CONFERENCE CALL: Fund chiefs want look-alike investments regulated

Give mutual fund executives an opportunity to sound off and they make the most of it by knocking the competition.

At a panel discussion sponsored by the Securities and Exchange Commission earlier this month, several of the executives said hedge funds and other types of packaged investments need more government regulation to protect investors.

Marking the 60th anniversary of the Investment Company Act of 1940, the SEC hosted all eight past and former directors of the division that regulates mutual funds, as well as three industry officials.

John Brennan, chairman and chief executive of the Vanguard Group in Malvern, Pa., said, “The Internet should not lead to a world where individuals put their hard-earned money into a packaged investment, whether it’s a mutual fund or a fund look-alike, and have little more protection than if they bought a toaster.”

Mr. Brennan, head of the country’s second-largest mutual fund complex, referred to products such as those offered by Foliofn, a Vienna, Va.. Investors can pay $29.95 a month or $295 a year to buy packages of investments that they can trade without commissions or asset-based fees.

The Investment Company Institute called on the SEC last summer to bring such investment products under greater regulatory scrutiny.

“A key challenge that you will see ahead of you,” Mr. Brennan told the gathering, “is this incredible technological change and people wanting to use it for their own benefit without the burdens that come from being part of a highly regulated structure.”

Some 88 million people now own $7.6 trillion in mutual fund investments, and Mr. Brennan lauded the SEC for its flexible and innovative methods for regulating the industry over the past 60 years.

He suggested that the SEC should continue to be flexible in regulating the new investments “that are directed at that middle consumer.”

He said investors are not able to distinguish between mutual funds, wrap accounts and Internet-based baskets of investments.

“Products that look, act and feel like mutual funds will inevitably be thought of by the consumer as mutual funds. They must have the same investor protections as a mutual fund. If any of these products stumbles in a way that shakes public confidence significantly, the entire fund industry, and fund shareholders broadly, will pay a price,” he said.

Nancy Smith, vice president of web content for Foliofn, told InvestmentNews in a telephone interview that her company is a registered broker-dealer, and “broker-dealer regulation is designed to protect investors and does a great job of protecting investors.”

The company’s folio product “is not a mutual fund,” she said. Investors can economically own a diversified portfolio of individual stocks, which they can manage themselves, and they have more control over tax liability.

sour grapes?

The attempt by the mutual fund industry “to convince others that we are a mutual fund really stems from the fact that they see us as a competitive threat. That’s why the mutual fund industry wants to stymie this innovative product, because they see that folios provide the benefit of a mutual fund without the downside,” she added.

Robert Pozen, vice chairman of Fidelity Investments in Boston, the largest U.S. fund complex, put in a plug for more stringent regulation of hedge funds. “These entities have very little, if any, regulation,” he said.

At one time, he noted, hedge funds could have only less than 100 shareholders. Now they can have 500 shareholders, and there are more than 6,000 such funds with more than $350 billion in assets. “For those who think that this is a small sideshow, it definitely is not,” Mr. Pozen said.

The near-default of Long-Term Capital Management in 1998, which prompted the Federal Reserve Bank of New York to get top Wall Street firms to bail it out, “raised very serious systemic issues about the financial system in the United States and the world,” Mr. Pozen said.

“What’s less well known is the structural characteristics of hedge funds,” he said, noting that one characteristic is that “they basically have unlimited leverage.” In addition, hedge fund managers make fees of 20% or more if the funds are profitable, but much less or nothing if the funds are not profitable.

“That asymmetrical structure has a tendency to encourage people to swing for the fences,” he said.

Mr. Pozen suggested that hedge funds be required to publish twice annually financial statements and statements of holdings, as mutual funds are required to do.

He also called on the SEC to loosen regulations prohibiting all transactions between mutual fund complexes and fund advisers. The regulations are aimed at preventing conflicts of interest between advisers selling assets to funds they manage.

With fund advisers now managing different funds within large fund complexes, the regulations make it more difficult for fund companies to operate, he said.

“If a bank trust department happens to own more than 6% of a money market fund, then you are no longer, unless you can get an exemption, able to do transactions with that part of that bank. That seems a little silly,” he said.