In a recent speech, Barry P. Barbash, director of the Securities and Exchange Commission's investment management division, cautioned mutual fund executives to polish their sales practices or risk alienating their customers.
The second of three installments of his speech follows. In part one, published Monday, he laid out reasons why investors have begun focusing on the drawbacks on mutual funds. In part two, he focused on the shortcomings of some verbal and written disclosures. The final installment will appear shortly.
Short-sighted or deficient sales practices would seem to explain much of the problem mutual funds have had with derivatives and other investments.
The complaint we have heard most often is that fund investors who were sold safe, conservative, or governmental funds were surprised at the losses experienced by those funds as a result in investing in certain derivatives.
We also have heard from investors who have expressed dismay in learning that the funds they thought were typical domestic equity funds were invested heavily in volatile foreign instruments. Many investors simply seem to be receiving the wrong messages about their funds.
The importance of mutual fund sales practice is underscored by recent studies of investors. An Investment Company Institute research report from last summer noted that investors purchasing fund shares through two of the three most significant fund distribution channels, full-service brokers and financial planners, most frequently mentioned an adviser from their channel as their primary source of mutual funds.
An informal survey conducted by the Office of the Comptroller of the Currency of investors in bank-affiliated mutual funds indicated that those investors depended more heavily on oral rather than written information in making investment decisions. Research released in 1993 by the American Association of Retired Persons and the Consumer Federation of America indicated that elderly investors rely excessively on the oral assurances of salespeople.
These studies would seem to suggest that for many fund investors, talk is not cheap and, in fact, can be quite costly.
Improving mutual fund sales practices presents a challenge to all participants in the regulatory process. For the Securities and Exchange Commission, the challenge is to develop new ways to deal with sales practices issues.
In the past, the SECT typically tried to deal with these issues by increasing the amount of mutual fund prospectus disclosure and by incorporating limits on various sales practices into its rules under the Investment Company Act.
For example, to deal with concerns about the operation of back-end sales loads, the SEC proposed to specify the way in which these charges must be calculated.
In reconsidering the issues of multiclass and master feeder funds and back-end sales loads, the SEC took a different approach to regulating fund sales practices.
In adopting the multiclass rule, the SEC acknowledged that too many mutual fund prospectuses have become unwieldy and unreadable and determine not to require extensive disclosure of classes or feeders not offered through a particular prospectus.
Instead, the SEC decided to deal with concerns that investors don't understand the complexities of multiclass and master feeder funds by encouraging better sales practices among sales representatives. We have been working with the National Association of Securities Dealers on providing enhanced guidance to sales representatives.
We also expect to develop a brochure for investors that will seek to explain multiclass and master feeder funds in simple English.
In adopting a rule covering back-end sales charges, the SEC reduced the number of requirements funds must meet when imposing those charges. At the same time, the SEC proposed for public comment amendments to the rule to permit mutual funds to impose deferred or installment loads of all types subject only to prospectus disclosure of the loads and compliance with the NASD sales charge rule.