Institute Chairman Testifies on Bill Concerning Fund Industry Practices, June 2003

Washington, DC, June 18, 2003 - Paul G. Haaga, Executive Vice President of Capital Research and Management Company and Chairman of the Institute, testified before a House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises hearing on H.R. 2420, the "Mutual Funds Integrity and Fee Transparency Act."

Background
H.R. 2420, introduced by Congressman Richard Baker (R-LA), contains several significant new provisions concerning disclosure and the structure and duties of mutual fund directors. Many of these provisions are supported by the industry and could be accomplished promptly through SEC regulation and through expeditious voluntary industry best practices.

Previously, the Capital Markets Subcommittee held a hearing in early March concerning "Mutual Fund Practices and Their Effect on Individual Investors." Financial Services Committee Chairman Michael Oxley (R-OH) delivered an opening statement at the hearing in which he noted that the the rapid growth in the fund industry was "unquestionably a positive development," adding that funds provide the opportunity to invest small sums of money in diversified portfolios of stocks, bonds, and other securities. Nevertheless, Oxley indicated the Committee's desire to examine fund industry practices to determine whether investors are "getting a fair shake."

H.R. 2420 addresses a number of issues related to industry practices including fund costs, governance, and audit practices. The bill would direct the SEC, within 270 days after the date of enactment of the Act, to adopt rules to require fund fee and cost disclosures. The bill would require this disclosure in the quarterly statement or other periodic report to shareholders or other appropriate disclosure document.

direct the SEC to conduct a study of the use of soft dollars by investment advisers;
amend Section 10(a) of the Investment Company Act to require two-thirds of a fund's board to be independent and to require that the chairman of the board be independent;
amend Section 15 of the Investment Company Act to require each investment adviser to a registered investment company to annually provide the fund's board of directors with a report on payments made by the adviser (or an affiliate) to promote the sale of fund shares (or revenue sharing arrangements); services provided to the fund or paid for by brokers executing securities transactions for the fund or its affiliate (defined as directed brokerage arrangements); and research services obtained by the adviser or its affiliate from a broker as result of securities transactions effected on behalf of the fund (or "soft dollar" arrangements)
impose a fiduciary obligation on fund directors to supervise these arrangements and to determine that the direction of fund brokerage is in the best interests of the fund's shareholders and that any revenue sharing arrangements are consistent with the Act, e.g., are not disguised payments from fund assets, and are in the best interests of the fund's shareholders. The SEC would be given rulemaking authority under the bill to implement the above requirements.
amend Section 32 of the Investment Company Act to require, among other things, that the audit committee of a registered management company, rather than the independent directors of the full board, to be responsible for the selection of the auditor;
amend Section 10A(m) of the Securities Exchange Act to exempt registered investment companies from the requirements of Section 10A(m) (the codification of Section 301 of the Sarbanes-Oxley Act) effective one year after enactment of the Act. This exemption would not, however, preclude one of the exchanges or Nasdaq from imposing audit committee requirements on listed funds in appropriate circumstances.

The bill would require the SEC to issue final rules to implement the above requirements within 180 days after enactment of the Act.

ICI Position
In his testimony, Haaga said the mutual fund industry clearly recognizes the need-especially in a current environment characterized by shaken investor confidence-to re-examine our regulatory system to determine whether there are ways to make it stronger and more responsive to investor needs.

The ICI called upon the SEC to "proceed expeditiously" and take action concerning provisions in the legislation relating to disclosure and soft dollars.

Fee and Related Disclosure
ICI urges the SEC to adopt rules it has already proposed that would require fund shareholder reports to disclose the cost in dollars of a $10,000 investment in the fund, based on the fund's actual expenses and return for the period of the report. In addition, the SEC should address other areas of disclosure identified in H.R. 2420, including the structure of portfolio manager compensation, portfolio transaction costs, revenue sharing arrangements, and fund brokerage practices.

Soft Dollars
The fund industry supports the legislation's provisions to clarify the roles of fund advisers and fund directors concerning soft dollar and directed brokerage arrangements, and also supports the legislation's call for the SEC to conduct a thorough review of soft-dollar practices.

Fund Governance
The fund industry is committed to taking voluntary steps to enhance investor confidence and the industry's own system of corporate governance. The industry supports H.R. 2420's provision to apply the standards for audit committees established in the Sarbanes-Oxley Act to mutual funds, and will recommend to the Institute's Board of Governors that the standards be adopted as an industry best practice.

The fund industry agrees that it is inappropriate for certain relatives and individuals with material business or professional relationships with management to serve as independent directors of mutual funds, and will recommend a best practice under which these individuals would not serve as mutual fund independent directors.

Inadvisable Provisions in Legislation
Existing fund industry practices, such as having lead directors and regular meetings of independent directors in executive session, make it unnecessary to require mutual funds to have an independent chairman of the board, as the legislation proposes. The Institute believes having an independent chairman could actually result in a less effective board.

The SEC, rather than legislators, should dictate the specifics of how certain items should be disclosed, and in which document they should appear. Congress should not inadvertently discourage investors from viewing fund prospectuses.

In addition, once the SEC adopts new rules on expense disclosure, Congress should study their effectiveness before mandating additional disclosures, such as requiring costly disclosure of individualized operating expenses, which would inhibit comparisons among funds.