For the past six months, the mutual-fund industry has been reeling from the worst scandal in its history. Five fund companies so far have agreed to pay $1.6 billion to settle a smorgasbord of charges. Many more remain under a legal cloud. Even so, industry leaders meeting for their annual confab in Palm Desert, Calif., on Mar. 22-24 were upbeat, and with good reason. The threat of a legislative crackdown that seemed inevitable just a few months ago has lifted. Unless lawmakers shift into overdrive, the chances of passing reforms are slim in a year when legislating takes a back seat to campaigning.
Too bad. If Congress misses this chance, the drive to restructure the $7 trillion industry is likely to fall far short of what's needed. While the Securities & Exchange Commission has enacted 16 new rules, some over industry opposition, there is plenty more for Congress to do. In some cases, lawmakers need to push the SEC to go further to protect investors. In other areas, the agency needs authority that only Congress can grant. And without Capitol Hill's imprimatur, new SEC rules can be rolled back once the taint of scandal is lifted.
Unfortunately, Congress -- particularly the Senate -- doesn't seem to feel any urgency about finishing the task of fund reform. "The chorus in Washington is, 'Let the SEC do it,"' says John P. Freeman, a University of South Carolina professor of business ethics. That seems to be the attitude of Senate Banking Committee Chairman Richard C. Shelby (R-Ala.). Rather than move on a bill that passed the House in a 418-2 landslide, Shelby has been holding hearings -- seven so far, with three more scheduled before he decides, sometime after mid-April, whether to act. Even a fellow GOP senator wonders whether Shelby "may be deliberately running out the clock" to appease campaign contributors: "Most of the money raised by his committee comes from Wall Street."
Shelby insists there's a simpler explanation: "I'm just being thorough." He also believes the SEC has dealt with much of the problem. Already, new SEC rules address two of the worst practices -- market timing and late trading -- that let big investors get better prices than less-favored customers. But Shelby says he may yet offer legislation to prod regulators to do more.
He should, because even an emboldened SEC tends to see issues through an industry lens. It's not certain, for example, that the agency will require funds to have independent chairmen, which would reduce conflicts between boards and the fund companies that appoint them. Vanguard Group and Fidelity Investments oppose the idea -- perhaps because at each family, the fund management's chairman also chairs all the funds. In the end, the SEC may mandate only a lead independent director. But that would allow board chairmen to continue to sit on both sides of the table when funds negotiate fees with their managers.
Congress also needs to stiffen the SEC's spine on fee disclosures. As of May, the agency will require semi-annual statements to show the cost of a hypothetical $1,000 investment -- rather than what an investor actually paid. "A hypothetical investment means absolutely nothing," says William D. Lutz, a Rutgers University professor of English who rewrites fund documents in plain language. Funds argue that it's a waste of investors' money to track all the factors that individual statements require, such as customer trades between statements. But even Shelby thinks the SEC was too timid in siding with the industry and against consumer groups.
In other cases, only Congress can enact reform. Some SEC officials want to ban "soft dollars" -- surcharges that funds pay when brokers execute stock trades. The extra fees are rebated to the fund as services, such as research. The practice is ripe for abuse -- but only Congress can eliminate it, because it created soft dollars in the first place.
The history of soft dollars reveals another weakness: Sometimes the SEC backtracks. In 1986, a deregulatory chairman, John S.R. Shad, lifted restrictions on how funds could use soft dollars. That opened the door to abuses, such as brokers paying fund advisers' rent and cable-TV bills. Absent legislation, similar rollbacks could undo the rules the SEC is adopting today.
In 2002, lawmakers decided not to leave the accounting cleanup to the SEC -- and enacted the Sarbanes-Oxley corporate reform law. Now, only Congress can permanently force funds to modernize their governance, disclose hidden costs, and explain policies in plain language. It should get on the stick.
By Paula Dwyer