TESTIMONY OF

ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION

CONCERNlNG TRANSPARENCY IN THE UNITED STATES . .

DEBT MARKET AND MUTUAL FUND FEES AND EXPENSES

BEFORE THE SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS

u.s. HOUSE OF REPRESENTATIVES

SEPTEMBER 29, 1998

u. S. Seauities and Exchange CommIssion 450 Af1h Street. N.W. VV~n,O.C.~9

SUMMARy OF TESTIMONY ARTHUR LEVl'rr, CHAIRMAN

U.s. sECURITIES AND EXCHANGE COMMISSION

This testimony discusses the level of price transparenc:y for corporate debt and mutual fund fees and expenses, both key issues of concerns for investors.

Bond Market TranJpart1l!;l

An SEC sta1freview of the state ofprice tranSparency in the U.S. market for debt securities found that price tnmsparency in the corporate bond market is less than that in the markets for government securities and, increasingiy, municipal securities. To address this problem, the Commission is calling on the National Association of Securities Dealen to take three steps:

• Adopt rules requiring dealers to report all transaCtions in U.S. corporate boods aDd pref~ed stoeb to the NASD, and to develop systems to receive and redistribute transaction prices on an immediate basis.

• Create 8. database of transactions in corporate bonds aDd prefened stocks.

• Create a surveillance program to better detect fraud in these markets.

The Commission intends to workc1ose1y with the NASD and the in4ustry to achieve greater price transparency in the corporate debt market.

Matpal had Fees

Fund fees have a dramatic effect on an investor's recum. A 1% umual fee, for c:umple, will reduce 111 eacfing ICCOUDt balun by 1m em 111 illveshlleat held. for 20 years. Mutual fund fees ~ ememe1y important, particulady DOW that ordiDaIy Americans - almost 40 "mil1lion of them - are relying on mutual fimds to fin,," the American dream.

Historlcally, Congress and the Commission have takm a ~ 8ppRSICh . to iDvestor protcctiolL Fmt, rtcluce conflicu ofinterest that eouhl result in exc:eaiYe charges. SecoDd, require that mutual fund feca be fully discloaec! 10 that iDves&on OlD.

make informed decilioDL ADd third, let: market CX)mpetitiOD, DDt sovc:mmeat iDt.erveDticm. ID5Mr the question ofwbetber any mutual fuDd', &a are too high or low.

The Commission raJUIins vigilam on bebalf' ofiDves&on in ita ovenisbt of ·null fund fees and expeDIeI. TU Commiasiou'l receat iDitiativea iDChldc~

•

-Increased focus on investor education about mutual fund fees;

• Use of public forums to inaease industry attention to fund fees~

• Inspections focused on fund f~

• A study of the trends in mutual fund fees; and

• A review of the role of independent directors in setting fund fees.

TESTIM:ONY OF

ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION

CONCERNING TRANSPARENCY JN THE UNITED STATES DEBT MARKET AND MUTUAL FUND FEES AND EXPENSES

BEFORE THE SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS

u.s. HOUSE OF REPRESENTATIVES

SEPTEMBER 29, 1998

u. s. Securities and Exchange Commlssion 450 Rfth Stree~ N.W.

Washington. D.C. 20549

TESTIMONY OF AR'I'IIlJR LEvm, CIIAIRMAN

U.S. SECURITIES AND EXCHANGE COMMISSION

CONCERNING TRANSPARENCY IN THE UNITED STATES DEBT MARKET AND

MUTUAL FUND FEES AND EXPENSES

BEFORE THE SUBCOMMII'I'EE ON FINANCE AND HAZARDOUS MATERIALS

CO:MMII"fEE ON COMMERCE U.S. HOUSE OF REPRESENTATIVES

September 29, 1998

Chainnan Oxley, Representative Manton and Members of the SubcoJDJDUtee:

I appreciate the opportunity to appear before this Subcommittee to testify on .

behalf of the Securities and Exchange Commission \Commission") coDCemiDg two key

issues for investors - the level oftranspareocy in the United States debt ma.rIcet aDd

mutual fund fees and expenses. I will begin with a discussion of debt market

transparency.

L DEBT MARKET TRANSPARENCY

A. IatrodactioD aDd SulllllWy

The Commission has long promoted eflicieacy and fairness in the U.S. capital

markets, including the debt markets. In that tradition, earlier this year •. the Comriaion

staff' conducted a review of the market for debt securities in the Uaited Stat.. with

The Commission sta1l's review found that, as a whole, the market for government

securities is characterized by bigh-quality pricing information for investors. The review

also cited significant improvement ovetthe last few years in the transpareDcy of the

municipal securities market. However, in the area of corporate bonds, the Comrrrission

staff found that price transpa.rency is deficient.

Consistent with the findings of the staffs review, the Commission is requesting

that the National As.,cociation of Securities Dealers do three things:

Fant, adopt rules requiring dealers to report all transacrioDS in U.S. corporate bonds and prefem:d stocb to the NASD and to develop systems to receive aDd redistribute transaction prices on an immediate basis;

Sec.on~ aeate a database of transactions in corporate bonds aDd prefenecl aocb. This will enable ~n to take a proactive role in supervising the corporate debt market, rather than just reacting to complaiDts brought by investors; aud

Third, in conjlm:tiOD with the development of a database, create a surveiIIaDce program to better detec:t fraud in order to foster investor confideDce in the faimess of these marla:u.

The NASD has said that it will move fotward on all oftbese recolIgncnd.timl.\ which are

B. History 0( the U.s. Boad Market

The boad IJJIZb:t bas played an impcxbWt role in this CIOUIIIrYs ~I_ frca

the very first days of the republic. 1be New Yen Stock&c:ha"F, in fIct, mgirPted in

1792 as & boDd exc:hange Fortbe fir;t time, scc:uritics issued bytbc DeWumted SUta

a'CIte a DeW mooey supply. but be me iabcl the iImatI of-waldly ~ 10 die

&Ie of die DI:'W CDUDtry.

l

As American corporations formed and evolved, a market for the issuance of

corporate bonds followed suit. Between 1850 and the early 1900's,-railroad company

bonds dominated the corporate debt market. At the same time, an expanding number of

public utilities and industrial corporations were also issuing bonds. Between 1900 and our

entry into World War 1, corporate debt tripled from S6 billion to over S19 billion­

exceeding the federal debt.

However, with the onset ofinfiation in the mid-1970's, deficit spending in the

1980's and the p.roliferation of technology in the 1990's, the debt market fundameIlta1ly

changed in practice and in scope. Global electronic markets, computer-based analytical

services and rapid fluctuations in bond prices are the order of the day. It is now a fast­

moving medium that plays a major role in America's economy.

The bond market touches ~ aspects of our lives - from the cost ofbuildiDg

schools and hospitals to corporate investment in areas such as plants and equipmeDt. h

impacts the assets of public and private pension funds, channels capital to mortgage and

car loans, and even iDfiuCIlccs revolving credit.

The debt market also affects the prices in the equity market that are followed so

closely. !fa compaDy's debt cannot bea.ccuratelyvalued, it is difiiadt to deteamiDc the

baseline value ofits equity.

The bond m.arket's economic significance is matched only by its abeer m.

Trcuwy seauities alone account for more than $3.4 'trillion ol1tm n6ing, CMIr S2 triDicm

in 1997 is.g'IDce, and tradiug of more than $200 billion per day in 1997. NnE listed

equities, in comparison, accountecl for about S10.7 trillion inllllUket value (May, 1991),

but only about $26 billion per day in 1997 tradiug aDd $21 billion in 199&. In additioa, tile

•

level of outstanding debt in the U.S. has grown sharply. For example, in the put 13 yean,

corporate debt outstanding has more than tripled - from $720 billion in 1985 to $1.3

trillion today. Table 1 below contains an estimate of bond market sizes in various marlcet

segments: I

Table 1: Es.timated Size or u.s. DODd Marketl

0._ ... ,.., ...... lweDlir ..... Villa v.. YGUM

~I ~ ....... U. S. Trea&U'Y rm ~ SeaIities

Treasuy Sea.rlUe 2192 $3,457 $2.168 $212

~Secu1tiee 15396 S984 $5.729 $40

Teal GcNemnatt SeaIttieB 17588 $4,441 S7,S $2S2

Mor1gage II1d ,.,.. BacMd 80rdB ~ t.b1gage Bacj(ed Bonc2i6 87542S S1,BZ7 S3S8 $47

fV.n;y CMOs(tranchea) 35393 $$2 $167 PrIvate lJIbeI MBS an:1 ~ 9011 IWJtI!t 8ack8d Barda Q92 $516 $185 $4

Tda! ~ II1d IWJS Backed Bards 924122 $2.9(1; S7Z $51

Corporite BaRil Il'Nestmert GnIde BordB D71 S5B3 sa H9I Yield " U'1nIted 8cniB 5062 5124 $4

V;rtatje Rate t«UI S2 Cawstltie BorG 51 T ataI Corpani.e 9cnaa 2f033 $2.300 S8B7 515

MlIlid~ BotD 1mXX> S1,_ S16T 59

For. SOI~ 8cniI ErragI~ MRIt 8CInca DaYelaped Ccuay 8cn:iI

Although the market continues to largely consist ofbrok:er-Gealen who commit

capital and take orden over the phone, it is likely that electronic U'IdiDg I)'ItCIDI will pow

in importance. According to a swvey conducted by the Bond MIrbt Auociation

\BMA j last year:

• 65% ofBMA. members believed that most dealers would offer electronic executions to institutional customers within two years;

• Almost 75% of these members expected institutions to demand multioodea1er systems within two years; and

• There was a consensus tbat the most liquid markets such as Treuury and agency securities are more amenable to electronic trading.

The Commission staff's review idmtifies ten elecuonic trading systems for bonds aJJ1'ently

in operation and several others that are aurentiy being developed.

C SEC Review of the BODd Market

The Commission stairs review found that, as a whole, the market for govemmem

securities is characterized by high-quality pricing information for investDrs. In additiOD,

because of steps taken over the last few years, transparency is much greater in the

municipal securities market. However t in the area of corporate boDds, price ttansparency

can be improved.

ffistorically. the debt mazkets have lagged well behind the equity markets in

making price information avallable to investors and the public. This can partially be

attn'buted to the fBcts that the debt market covers & much wider variety of iDstrumeDts and

is largely institutional. Nonetheless, the CommissioD, on sevcnl oc:cuioDJ, has acted to

encourage debt market traDspan:IlCy.

In 1991 - with c:ncouragemcnt from the Commission IDd Congreu, GovPX - a

24-bour, world-~de electronic reportiDg system - was formed to distribute real time

quotes and transaction prices for U.S. Treasury IDd other govCmmeat seanitics. AB a

result, these marketa DOW enjoy 1 higher level of quality price iDfonuation.

In 1995. spin with the CommissiOll'S active eDCCJW'IICI'I-. tbc Mamic:ipal

Securities RuJcmaking Boanl \MSBBj bepD coJ1ec:ting !be cletaU. of da1er-to-deller

6

transactions in the municipal bond market and distnouting daily summary reports. In

August of this year, with Commission approval, the MSRB expanded its daily reponing to

include customer trades as well as inter-dealer trades.

Now, for the first time, investors, particularly smaller investors, are able to obtain

the prices and volume data of municipal bond trading between dealers and their customers.

Moreover, the Commission expects the momentum provided by the MSRB's efforts to

continue, ultimately leading to more immediate transaction price reporting.

The Commission believes that it is now time for the corporate bond market to

make similar progress. Although technology is revolutionimlg how business is beiDa

conducted, the corporate debt muket remains one of the last major markets ill the United

States to lack some type of electronic price disclosure system. The recent volatility in the

markets underscores the need. for greater price transpan:ncy in this market

While the activity in the stock markets on AugUst 31, 1998 is widely known, the

no less real absence ofbuyiDg interest in the corporate bond market that same day was far

less visible. This lack of liquidity was readily apparent to the professional trader, but it

was not known to the general public until reponed by the press the following day. What

was not reported until weeks later wu the ciifliculty in the pric:iDg ofhigb-yidd corporate

securities. This lack of priciDg iDfimDation bad an impat1 on • wcll-clefined ..",. of

mutual funds - those which heavily invest in the high-yield market.

traDspareDcy wiD. harm liquidity or mnfime iIIvestora. Similar CODCarDI were raiaecl wileD

the Commission sought to improve traDspareDcy in other ~ ortbe debt marbta.

Those fear&, bowevu, proved to be paundleu Tbe CO"""'ipjon', cxpcrieDco with

GovPX shows that enhanced information bolsters investor participation and market

liquidity. Further, the MSRB bas significantly improved municipal securities IIW'ket

transparency without harming liquidity.

Improved transparency, done correctly, will not confuse investors. Rather, in

order to interpret pricing infonnation, investors need the types of analytical tools that are

already available to dealers and many institutional investors. It is reasonable to expect

that, once prices are widely available, the market will also make available the 1DIIytica1

models needed to interpret those prices. Moreover, widespread availability of prices from

. actual transactions will improve the quality of the valuations created by end-of-day priciDg

services.

The Commission is not suggesting that the entire national market system built for

equities be transposed to the debt markets. Instead, the Commission's goal is to protect

the interests of investors by tailoring requirements to the manner in which bond awkets

operate. For example, while continuous quotes are customary in equity markets,

corpomte bond dealers do DOt ge:neraUy publish firm quotes. Thus, UIIlil the marizt

develops in that direction, it would not be appropriate to impose .. rule requiring firm

quotations on the corporate bond markets. Thus, the CommiMion bas DOt suggested such

a rule.

Although the Commission does not seek: to impose the whole panoply oC equity

market regulations on the bond markets, it is dearly time for this segmc:at oCtile debt

market to improve the avai1Ibi1ity of priciDg information.

The decision to call upon the NASD to address corporate debt traDspareDcy is aD

important step. These actionJ can result in & higher lewl of price tranIpIreDcy far the

o

corporate debt ~ than what cmrent1y exists in municipal seauities, which, as

discussed above, has made significant progress in recent years. The Commission is

determined to do everything it can to achieve that result.

D. Need for Improved Price Transparency

There is little dO\1bt that the debt market has experienced strong growth. In many

respects, it is the backbone of corporate development in this country. These filets,

however, by no means suggest that the bond marlcet, including its transparency, cannot be

significantly improved. The imperatives of globaJimjon and rapid advancemeDts in

technology have put a premium on infonnation. Governments analyze and respond to it;

the press reports and editorializes it; companies sell it; markets act on it; and investors n:ly

on it.

Today, market information moves at the speed of light. The availability ofacc:urate

infonnation to ensure the long-term stability of our markets bas JIC'Ver been more

important. The corporate debt market is DOt immune from these realities.

The Commission's c:frorts are aimed at making this market as trIDSpIreDt as other

markets. These efforts lie consistent with the values oftnast, accoumability, iaDovItion

and confidence that have been the hallmarks of AmeriCl'S capital markets.

Transparency is both a means and an end. It playa & fundamemal role in making

OW" capital marb:ts the most efficient, liquid IUd resilieat in the world. At the same time,

tnmspareDcy is a goal. The Commission's 'past experience iIluItrItes that tlMft is & direct

relationship bctwcc:Il inf'ormItion IDd iuYator cc:mfidcacc: the two vUua ~ in 4irect

proportion to one another.

9

The Commission intends to work: close1ywith the NASD and the industry to

accomplish greater tranSparency in the corporate debt market.

D. MUTUAL FUND FEES AND ~ENSES

The subject of mutual fund fees and expenses is crucially important for all

Americans investing in mutual funds - almost 40 million today - and it deserves the close

attention of all of us who are charged with making decisions that affect those who haft

entJUSted their savings to the fund industry.

A. Introduction

The investment company industry is one of America's true business success

stories., having attained major significanl:e in terms of size and stature in recent years.

Assets under management have grown dramatically; fund assets grew from $770 billion at

the end of 1987 to $4.5 trillion at the eDd of 1997, an inaase ofmo~ than 484 %.2

T ociay, fund assets elCc:eed the assets of commercial banks. Over the same tm-year period,

the number of available funds bas iD:reased from 2,300 to 6,800.3

Perhaps more significant than the: growth in fund assets or the DDI'IIw offimds is

the inacasi:ag role of mutual fimds IS an iIM:stmem vehicle for IDIIIY Americ:aDs. A

mlmber of fact~ iDcludiDg low inteRst rates for bank deposits aDd 1be popularily of

bowebaIcb that own fimds to incn:ue fran 6% in 1980 to 31% toay.' The """'" &lad

iDdusuy ICCOUD!! for 16% oftotalletitaueat ass=ts aDd ... 40% m 40100 .... 5

U\

The good news about growth in the fimd industry has been accompanied by a

rather sobering debate over whether fund fees and expenses are too high. At the core of

the debate is whether fund investors are paying too much for the services they receive.

Those who believe that fund.fees are too high point to statistics showing that the

dramatic growth in fund assets has been accompanied by increasing levels of fees and

expenses. Tney·~e that investors have not received the benefits of economies of scale

.. I)

in the fonn of reduced fees and charges.

Those who believe that fund fees are not too high ugue that shareholders today

are getting more for their money - more services, such IS telephone redemption mel

exchange privileges. check or wire redemptions, and consolidated account stalemears, IDd

more investment opportunities, such as international and other specialized fund.&, which

have higher operating costs than more traditional funds. ADd they 8J'8Ue that the mllnben

showing an inaease in fund fees are misleading becaJlse they do DOt take into ICCOUDt the

fact that funds have incn:asingly moved away~m &om-c:nd sales c:lwges (which are

borne directly by the investor and cio DOt enter into the computation of &. fimd', ex:peIUIC

ratio) to 12b--l fees (which are paid indirectly through the fund and do increase a timd'.

expense ratiO).7

There is much room for debate over whether fimd feel are too high. but there caD

be no debate over. whether fund fees'have a dramatic etfect on III i.Dvesaor's n::tum. A 1%

held for 20 years. And 10, the debate over the level of feealDd expeaaea is III importuIt

one, particularly now that ordinary c:itimls are relyiug 10 haaWy on iDYestoMJlh in mutual

funds to finance housi.ag, cbildral', educatioDS, IDd retU&IIiiIIIl- the AmcricIII dn:Im.

11

The debate over fund char:ges is not new. Both Congress and the Commission

have been focusing on these issues since before the Investment Company At;t wu enacted

in 1940. The result of 60 years of dehOeration is a regulatory framework that takes a two-

pronged approach to investor protection in the area offees: first, create procedural

safeguards to reduce conflicts of interest that could result in ex:cessive charges and,

second, require that fees and charges be fully disclosed so that investors can make

informed decisions.

The Commission continues to believe that this approach is fimdamt:ntaDy IOUDd.

The Commission should not be the arbiter of the appropriate level offimd fees. Wbetb:r

fund fees are too high or too low is a question that we believe must be answered by

competition in the marketplace, Dot by govemmeut intervention. But the Comnrission

does have a significam role in ensuring that coDfiicts of interest do DOt lead to excessive

fees and that fees are fiilly and fairly disclosed - in plain FngJisb

The Commission remains vigilant on bc-balf' ofiDYcstors in its CM:l"SiJht of !II11nIJ

include:

• changes to disclosure requiremems to ~ fi::e disclosure more UICfiJl ad easier to unde:rstaDd;

• efforts to use public forums aDd other meaDS to iDcreue incbJS'!y Itt" ...... to fimd fees aDd ~

• inspectiom focused on Dlrtna' fimd fees, ad die role ofan ... ",.", .... and fimd Gncton ill HtIbIjsiring fee&;

....

• a study of the trends in mutUal fund fees and expenses, iDcludina wbetber economies of scale are passed on to shareholders through the £ecs they pay; and

• a review of the role of independent directors in setting fund fees, including I roundtable on fund goverDance to be held this fBll.

These are described more fully below.

B. Regulatory Framework fQr Mutual Fuad Fees

Over the past 60 years, Congress and the Commission have sought to protect fund

investors from excessive fees by using a two-pronged approach: ~ aeate proc:edural

safeguards to reduce conflicts of interest that could result in inappropriate charges, and,

second, require that fees and charges be completely disclosed so that investors can make

informed decisions. This approach bas bec~ refined over the yean since the pa.lIge of tile

Investment Company Act. but its broad Ol:It1ines have stood the test of time.

1. Conflicts of interest.

A mutual fimd bas a unique struct:w'e. Although mutJJ81 fimds are usually

organind either as corporati.ons or busines tru&U, they ~ DOt typicaUy maDapel by their

own officers amd emp1oycc:s. bthcr, a mutual fimd typally iJ orpni_ 11M! opcnaecl by

an UMst iidtt. adviser that is I. scparme corporate ad:ity with ita own 1barebokIen. TIle

wiUl the fimd, IDd 1be adviser or aD aftjIjat~ oft.m sdk &md Ibara purwaa to I COIIInCl

to 1:% as ~ UDderwrit.er."

with I. cifiscm _« iar&n=h"'-im, 6rft is P"""'i" 6Jr c:aaficsI 0( ..... ill ......

dUviayad odar:r ICI'Vicr.& bctwoaD the imd .s 6e .. [.11 ...... c.c..-..

1'2

the ~mmission gencraJly have not chosen to address the conflicts through fee caps or

other direct regulation of fund fees and charges, preferring to leave the establishment of

fees and charges primarily to market competition and the imposition of any caps on sales

charges to the National Association of Securities Dealers, Inc. ("NASDj. Over time,

however. Congress and the Commission have developed a regulatory scheme that

provides proced~ safeguards to guard apnst potential abuses resulting from these

conflicts.

As enaded in 1940, the Investment Company At:J. bad few limits on mutual fUnd

fees, including sales charges and a4vis0ry fees.' The Ar:J. included I. ger.x::al prohibition on

unconscionable or grossly excessive sales loads., to be defined by the NASD.' The Aa.

also required that advisory services und fees be stipulated in a writtal contract approved

initially by a fund's shareholders and direetors. IO In addition, the As::t required that DO

more than 6()D1. of the members of the board of directors be officers or employees of tile

investmCD1 company or affiliated with the ~ adviscr. l1

In the mid-1960s, the Commission recomm.ended greater lesu1abon of advisoIy

fees and sales loads after studying the fund industry at that time. The Commiwon

recommended that Congress am.eud the InvestmaJt Company Art to require that Ill)'

compensation received for services provided by iDvestmeDt adviscn be ~DIble" IDd

impose a statutory cap of 5% on sales loads for mutual fimd&. U

In respoase, Congress in 1970 amended the InvesImeat Company Art. pnwiIioas

reganliog advisory fees UId sales charges. Congreu adckd IOCtiaIll6(b) to tile

Investment Company Al;t to impose I. fiduciary duty on the iIMJIIJ.laltldvils' of I. &.md

with respect to the receipt of compeDSation for ICnicII. U Tbe acm.--. duty uDder

section 36(b) applies not only to advisory fees, but also to distribution cbarpllUCh .. rule

12b-l fees paid by funds to advisers and their afiiliates.14 Congress also IIJleIIdecl ACtion

lS(c) of the Investment Company Ad to impose on directors a duty to eYI1uat.t, and 011111

adviser a duty to fumi~ all relevant information needed to review the terms of an

advisory contract.1.5 This amendment was designed to strengthen the ability of directors,

particularly the independent directors;, to carty out their responsibilities with respect to

approval of these contracts." In eval'!Jlating an a.dviscr's breach offiduciary duly with

regard to co~on UDder section 36(b}, courts have idmtifir4 the role ad dec:iJioD..

making process of fund directors in approving compenszrioD arnnp:mrnts to be l"1OIII

the most importaDt W:tors. 17

In 1910, ratbcrtban impose I cap on sales loads IS the Commillion recollmOtded.,

the lJMo:g'iWM CampaD)' AD. was I'e\'ised to provide the NASI> IUdIarity to raIri:t ...

ioIds suijea 10 Coiiliis9aa ovenigtl.. It Statqki'ty. tile NASI) .. P(+MjptaI ,

rule pmhii.iug NASI> ft'ri'MlGi from seIiag pt"al imd Ihms ifClle -*sdlqel

lu irs rules lela! i .. g to i:es aadi chagr:s. die C .. =- lie a ia: lIB "-,aI

? ' .....

lD.-rircia.iMi.f1l"'~"''-l-.s~~(, ...... n II -,. I;

lSBS1D cia: i whIM; • ... il6e-.,.6eCC_.· .. ·• . ..... III • 5' • •

an invc:sunent advisory contract In particular, rule 12b-1 requires that payments for

distribution out of fund assets be made pursuant to a written plan that bas bcc:n approved

by a majority of the fund's outstanding voting securities and a majority of the fimd's board

of directors and disinterested directors.22

2. pisclosure requirements.

The full disclosure approach to securities regulation employed by Congress IDd the

Commission for over 60 years has proven to be very successful. For that reason, the

Commission bas complemented the confiict of interest regulatory scheme described above

with , requirement that mutual fund fees BDd charges be fUlly aad accurately disclosed..

Full disclosure is respDDSl"ble for the development in the United States of the world',

fairest, most efficient, most liquid capital markets. It is equally responsible for the fact

that an investor contemplating I. fund investment today bas access to comparable

information about competing funds' fees ~ cbarges.

Mutual funds register on Commis9on Form N-IA, which specifies the iDformItion

that is required in I. fund prospectus, a fund's principal selling document ZJ In the 198Os,

the Commission hearne concerned that the increasing vuiety of sales loads aDd otbI:r

timd disuibution amngetilenu could, unless uDifomlly presented, mnfj.se iDvaton.. Far

that reason. since 1988, Form N-IA bas required every mmual fimd prospecIUI to iDcIuOe

I. fee table. The fee table is imc:uded to pRSel1t fimd iJIvestors with ap:DIC ctildolUre tbIt

can be understood easily._ that fa"Tftltes comparison of expemcs I!!IOIJ& imd&. J6

The fee table is • uaifurm. tabular pres ,',liaD that sbows abe fees md c::bIa:p:a

ascociated with • 1Ip!!"11 fimd imrestnMiUl The table le8o:D: both (i) =pc pas ady

by • sbatebolder out ofhis or her iuYatnent. IUCh u &CU .... b-*1D&l .... ~ II1II

16

(ii) recurring charges deducted from fund assets, such as management fees and 12b-l fees.

The table is located at the beginning of the prospectus. It is accompanied by & IIUIIlerical

example that illustrates the total doUar amounts that an investor could expect to pay on a

$10,000 investment ifhe or she received a 5% annual return and remained invested in the

fund for various time periods.

The fee table generally has served the Commission's intent. As a result of the

Commission's efforts in designing and implementing the fee table. information about

mutual fund fees and expenses is accessible. The very existeDce of the debate over

whether mutual fund fees are too high illustrates this; the debate is possible only because

data about mutual fund fees and expenses is readily available, both to iDvestors IDd to the

financial press.

Nonetheless, the Commission rema;n~ vigilant to ensure that the fee table is the

best possible vehicle for dissemination and comparison of information about fimd charges.

Earlier this year, the Commission overhauled the prospectus disclosure requUements for

mutual funds in order to provide iDvestors with cl.emr aDd more UDderId.Mab\e

infonnation about funds.25 At the same time, the Commiuion adopted a rule that permits

a mutual fund to offer investors .. DeW disclosure dOClI!DC!l!t, called the "profile. " that

summarizes key information about the fund.26 As part of those iDitiatives. the Commission

made improvements to fund fee disclosure.

The Commission', receDt ctisdosure iDitiasives require the froDt perioD of all

mutual fund prospectuses to contain a risklretum ptIIlIDII)' in plain &psb that fimotiom

as a standardized "executM slImmary" ofkcy iufonDatiOilibaut the &md. 'Ibe tee tIbIt is

included in the plain Pnalisb riskJresum IUftIIDII)' becaule oftbe Omnniaion'. be&ftblt

,.,

fees and expenses are crucial to a typical investor's decision to invest in a fund. %7 The

same risk/return summary, including the fee table, also is required to appear as part of the

new fund profile. This reflects the Commission's commitment to promoting investors'

access to fee information as a basis for a fund investment decision. 21

The Commission made several improvements to the fee table. In order to give

investors clearer information about the long-term costs of an investment. the Commission

modified the manner in which a fund may show the effect of expense reimbursc:mcnta and

fee waiver ~gements that-temporarily reduce costs.a The overhauled fee table

. includes narrative desaiptions of the fee table and example, as well as modified fee table

captions, that are intended to belp investors understand the information provided. The

Commission also increased the investment amount illustrated in the example from SI,ooo

to $10,000 to reflect the size of a ~re typical fund investment and to approximate more

closely the amount of fees and c:xpeoses that .. typical investor would c::ICpC(X to iDcur over

time. Finally, the Commission added a line item to the fee table to eDSUI'C that III ICCOUIIt

fees charged by a fund UJd paid directly by typical sbarebolden, IUcll as admiDistrasive

fees charged to maintain an account, are disclosed.

C. CUn"ellt lDitiatives

1. Monitorin& the industo'.

BCC2IJSC of the importance of mutual fund fees IDd expenses to investoR, the

Commission continually monitors the fees of individual fimda to verify compliance with

the CWTeIlt requirements Cor .setting and disdasiDg fees. The Commission also hu

concluded that it is appropriate to take a comprehensive look at fee treDda IDd fee.eettina

'0

practices in the industry as a whole. to detennine whether the regulatory system is

continuing to work: well in this era of explosive industry growth.

On an ongoing basis, the Commission's inspections sta1f' scmtinizcs compliance by

investment advisers and fund directors with their statutory duties in establishing and

approving fund fees. The staff regularly evaluates the directors' review and approval of

investment advisory contracts to confirm that advisers and directors are fidfiDing their

fiduciary duties with regard to fees. The Commission expects directors to be Yiailaat in

their review and approval of fees.

Several months ago. the Commission staff commenced a study oftreDds in mutlJ"

fund fees. The stIdf is reviewing trends in the overallievela of fees, the manner in wbirJl

fees are assessed, and whether economies of scale are passed on to sbareholdcn through

the fees they pay.30 The stafris cxamining trends in fees assessed on fimds sold to

individuals and also on timds cli.stributed tbrough40 1 (k) piau. The Commiuion

anticipates that the staff'1 review will be complete cady DCIXt ,ear.

S;agJltaneously with the staft's study, the CommiuiOIl is reviewiD& the role of

iDdepeDdc:Dt fimd ~ iDclwfing tb:ir importaDt role in approviDg fimd fee&.

ltecanly, the rWe ofiDdependmt ciin:c:un in safqpmrdiDg Jban:tddcr imcresu baa

received iD::reued I!tft!rion. ad lOme haYe qufllrionrd wbdber ~ direcIan let

iDdcpendmdy in an cues..)1 Tbe Cas'A,Fi'" piIDI to bait & RJlmctn.blt OIl imd

Ka6a'U. ad athe:n fir a.n,Poo of1hc iurpcx'taa iaaa oowpnj", imd diracr.on IIIId

tbeir datieL Tbis wilt dow the Cu,,,ej..,., to cbcIiD & braid ... rL Of is inN fraIIl

19

many of the involved parties on how the Investmeat Company M. scbemt for pteYcmiug

conflicts of interest is working in practice.

Both the staff study of mutwll fund fees aad expenses, and our eqnrinarion of the

independent director's role, will be extremely use61l to the Commission as we assess

whether we are doing all that we Calli to protect investors. We will act promptly to fix any

shortcomings that we discover.

2. Investor education.

The Commission believes that its effons to make mutual fund fee information

readily available to investors have succeeded. With the implementation of our recent

disclosure initiatives. fee information will be available in a more UDderstaDdable, euy-to­

use fOrmal. The Commission is very concerned, though, that many fimd investors are not

paying attention to the available information about fees.

Our own research shows that fewer than one in five fund investors could give any

estimate of expenses for their largest mutual fund and fewer than ODe in six fund iDYestors

understood that higher expenses CIIlI lead to lower retums.12 ADotber teceDt study fouDd

that 4()01o of fund investors surveyed incom:ctly thought that a Dmd', IDIIUI1 opsatiDg

expenses have no effect on the gaim: they earn. 33 We believe that our RICalt disdosure

initiatives will help to close the gap in investor UDderstlading of 6md fees IDd cbarps.

But we also believe that better disclosure alone wiD not cure this problem."

The Commjs-90n bas mounted an extensive investor education campaip to

improve the fjnanciallitera...'1' ofiDvcstors. Bliamtiy, the Commission aDd .. coalition of

other government agencies, businesses, and consumer orpDizatioDs ll1mched • "Facti em

Saving and Investing Campaign" to motivate Americans to get the &eta they oeocl to ave

and invest wisely. A product of this effort is the "Financial Facts Tool Kit," which

contains i wealth of information to assist investors in planning their financial future, that is

available on the Commission's website. 35

The Commission has published other educational materials, including I widely

disttibuted brochure about investing in mutual funds that contains , section on the

imponance offees.36 We have posted this brochure and many other cducatioDal materials

on our website for easy access by the investing public. In town mtding$ and speecbes to

investors across the country, we are emphasizing the imponance offees in evaluatiDg

nuitua1 fund investments. Hearings like this one also will contribute to raising the

awareness of the investing public to fund fees.

I continue to be struck by the lack of investor knowledge of fund fees and

expenses. The typical investor simply is not using the wealth of available fee information

in considering mutual funds. To address this, I have asked the staff to fOQlS on two goals

in considering additional investor education efforts. F&rSt, educate investors 10 they bow

what questions to ask about fees before they buy a fund - questions like: How much do I

pay up-front in sales charges? What portion of my assets will be used to pay for fimd

management and marketing costs every yeat'! Second, help out the investor who kDoWi

what fees a fund charges, but does not understand the dollar effect those fees have 011 biJ

or hcrrdUm.

I am also calling OD the fUnd iudustry to jom with the Commission in our ef£orta to

educate investors about fees and charges. The Commiuion hal ronrinnaU), aauDdCId the

call for the mutual fund indusuy to do· a better job of explailling fees aDd expeDIeI to

investors." The industry bas participated with us in education dforta. inclncfq the "Pacu

on Saving and Investing Campaign." but our continuing cballenge - IDd tbc:irs - is to do

whatever it takes to improve investors' understanding of fund fees.

We have suggested that one way to meet the goal is for funds to provide their

shareholders with personalized statements of expenses. The information, provided in

quarterly or year -end account statements, would tell an investor bow much, in dollars, he

or she.paid for an investment in the fund. Our hope is that ifinvestocs sec, in dollars, how

much they pay to be invested in a fimd. and how DBlch they earn or lose on the Um:stmcot.

they will begin to understand the relationship between fees and reIUm. Today 11m

inviting fund groups to engage in a dialogue with the Commission to consider whether we

can make personalized statements of expenses a reality. Each and every investor deserves

to understand what be or she is paying: for a fund - plainly, simply, in dollars and c:c:uta.

We want the industry to work with us to make that happen.

IlL CONCLUSION·

Transparency in the corporate debt.maria:t·1Dd mutual fuod fees aDd c:x:pc:uac:s arc

both imponam issues for investors. Accurate and aca:ssible price dati. is euenriaJ to

maintain investor confidence, and thus ensure the long-tc:nn Itabili:ty ofthc corpoElte debt

markt:t The Commission will comitwe to wod:: with the NASD ad the industry to

promote price tnmspar'CIICy in thi$ importaDt mam:t. In the area of IDI!!J"J fimd feCI, we

remain vigJlaDt both to walc:h for abuses and to provide investora with the pat.at

possible uhdentaDding of the aJDCJUDlS they pay to iDvest ill fi.md&. Tbe Commiaioa baa

bec:n espec:iaDy concemed with the RI betWtal availaiHe iDformIs:ioIl about fi.md feel ad

investora' use of that iDfi:H'msrion., aDd we iIIteDd to move b ward with tMsticMJII dbu

to dose that gap.

I Table I contains estimates of trading volume. uumbcr aDd wlue of issues outst.aDdiag, ad tbe vahle of 1997 issuaDc:c. Estimates of value outstaDdiDg aod 1997 issnana: came from tile Boad Market Associatioo aDd ale comparable. The u.umbers of DOD..mmricipa1 issues ~ proYicbl by the Bridge FWd Income Darabase: aDd repn:sem the DUmber of unique CUSJP mnnbcn in c:adl c::ateg01)'. The number ofTrc:asury issues includes priv3t.dy ssripped Tn:asury bauds (Zeroes). lbc mwbc:r of municipal issues was prcMdt.d by the MUDicipal Securibcs RokJnakiDg Board ("'MSRSj and reprcscDts the appmximate IIUIDber of CUSIP JIDIDbers for uaexpind rnrnticipal bcmds.

DefinitiOllS aDd coaveatiaas for volume data are DOt always C."Q4t1"b1e. Fare:ample. vabmIe eqimates for paiiUiCU1 sccuritics IUd agaacy mortgage ba.ckrld securities CDIJC from the New York Fcdenl Reserve ~ aDd are derivw:d from reports from primary cIeaIm. 1lae esajm.trs

ad .. customer volume of IDl-primary d::al:n, but iDdudc volume in Treasury ad Aps;y IDDDCY maria:t iDsttumcms. Volume estimates for COIpOratc boods ale ckriYed from two IOiiICCS.

ckalerIcustomcrtransartioas SCUlcd through the DepositoIy Trust C"4wny. mi iamdcak:rtradcs cleared through the NatUmal Sccuritics Clearing Corporaticm. U"maciaJ. paper is ezcIudrIl-

. ~ retail customer transactioas. Volume mj .. ptes for fore:ip SOYCR:ip baads ~ based OIl

surveys dcme by the Emc:rgiDg Maria:Is Traders .Association aDd czdnde dewIopcd CXJUIIIZ)' baads, but iDcludc at l:ast some DOrMioDar cJrmminatai baods. VolUIDC estima'es i1r ""'''icipaJ bauds come from the MSRB aDd· are based on sample results from the MSRB's DeW.Daily R.c:port. AD volume estimates are for the year 1997 c:K.CqJt those for Corporate Boods IDd AI;s4 Bacbd Boads which are based OIl the period January - April. 1998, aDd those far municipal beak wbidlllR

derived from a ~ in IUDe 1998.

2

s

lDwstnmt Compauy lDsribdc, Mutual FUDd pac; Bcd; 63 (3B1b eli. 1991).

ld. at 64.

Id.814O.

lti. at 44, 41.

6 See. e.g .• lolm C. Bogie. -00 Mumal f1IIXis ClIarF Vag Too Nudl!." Mmp! fm+ 10 (Oct. (991); Amy C. Amau.. --n.c IUsiDg T .... M9!"iuit>1¥ Mggpl E-SI.s2 (Ocr... U. 1996).

, s.c. e.g .. Willard L. Uwpbier. "1)0 M=ual Faads 0IatF Yw Too NDcAt,- Mggal EM SI (Oct. 1991); Lipper ADat)1ical Seni=, IDe... -n.e Tbft WbiSIe hpIr. Are MaIIIIl FUDd Fa Rc:e .... blcr (Sept 1997).

I Bc:frxe the C!!II2mmf aftbe JmesthWW 01''1_0)' AI:I., tbc eEl • II· 3" - Ie +w. t a CXIIIIIt.,jmpDy """,t"&1 study rL memlroc .,.".Iies. wba iInaad die .. far die NL S. SBC.. IDw:st"MiIf Trusta ad IIM:m'm C".4'ies. H.ll Doc. No.. 219. 7&h c::a.a.. lit SaIL pt. 3 (1940). s. also DMsicm af'bMst"mt )I_genc«, PISP.hIe pass AHllfCnerrrl

Investmegt. Company Rgulation ("protcqing hryestotsj cll. I (May 1992) (cIisrJ·gjnn of legislative aDd adminisamive history of DDItUal fuud fee regulatiaD).

9 mvestmcDt CnmpaDy At::t of 1940. Pub. L. No. 76-761, § 22(b), 54 Stat. 789. 823 (1940).

10 Id .• § IS, 54 Stit at 812-13.

11 ld.. § 10(a), 54 Stat at 806.

12 R.cpart of the Securities and E.vbalJ8e Cnmmissim m1bc Public Policy Imp1iadioas of hrvcsnnmt CompaoyGmwth, KR.. Rcp. No. 2337, 89th Coog.. 2d Sea. 126-27, 14347,221.23 (1966) \pPI Report"). The PPI Report drew upoD a report by the Whan.oD Sc:baol ofFiDaDce aDd Co!iiii<tCe 0Il1lllIlUal fimds rcqucstcd by tile Cnmmissioa. and a Conmrissim sta1f'RpOIt. Wba.rtao Scbool ofFiDaDoe aDd Ca1li1acc. A Study ofMutuaJ. FUDds. KR..IqJ. No. 2274. 87th Coag .• 2d Scss. (1962); Report oftbe Special Study ofSccurities MarkI:cs ofthc Scauitics IIId Exrba. Commission. KR.. Doc. No. 9S, 88th CoDg., 1st Semi. (1963).

13 hrvcsnnmt Company Ammdnmts Ad. of 1970. Pub. L. No. 91-547 ("1970 AmcadmcDtsj, § 20, 84 Stat. 1413, 1428-1430 (1970).

14 lIM:stmem Crmpaoy AI:. § 36(b), IS U.S.C. § 80a-3S(b). Su auo Krimt y. fppd Asset Msmt,. Inc .. 715 F. Supp. 472 (S.D.N.Y. 1988). ~ S7S F.ld 404 (2d Cir. 1989), ~ denied, 493 U.S. 919 (l989).

15 1970 Amcnd~, suprrz at 13, § S(c), 84 Stat. at 1420.

16 Set S. Rep. No. 114, 9Ist Coug., 1st Sess. IS (1969) rs. Rep. No. 184;.

17 Krinsk v. Fuud Asset Mgmt.. Inc. et aL S7S F.2d 404, 412 (lei Gr. 1989), mt 4eaisd 493 U.S. 919 (1989); Ciart;nbergv. Mqrill LypghAgetMsrnt.k ¢al.. 694 Fld 923, 930 (2d Cir. 19&2).!im ~ 461 U.S. 906 (1913). .

11 S. Rep. No. 1&4, supra DOte 16.

19 1970 Amrndnwm, SIlp1'rJ DOte 13, § 12, S4 Stat.. at 14ll.

= Rule 2g30, NASD Cwuet RDles. CcMml sal:::s c:bugc:s irlnde fraIl"-.. paid by an iD.w:stDr upon shalt purcbasc. assct-bascd sales c:bazps or Ml2b-l fa" paid out offimd. assm QIl&canrimq basis, ad "'P1ri"8emdc!errecl sales loads paid bymiDwsua upcmRd "­priotto 1bc campldiaD of & specifitd holding period. A fDDd withaat m &SId.bued c:baIp CD

c:barF & maxjmum ofl.S" .. ~ rule also caps ammal USCl~" dwtpc. 0.15%« aw:rage ammal oet assdS, allowiug an wMitioaal 0.25% fi:1r scrW:c !Ia.

21 bnrestlieut CnmpaDy M Rdeasc No. 11414 (Oct. 21, 1980) (45 PIt 73198 (New. 1. 1980)].

22 hlYcstliort e'''I*MY Aa rule Ilb-l(b117 C.F.It f 270.l2b-l (1991). S-Pdr .... 1bc (,'mppissicm ~ mlc 18f-3 UDdcrtbe Iuweunent C"'._ay A4 to aJkJWmnIDI' __ 1D sell multiple classes of Ihares, the Cmmissim Pduded tbe ~ thE & DaW IllllItipIe daa

plan be approved by the board of clir=ors aDd by a majority oftbe ~ ctirectan. Invcstzoalt Company M.. Rdc:ase No. 20915 (Feb. 23, 1995) [60 FIt 11&76 (Mar. 2, 1995») (codified at 17 C.F.R. § 270.18f-3).

2l Section 8 oftbe ~ Company M. requires mutual fimds 10 RgiItcr wiSh the Qmmission. Iftbe fuDd is c:anducring a public u1f:tiug ofils sbues, it also IIIDIt file a rcgisuatioo stalI:meDt 10 n:gisU:r those shares UDder the Securities As:J. of 1933 \SecmiIiCI At:t.j. Form. N-IA is used by a ID11b1al fuDd both to rcgistcrUDdcrthe IJM:sUnmt Ca .. ,.auy Actml to register Us shares UDd:r the Securiti:s AI::.. The registratiOl1 stattznmt includes the fuad'. prospcdUS.

24 lnvestmeat Company AI::. Release No. 16244 (Feb. 1. 1988) [ 53 FIt 3192 (Feb. 4, 1988)] (adopting rcl:ase); ~ Company At:t hl:ase No. 15932 (Aug. lB. 1987) [S2 FIt 32011 (Aug. 25, 1987)] (reproposing release); ~ Cilipany Aa Rdcast No. 14230 (Nov. 9, 1984) [49 FR 45171 (NO\'. IS, 1984)] (proposing tdcasc).

15 mVCS1mcDt Company A4Rdcase.No. 23064 (Mar. 13. 1998) [63 FIt 13916 (Mar. 23, 199B»).

:u 1nvestmcm Company A4 Rdca.se No. 23065 (Mar. 13, 1998) [63 Fll13968 (Mar. 23, 1998»).

27 Item 3, Fonn N-IA.

21 Securities M. rule 498(e){2)(IV), 11 C.Flt § 230.498(e)(2)(av).

~ In aD cxpeose rcimburscm::Dt arnmpnmt, the advisc:r R:imbancI the Dmd far 1lIIY c:xpcmes that exceed & prc:ck:a:lwiDed ammrt UDder a. me WIiw:r 8i&." •• the ~ aa:rca to ~ a. paniOI1 of its = in order to limit fimd c::xp:.mc:I to & proktH miSN IDII-P'

JO S« Rcmadcs by Barry P. Bazbasb. U.s. Se::mitits ml F IS ' • ...- C MIMI ,jgjrm, ID file MU!Ual FUDds aDd lzMsrmmr CcIIfcacw:, Odaudo. Flaridit (March 23. 1991) ~:Ifwww.st:J:~t.iJalspch201.tz:>\BatbashR ... AMj;Ea:hranfW).IIt..es.£.C. Studies Wbsh:r MIIlDIl F1mds Pass Akmg M::IgI:r Bmefih," N.Y. TIID!S DS (Mar.~. 1991).

)1 See. e.g., Mi&dal v..Rm!e ~ lrllDc= et aL Civil AcIiaR No. ANI).9I:-21Q (D. Md. Jul.. 6, 1991); $pp;1&o Vi Bmini et aL 97 Civ. 3179 (RWS) (S.D .N.Y. May 16,. 199'7t Sppugo v. Sa.ddq. ~ pd "'* 96 «:iv. 2136 (RWS) (S.D.N.Y. Mar. Z2., 1996), _,., Edward Wymt. -empty SailS 1Il1be Baam Roam; ~ Fire, MaIal t=.d Dire ... , Seaa lD:rcasi.ty HawsuwC'-N,Y, Tmn CI (Jaa.. 7, 1995); S1=wm D. ~ ~ baa. ir!,* U,S Net & Wodd RgJ. 64 (Feb. ~ 1995'J-

12 RqJan a( 1bc Office afthe C 1"'il6:r afdle Cmti.iiieJlSo _ Ii- .. Ii" ' I' Cc .""dg I' S1ney afMutmt F1IIIIl hziCAJU (l996).

2S

34 As the financial colWllDist James Glassman nx=dy poiDlal out, despite 1bc wide availability of manual fuDd &e infonnatiOll, few investors pay attenrioa to COSII. lames Ie. GlaS$IDID, "'FUDds' Lofty Fees Add Insult to Injury," Wash. Post HI, H13 (Sept. 13, 1998). See also Charles Gaspariao. "pain ofMutual·FUDd Fees Is More Acute Wbca the Mada:t Is GoiDg Down Than Up." Wall St.1. CI, 01 (Aug. 25, 1998).

]5 <31ttp :llwww.sec.goviaJlJSlJl1.1.CfltDtolkit.htm>

S6 lovcst Wisely. An Introduction to Mutual Funds, Advice trom the U.S. Sccuriti:s aDd &rha• Commissioo (Aug. 1996).

37 Set. e.g .• Ranarlc:s by CbaUman Arthur ~ U.S. Securities aDd Exchange CommissiOll, at the loveslmeZlt Company iDstitut:, Wasbiagtaa. D.C. (May IS, 1998) <bup:JIwww.sec.gov/uewslspeccheslspch212.txt>;Rcnari:s by Barry P. Barbash. U.S. Sccuriti:s and. Exchange Commissiou. to the Mutual Funds aDd luves1m=t Ccofaaacc, OrtaDdo, Florida (March 23, 1998) <l1ttp:llwww.sec.gov/DeWSl~spch20g.txt>.

26