Conference Call: Debate heats up over regs for online portfolios

The debate over how some unconventional investments are regulated is intensifying.

Scott Zoltowski, a lawyer at the Philadelphia firm Dechert, told a group of attendees at a recent conference on catering to the wealthy that the mutual fund industry’s argument – that online portfolios ought to be regulated as mutual funds are – is pretty weak.

Online portfolios, also called “synthetic funds” or “folios,” allow investors to create a basket of stocks that can be traded online. Companies offering them, such as FOLIOfn Inc. and Sharebuilder.com, typically register as broker-dealers.

In a March rulemaking petition, the Investment Company Institute asked the Securities and Exchange Commission to regulate the fractional-share portfolios of FOLIOfn and similar companies as it does mutual funds.

The Washington mutual fund trade group argues that because such companies offer preselected portfolios of stocks that are managed by others, they should be regulated as investment companies.

disputed

But not everyone agrees.

“The fund industry’s argument is a difficult one,” said Mr. Zoltowski, a speaker at the three-day Boston conference organized by the Performance Institute, a consulting firm in Alexandria, Va.

“FOLIOfn is a broker-dealer. The end user is executing the trades. There is no one telling that user when to buy or sell,” he added.

Of course, it’s worth noting that one of the main sponsors of the conference two weeks ago, the 2001 Summit Beyond Mutual Funds, was none other than FOLIOfn, the Vienna, Va., firm founded by former SEC member Steven Wallman.

Still, folios are different from mutual funds. For starters, investors in folios can buy fractional shares of stocks.

A bigger distinction lies in the amount of control investors can exert. Unlike mutual fund investors, those investing in folios own the underlying stocks and thus can freely move in and out of them.

Threatened

The debate comes at a time when the mutual fund industry is being threatened like never before.

Besides folios, the maturing mutual fund industry faces intense competition from up-and-coming products such as hedge funds and separately managed accounts.

Exchange-traded funds, hybrids that combine features of mutual funds and stocks, also are putting a dent in mutual fund sales.

Paul Roye, director of the SEC’s division of investment management, said last month in a speech that the agency is taking a close look at how online portfolios fit into the regulatory landscape.

An issue with some products, he said, is whether the companies offering them should be registered as investment advisers.

“While some are registered as broker-dealers, there is some amount of advice inherent in creating the baskets of securities that they offer,” he said. “If that advice is more than incidental to their brokerage business, then they will have to be regulated as investment advisers.”

Online portfolios were not the only unconventional investment products on the agenda.

At an earlier session, Robert Rosenbaum, a vice president in charge of third-party sales at Tremont Advisers Inc., a hedge fund-of-funds business in Rye, N.Y., told attendees that the demand for hedge funds is growing among wealthy investors.

Among the handful of hedge fund “myths” that Mr. Rosenbaum attempted to dispel is the perception that the industry has peaked, thanks to the recent exit of such pioneers as Julian Robertson and George Soros.

Tremont, which two weeks ago agreed to become part of OppenheimerFunds Inc. of New York for $140 million, estimates that there are about 6,000 hedge funds, with about $450 billion in assets. That figure is expected to grow to between $600 billion and $800 billion by 2002, Mr. Rosenbaum said.