In a recent speech, Barry P. Barbash, director of the Securities and Exchange Commission's investment management division, discussed questionable sales practices in the mutual fund industry. Here, in the third and final installment of that speech, Mr. Barbash urges that the
National Association of Securities Dealers - a trade group that sets professional standards in the brokerage industry - do a better job of cracking down on improper sales practices in the fund business.
The National Association of Securities Dealers is the principal overseer of broker-dealer practices. And the challenge it faces in improving the manner in which funds are sold may well be greater than it is for the Securities and Exchange Commission.
For some time, the NASD seemed behind the curve on this issue, though there are signs that this is changing. Over the past three years, the NASD has in various notices to members acknowledged the tremendous growth in mutual fund sales and emphasized the need for its members to ensure that mutual fund investments are suitable for their customers and that important fund information is disclosed to those customers.
In addition, the NASD, in response to perceived sales abuses, adopted guidelines last year regarding the use of rankings in mutual fund advertisements and sales literature.
The challenge for the NASD is to expand its regulatory horizon beyond reviewing advertising and to devote more time, effort, and resources to mutual fund sales practices.
That kind of strong commitment is necessary to allow the NASD to anticipate rather than react to concerns about sales practices.
If anyone needs to be ahead of the curve, it's the NASD. And yet, proprietary bank mutual funds sold primarily through sales agents employed by NASD members were on the scene for at least five or six years before the NASD took a close look at sales practices relating to those funds.
To provide clear and prompt guidance on novel or evolving practices will require the NASD to track the activities of its members more closely.
Absolutely essential to NASD oversight of fund sales practices is education of its members' employees. On an ongoing basis, the NASD needs to determine whether additional testing of registered representatives should be required to insure that they understand increasingly complex mutual funds.
Addressing mutual fund sales practices effectively will require the NASD to deal with hard issues. The NASD needs to consider how brokers are compensated for selling mutual fund shares and the manner in which the compensation is disclosed to investors.
Investors should know if the broker recommending a mutual fund has a financial incentive to recommend that fund over another one that may be better suited to the investor's needs. This has become an increasingly important question as the methods of financing mutual fund sales have become more complex and creative.
The goal of enhancing fund sales practices can be achieved only if the efforts of the regulators are matched by those of the regulated.
For the regulated, the key to good sales practices is to balance thoughts of profits with thoughts of investors and their needs.
Mutual funds and their distributors need to ask themselves whether advertisements and sales literature provide investors with balanced presentations of the risks and rewards of investing in particular funds.
Marketers need to fight the urge to oversell performance. Investors need to be told that past performance is typically not predictive and that they may now have to accustom themselves to lower rates of return than the returns of the 1980s.
Marketers need also to fight the urge to emphasize new funds with bells and whistles over older funds following established and time-tested strategies.
Distributors need to consider whether comforting-sounding words such as "safe" or "conservative" convey to potential investors the essence of a fund's operations.
Fund managers need to ask whether the flexibility provided to portfolio managers caused investors to be surprised at their funds investment results. And fund boards need to consider whether the names of their funds are indeed consistent with the investment strategies they use.