Taking Sides: SEC must move disclosure to the top of its agenda

Some important unfinished business is still pending before the Securities and Exchange Commission, and it remains problematic at this point whether the agency will clear its agenda before the new president takes over — whoever that may be.

But if there is any issue that should rise to the top of the commission’s priorities at the 11th hour, it should be greater public disclosure of financial information across the board.

The National Association of Securities Dealers’ decision late last week to support greater disclosure of potential conflicts of interest involving analysts who make stock recommendations in the media is a welcome recognition that the problem needs to be addressed.

improving credibility

In a public statement on the matter, the SEC promised to work with the NASD and the New York Stock Exchange to develop rules “in short order” that would “establish a fair and workable disclosure … that promotes public confidence.”

As the SEC notes, the investing public has a right to know whether an analyst’s employer has underwritten a recommended stock or has a significant position in that equity.

“This can only improve the credibility of those who make recommendations to the public — credibility that has come under attack in recent months,” the agency said.

We couldn’t agree more. But the SEC shouldn’t stop there.

The commission has had on its agenda for some months proposals to increase public disclosure of mutual fund holdings. Attesting the importance of the issue is the fact that it’s one of the few that has drawn attention from both the investment community and the public at large.

Last summer, the Consumer Federation of America and nine other consumer advocacy groups petitioned the SEC to require more-frequent disclosure of fund holdings.

Their petition came on the heels of a similar request by the Financial Planning Association, which represents 29,000 financial advisers.

Greater disclosure would help prevent funds from engaging in “portfolio pumping” and “window dressing,” two practices designed to mislead investors by making funds look like they’re performing better than they really are.

Fund companies and the Investment Company Institute, the Washington trade group, have raised a number of concerns. Chief among them is the possibility that short-term traders would try to “front-run” a fund — that is, buy or sell stocks ahead of the fund to cash in on moves it makes in the market.

That’s a valid concern, but the benefits of greater disclosure far outweigh the likelihood that it will touch off a wave of front-running.

A case in point is the recent blowup of two small-time municipal bond funds, the Heartland High-Yield Municipal Bond Fund and the Heartland Short Duration High-Yield Fund.

Last October, Heartland Advisors was forced to reprice its highly illiquid municipal bonds, thus depressing the value of the funds. In a single day, investors lost 69% and 44%, respectively, of their investment in those funds (InvestmentNews, Oct. 30).

A post-mortem of the debacle published recently in BusinessWeek shows clearly that greater disclosure of fund activities could have tipped off investors to problems much earlier — or may even have prevented the funds from exploding.

Right now, funds need only report their holdings twice a year, and on their own timetables. During that time, those holdings can change dramatically, leaving investors in the dark about what they own.

If the SEC does anything in the coming weeks, it should adopt those much-needed reforms.