that 1% annual 12b-1 fee can cost an investor 35% to 40% of his or her retirement income.

Importantly, MFRA does not prohibit distribution expenses or sales charges. MFRA permits charging a load subject to NASD rules. As Fitzgerald stated, “There’s nothing wrong with an honest load, but funds should call a load a load, make it account-based, and not disguise it as a permanent asset-based distribution fee.”

The Fitzgerald-Levin-Collins proposal also strengthens and clarifies the fiduciary duties fund directors and fund advisors owe to fund shareholders. MFRA has three titles: Fund Governance, Fund Transparency and Fund Transactions.

Attachments Below:

Summary of Key Provisions [PDF]
White Paper describing each of the provisions in detail [PDF]