THE NEXT phase of rebuilding trust in mutual funds, implementing reforms, sounds more boring than uncovering scandals. But it's more likely to affect you as a fund investor.
Last week, this column focused on some of the proposed regulatory and legislative changes and how those alterations would affect investors.
Today, we examine the remaining key reforms under consideration:
Bright idea: Create a mandatory fee for ultra-short-term redemptions.
Fees for investors who trade rapidly in a fund would discourage many of the moves that were central to the mutual fund scandals, so putting them on any fund not designed specifically for market timers makes sense.
Many fund firms have redemption fees for anywhere from 30 days to a year, but the scandals proved that those charges are frequently ignored, with back-room technological deficiencies letting some traders slip through the cracks.
The proposed mandatory five-day, 2 percent redemption fee fills the holes, is compatible with everyone's technology (because it's one rule for all funds) and provides some measure of deterrent to rapid-fire trading that most funds are not built to handle.
Dim bulb: The mandatory fee is too small.
The Securities and Exchange Commission does not believe that it can impose a fee of more than 2 percent.
Not only is that poppycock, but it also limits the effectiveness of the rule.
Investors who make almost-daily trades are looking to collect many slivers of quick profit. If they see potential for a fast 3 percent jump, giving back two points is no big deal.
A 5 percent redemption fee would go much further to reduce the attractiveness of short-term trading. A sliding scale that reduces the fee over time - but keeps it above 2 percent for up to 90 days - would help most fund investors.
Bright idea: Improved disclosure on fees, costs and management concerns.
Shining a brighter light on how funds operate is always a good solution.
Dim bulb: Putting all of that information in the prospectus.
The prospectus - which really is your contract with a fund - is already nearly impossible for ordinary folks to read. Making it more dense and difficult hurts investors.
One proposal would require funds to put the board's reasons for renewing the manager's contract into the prospectus. It's now in the Statement of Additional Information, which shareholders get only on request.
This disclosure was a big deal when it was enacted a few years back. Alas, the statements have proven to be all jargon and no explanation, lacking the real answer to why management was kept on.
Added to the prospectus, this disclosure won't help anyone make an investment decision.
Regulators need to improve disclosures, but not every item needs to fall into the prospectus. Creative use of resources like the Internet can improve fund transparency without damaging the documents. (And while they are at it, regulators could overhaul the prospectus entirely.)
The light switch is broken: Close all trading in funds at 4 p.m., with no exceptions.
The problem being solved here - moves made late in the day and completed after the fund is supposed to be closed, thereby allowing some sharpies to game the system - must be fixed.
But this solution creates its own raft of problems, many of them fairness issues. For instance, an investor on the West Coast may have to process trades in a retirement plan before breakfast to get them credited at the day's closing price.
Regulators and Congress are deciding whether to leave investors unprotected or unhappy. Unprotected is not an option, but let's hope this fix evolves into something better.
Bright idea: Limit "soft-dollar" deals.
Brokerages use soft dollars to process a fund firm's trades. If a fund company pays 5 cents per share to trade, the brokerage firm kicks back a penny to pay for computer terminals, investment research, newspaper subscriptions and more. Soft dollars encourage wasteful spending and raise investor costs.
Dim bulb: Not going all the way to eliminate soft dollars.
Proposals on this issue turn back the clock, eliminating the excesses of the 1990s but leaving the allowable kickbacks at the more limited standards set in the 1980s.
That's a start, but eliminating soft-dollar deals would be better. That kind of change would require legislative action. Due in large part to the strength of the financial services lobby on Capitol Hill, that's just not going to happen now.
Of course, fund firms could simply stop making soft-dollar deals, but most won't unless they are dragged to it kicking and screaming by regulators.