Tags: White | SEC | Dodd-Frank | mutual funds

SEC Chairman White Is Questioned on Mutual Fund Issues

By    |   Friday, 31 May 2013 01:44 PM

My previous two articles discussed the atmospherics and substance of the first appearance of Mary Jo White, chairman of the Securities and Exchange Commission (SEC), before the House Financial Services Committee.

This last article in the series will consider several issues raised during the hearing that relate specifically to mutual funds and therefore are likely to affect and interest many readers:

1. Regulation of money market mutual funds (MMMFs). MMMFs are mutual funds that invest in short-term Treasury and corporate debt, thus offering an attractive vehicle for investors needing to park funds for a shorter period of time than is required for CDs and receive a higher return than is offered by banks.

These funds have become quite concentrated in the debt of U.S. and foreign banks, and during the 2008 episode of the ongoing financial crisis, one of the triggering events occurred when a prominent fund, the Reserve Fund, "broke the buck," which meant that it could no longer redeem investments dollar for dollar. This precipitated a run and a subsequent bailout through an FDIC program that insured investments in MMMFs, which are not insured by the FDIC.

Depending on who one believes, MMMFs have had over 100 incidents that could have led to runs since 2008, or they have pitched a shutout. The Financial Stability Oversight Council (FSOC) has identified MMMFs as a source of systemic risk and called for a regulatory response to deal with this threat.

The SEC strengthened its regulation of MMMFs in 2010, but both the FSOC and then-SEC Chairman Mary Schapiro found that these changes were insufficient to protect the financial system from the risk of future runs. Therefore, Schapiro proposed that the SEC consider regulations that would allow the share values of MMMFs to "float," rather than be maintained at a constant dollar, and to require MMMFs to maintain a minimum amount of capital behind the funds.

The industry rebelled and mounted a campaign against the regulations on the ground that they would destroy the utility of the funds for investors like municipalities that have come to rely on them as places to park, for example, tax receipts during the time between the inflows and expenditure of the funds.

Sen. Pat Toomey, R-Penn., and Rep. Mike Fitzpatrick, R-Penn., have positioned themselves in the vanguard of legislators expressing fidelity to the industry (puns very much intended). Fitzpatrick appeared near tears as he pleaded with White to assure him that the SEC will take into account the interests of the funds and municipalities. Schapiro was unable even to bring her proposal before the Commission, because Commissioner Luis Aguilar opposed it.

In response, the FSOC resolved that if the SEC does not act on the regulation, the FSOC itself would do something under the powers provided by Dodd-Frank.

White told Fitzpatrick that the SEC plans to go ahead, and a meeting on the regulation has been scheduled for June 5. The debate is likely to remain highly charged, and this issue stands as an example of the failure of the industry and of friendly legislators to acknowledge the threats that various financial products pose to the global financial system and allow prudent regulations to be adopted to contain this risk.

2. Adopting a single standard of liability for investment advisers and broker-dealers. The Dodd-Frank Act contains a provision intended to address confusion on the part of investors as to the standard of care they can expect from people and companies who try to sell them mutual funds and other investment products.

Currently an investment adviser is held, under the Investment Advisers Act of 1940, to a fiduciary standard, which means that the product must serve the best interest of the customer, whereas a broker-dealer's products must be merely "suitable."

Historically, broker-dealers, which are often affiliated with banks, have resisted even a suitability standard, so they apparently assert the right to sell unsuitable products to uninformed or unwary customers. As usual, the industry is resisting the implementation of this provision, and members of Congress, prompted by industry lobbies, have raised questions at hearings.

At a previous hearing, Rep. Blaine Luetkemeyer, R-Mo., complained that onerous regulations could lead representatives of broker-dealers to leave the business and thus deny to customers the opportunity to achieve a secure retirement through mutual funds.

At the White hearing, Rep. Gregory Meeks, D-N.Y., made the same argument with respect to African-American customers. Just as there are housing fascists who insist that home ownership is the indispensable key to financial security, there are mutual fund fascists who make the same argument, and these have been empowered by regulations that make mutual funds the default choice of rank-and-file retirement fund participants.

Several years ago, American Enterprise Institute held a series of conferences to celebrate the 70th anniversary of the mutual fund industry. Champions of the industry repeatedly spoke of what amounts to a mission to sell the funds, and one of them proclaimed, "Mutual funds are sold, not bought." During Q&A, I suggested that if Jack Bogle, founder of Vanguard, were there, as he was for a previous panel, he would argue that fund managers don't do anything for which they should be paid more than nominal fees, because if they achieve outstanding performance, they probably can't repeat it.

The representative of the leading industry lobby, the Investment Company Institute, responded that the industry has a sales force than needs products to sell, and if it weren't selling mutual funds, it would be selling more abusive products.

None other than Commodity Futures Trading Commission Chairman Gary Gensler, whose twin brother runs a fund, has warned of the risks in his book, "The Great Mutual Fund Trap."

This debate is certain go continue, and I suspect that ultimately if retail investors become overexposed to stocks, the government will come to the rescue, because the industry is too big to fail.

3. Regulation of mutual funds by the Department of Labor (DOL). Another front in the debate over the regulation of mutual fund sales is the proposal by DOL to impose a stricter fiduciary standard on funds sold to participants of covered retirement plans. DOL is doing this in its capacity as regulator under the Employee Retirement Income Security Act.

At the White hearing, she was importuned by legislators taking the part of the industry, in effect, to lobby DOL and encourage it to take the industry's concerns into account. She responded that the SEC has been communicating with the DOL, as both agencies have considered their regulations, but she pointed out that DOL is independent of the SEC and is not required to follow whatever course the SEC might take.

The debate at the hearing was very intense over regulations that the SEC and other financial regulators may adopt as they go about implementing Dodd-Frank three years after its enactment.

So much is at stake that whenever the agencies actually issue regulations, the pushback from the industry could rise to tantrum proportions.

On the other hand, the official line from the administration is that the industry is resigned to the implementation of Dodd-Frank and sees benefit in the resolution of uncertainty.

I take the more cynical view, especially when one takes into account the incentives for legislators seeking campaign contributions and hoping for future employment in the industry and for the brigades of lobbyists already enlisted in combat to keep the issues alive for years, decades and even generations to come.

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This last article in the series will consider several issues raised during the hearing that relate specifically to mutual funds and therefore are likely to affect and interest many readers.
White,SEC,Dodd-Frank,mutual funds
Friday, 31 May 2013 01:44 PM
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