WASHINGTON -- The Securities and Exchange Commission staff may propose rules later this year that are designed to improve mutual funds' disclosure of information about their derivatives activities, according to SEC commissioner Richard Y. Roberts.
"I know both the staff of the commission and the [Investment Company Institute] are working to improve the disclosure practices of mutual funds with respect to their investment objectives and their derivatives activities, including the risks..." Roberts said in a speech at a municipal derivatives conference in New York City.
"Commission rulemaking activity in this area before the end of the year remains a strong possibility," Roberts said, stressing, however, that these were his personal views and not necessarily those of the commission.
In particular, the SEC staff is considering proposing a "quantitative risk measure" that would more effectively inform investors about any derivatives risks in bond funds, whether the funds are taxable or taxexempt, he said.
The SEC staff is also considering whether funds should be required to have a risk summary description that would give investors a "flavor" of their derivatives risk, Roberts said.
Roberts remarks come as Rep. Edward Markey, D-Mass., and Rep. Jack Fields, R-Tex., the leaders of the Energy and Commerce subcommittee on telecommunications and finance, have asked the SEC to study mutual funds' derivatives activities and to determine whether any changes in securities laws and rules are needed to govern the activities.
In his speech, Roberts advised investment companies to include more useful information about their derivatives activities in prospectuses.
Investment companies should explain their objectives for using derivatives, the risks involved, and the percentage level of overall fund assets in these products, he said.
"This may help avoid problems in the future from regulators and from investors," Roberts said.
Markey and Fields had asked the SEC to determine if derivatives were suitable for money market funds.
In his speech, Roberts cautioned managers of tax-exempt and taxable money market funds that they have no business investing in a derivative product whose market value would not approximate its par value at the time its interest rate is reset.
The SEC has warned money market funds about this matter twice in recent months, he said. That the SEC had to issue a second warning "causes me to question the alertness of several money market fund managers," he said.
Roberts noted that some mutual funds have encountered "severe difficulties" complying with the pricing requirements of the Investment Company Act for derivatives.
Among other things, the act requires mutual funds to compute their net asset values on a daily basis. To do the computation, funds must be able to value each of their portfolio securities accurately.
But some fund managers have complained that certain derivative products are difficult to value because they are complex and specifically tailored for them or other investors.
"I wish to caution all mutual fund managers to make sure that they are taking all reasonable steps necessary to adhere to the daily pricing requirements of the Investment Company Act," Roberts said in his speech.
"Further, securities firms that sell municipal derivative products to mutual funds, unless agreed otherwise, would be well advised to be prepared to supply secondary market liquidity for the product and to provide adequate pricing information for the product," he said.
Roberts said market participants should question whether a derivative product is a suitable investment for a mutual fund if it cannot be priced daily in compliance with .the Investment Company Act.
Roberts said the SEC is very concerned about whether securities firms are selling derivatives products that are suitable for their customers, whether they are institutional or retail customers.
"The concern lingers at the commission that some derivative products are being marketed more for the fat profit margin they make available to the securities firm than for their suitability for the potential customer," he said.
Repeating a warning he has made before, Roberts said, "If I had only one suggestion for securities firms that sell derivatives, that suggestion would be to take all the reasonable steps necessary to ensure that the derivative products being sold are suitable investments for the prospective end user."
Roberts noted that the SEC is talking with the Securities Industry Association about developing voluntary sales practice standards for unregulated derivatives affiliates that would "guide the sale of derivatives to users such as cities, pension funds, and mutual funds, in which unsophisticated investors have financial stakes."
He noted also that the SEC approved amendments in April that were aimed at strengthening Municipal Securities Rulemaking Board rules that require securities firms to sell suitable municipal securities to their customers.
Roberts said that while the revised rules may be adequate to cover municipal derivatives, "it is my understanding that the MSRB is considering issuing a separate rule to cover specifically municipal derivatives transactions." MSRB officials could not be reached for comment.
