Mutual Funds:

Greater Transparency Needed in Disclosures to Investors

GAO-03-763: Published: Jun 9, 2003. Publicly Released: Jun 16, 2003.

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The fees and other costs that investors pay as part of owning mutual fund shares can significantly affect their investment returns. As a result, questions have been raised as to whether the disclosures of mutual fund fees and other practices are sufficiently transparent. GAO reviewed (1) how mutual funds disclose their fees and related trading costs and options for improving these disclosures, (2) changes in how mutual funds pay for the sale of fund shares and how the changes in these practices are affecting investors, and (3) the benefits of and the concerns over mutual funds' use of soft dollars.

Although mutual funds disclose considerable information about their costs to investors, the amount of fees and expenses that each investor specifically pays on their mutual fund shares are currently disclosed as percentages of fund assets, whereas most other financial services disclose the actual costs to the purchaser in dollar terms. SEC staff has proposed requiring funds to disclose additional information that could be used to compare fees across funds. However, other disclosures could also increase the transparency of these fees, such as by providing existing investors with the specific dollar amounts of the expenses paid or by placing fee-related disclosures in the quarterly account statements that investors receive. Although some of these additional disclosures could be costly and data on their benefits to investors was not generally available, less costly alternatives exist that could increase the transparency and investor awareness of mutual funds fees that make consideration of additional fee disclosures worthwhile. Changes in how mutual funds pay intermediaries to sell fund shares have benefited investors but have also raised concerns. Since 1980, mutual funds, under SEC Rule 12b-1 have been allowed to use fund assets to pay for certain marketing expenses. Since then, funds have developed ways to apply Rule 12b-1 fees to provide investors greater flexibility in choosing how to pay for the services of individual financial professionals that advise them on fund purchases. Another increasingly common marketing practice called revenue sharing involves fund investment advisers making additional payments to the broker-dealers that distribute their funds' shares. However, receiving these payments can limit fund choices offered to investors and conflict with the broker-dealer's obligation to recommend the most suitable funds. Regulators acknowledged that the current disclosure regulations might not always result in complete information about these payments being disclosed to investors. Under soft dollar arrangements, mutual fund investment advisers use part of the brokerage commissions they pay to broker-dealers for executing trades to obtain research and other services. Although industry participants said that soft dollars allow fund advisers access to a wider range of research than may otherwise be available and provide other benefits, these arrangements also can create incentives for investment advisers to trade excessively to obtain more soft dollar services, thereby increasing fund shareholders' costs. SEC staff has recommended various changes that would increase transparency by expanding advisers' disclosure of their use of soft dollars. By acting on the staff's recommendations SEC would provide fund investors and directors with needed information about how their funds' advisers are using soft dollars.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: With rules that became effective on May 10, 2004, SEC now requires that mutual funds disclose in their reports to shareholders fund expenses borne by shareholders during the reporting period. Mutual fund shareholder reports will be required to include: (1) the cost in dollars associated with an investment of $1,000, based on the fund's actual expenses and return for the period; and (2) the cost in dollars associated with an investment of $1,000, based on the fund's actual expenses for the period and an assumed return of 5 percent per year. SEC is also proposing in separate rules still out for comment that broker-dealers provide disclosures at the time of sale on the fees paid by fund purchasers. After considering placing additional disclosures in quarterly statements, SEC choose to expand the existing disclosures in shareholder reports instead.

    Recommendation: To promote greater investor awareness and competition among mutual funds on the basis of their fees, the Chairman, SEC should increase the transparency of the fees and practices that relate to mutual funds by considering the benefits of additional disclosure relating to mutual funds fees, including requiring more information in mutual fund account statements about the fees investors pay.

    Agency Affected: United States Securities and Exchange Commission

  2. Status: Closed - Implemented

    Comments: SEC is in the process of evaluating ways to best provide investors with information about the revenue sharing practices that could create conflicts of interest between broker-dealers that market mutual funds and investor customers. A draft rule that would require broker-dealers to disclose the extent to which they receive revenue sharing payments from mutual fund advisers in point of sale and trade confirmation documents has been issued, undergone a public comment period, but is currently being held as SEC staff across various divisions study how best to use various disclosure regimes to provide information on this and other issues to investors.

    Recommendation: To promote greater investor awareness and competition among mutual funds on the basis of their fees, the Chairman, SEC should increase the transparency of the fees and practices that relate to mutual funds by evaluating ways to provide more information that investors could use to evaluate possible conflicts of interest resulting from any revenue sharing payments their broker-dealers receive.

    Agency Affected: United States Securities and Exchange Commission

  3. Status: Closed - Implemented

    Comments: On July 18, 2006, SEC issued an interpretative release, Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934 (34-54165), which was intended to provide greater clarity to what services and products that money managers could receive as part of soft dollar arrangements. According to the release, this interpretation addresses the current environment and the issues raised by its 1998 soft dollar examinations report.

    Recommendation: To promote greater investor awareness and competition among mutual funds on the basis of their fees, the Chairman, SEC should increase the transparency of the fees and practices that relate to mutual funds by evaluating ways to provide more information that fund investors and directors could use to better evaluate the benefits and potential disadvantages of their fund adviser's use of soft dollars, including considering and implementing the recommendations from its 1998 soft dollar examinations report.

    Agency Affected: United States Securities and Exchange Commission

 

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