Taking Sides: Cool the rhetoric on fund disclosure

In the give-and-take of Washington politics, it always helps to claim the moral high ground. That’s a place usually staked out by all sorts of so-called do-gooders, from consumer advocates to public-interest groups to anti-abortion activists.

But every so often, the purported corporate black hats strike back and give the do-gooders a little dose of their own medicine. So it goes with the Investment Company Institute, the main trade group that represents the mutual fund industry.

Shareholder rights groups and public-interest advocates such as the Consumer Federation of America have been pressuring the industry for months to increase the timeliness and amount of information they make available to the public about the stocks held in mutual fund portfolios.

Caught in the middle of the debate are millions of people who hold mutual funds in their retirement or investment accounts. According to ICI figures, the median household income for mutual fund shareholders is $55,000, and median investible assets total $80,000, excluding the primary residence. The median mutual fund holding is $25,000. In short, most retail mutual fund shareholders are middle class.

Under current law, individual mutual funds have to make information about stock holdings available only twice a year. Although some release it more often, the information is usually out of date by the time that it goes public.

Shareholders, critics argue, have a right to know what they own in their mutual funds. Knowing what’s in the portfolio is the best way to safeguard against style drift.

But the kicker to their argument has been a series of allegations that the cloak of secrecy allows portfolio managers to engage in all sorts of nefarious practices, from “window dressing” and “portfolio pumping” to “front-running” a fund’s stock purchases.

Fund managers engage in window dressing or portfolio pumping to artificially inflate a portfolio’s return – and with it their management fees. Or they may engage in front-running to profit personally from their own trades.

Although those practices don’t appear to be widespread, they have put the industry on the defensive and allowed critics, in the name of reform, to seize the moral high ground.

Their arguments have been persuasive enough to prompt the Securities and Exchange Commission to consider changing its rules to require more fund disclosure.

But the ICI struck back earlier this month in a letter to Paul Roye, director of the SEC’s investment management division.

Backed by an academic study, the letter questioned the motives of those pushing for more disclosure, and claimed that more openness would actually harm shareholders.

“It would facilitate the ability of professional traders and other opportunists to front-run trades … and exploit fund research and proprietary investment strategies, all at the expense of fund shareholders,” the letter asserted.

“Indeed, abusive practices like these occur today,” it added.

The ICI has even come up with its own catchy terms for those abuses, such as “free riding” and “reverse engineering.”

A number of financial websites, it notes, tout their ability to “piggyback” off mutual fund research and investment strategies.

What’s more, the ICI claims that its own surveys have found “virtually no demand for more portfolio holdings disclosure” from shareholders.

If fund shareholders don’t want those so-called reforms, who does? Could it be those greedy “professional traders” and “opportunists”?

You can see how the plot thickens.

Needless to say, shareholder advocates such as Mercer Bullard’s Fund Democracy and the Consumer Federation – not to mention a few financial advisers – are outraged by the implication.

But what this all suggests is that the debate is starting to get out of hand.

Both sides need to cool the rhetoric and let the SEC make its Solomon-like decision without all the mudslinging. We don’t envy it that task.