The aftermath of some of the biggest scandals in the history of the mutual fund industry has provided an opportunity for the acceleration and maturation of its transparency and oversight rules. But these scandals have also created an environment for the wholesale marginalization of industry best practices that may put investors and shareholders at risk.
It is a truism that free markets are the servant of both the ethical and unethical, and therefore requires a degree of regulatory oversight and transparency. Indeed, such constraints are often necessary in order to ensure market efficacy. However, the very laws and regulations by which this must be realized also represent a market or industry's greatest health risk. In any market, a reasonable equilibrium between free market principles and the regulatory parameters within which they work must be the perpetual goal ... and it appears the mutual fund industry is being forced in the wrong direction.
The total dollar value of mutual fund assets is approaching $8 trillion dollars, with the number of funds having increased nearly ten times from what it was 20 years ago, and now represents the most popular investment vehicle in America. The dramatic increase in fund investment has been promulgated by technology, having widened access to funds to a larger pool of potential investors, as well as the general safety, diversity and quality of fund products and services. It is here that free market dynamics have demonstrated significant benefit to the investor.
The mutual fund market has experienced tremendous growth while simultaneously accommodating and managing that growth through improved products, market-driven pricing and industry oversight practices. Market influences (i.e. competition), industry self-regulation and legally mandated transparency and disclosure requirements have combined to further engender investor confidence, which has also helped to reduce investor costs and promote growth.
Nevertheless, regulators have proposed new governance standards that would create additional oversight responsibilities for fund directors, and require that fund boards be headed by an independent chair and be comprised of at least 75% independent directors. I submit that the wholesale adoption of such proposals is wrongheaded on at least three levels: 1. They are not necessary, 2. They would undermine positive market dynamics, and 3. They would expose the industry to burdensome administration and potential litigation.
Governance standards have evolved over the years by instituting best practices and adopting a number of rules to improve how fund directors to do their job. A fund director's job is fundamentally to police conflicts of interest between the fund and its investment advisor, oversee fee schedules and monitor compliance with federal securities laws. The incorporation of strict standards, tools and practices has served, and continues to serve, investors well.
Indeed, the suggestions prompting many of these new regulatory proposals (that fund directors are ineffectual and are therefore somehow the origin of past improprieties) are misplaced. A fund director is responsible for protecting the investor as a client of the fund advisor, who the client has selected. It is inappropriate to expect the fund director to also challenge the conscious choice of the investor in selecting that advisor, and then be solely accountable for every malefaction. Yet this is what is happening.
Also, regulatory mandates and industry protocols exist to ensure the independence and authority of independent fund directors, such as the Investment Company Act and the "supermajority" requirement to have independent directors, and to have regular meetings of independent directors in executive session. These and other existing codified practices render new regulatory proposals as superfluous.
Lastly, the new responsibilities for fund directors require them to negotiate prices down by comparing them to other heterogeneous funds in an effort to achieve a "fair profit." This is akin to price fixing and is contrary to free market practices, jeopardizing the very benefits thereof.
Fair-minded reaction to the scandals this industry and its customers have endured necessarily requires both governmental and industry introspection accompanied by legitimate action to improve its practices ... and much has been done toward this end. The implementation of unnecessary regulations and efforts to effectively commoditize an industry, though, seem to represent more of an attempt at penalization in the name of protecting shareholders, when in reality it is the shareholders who may be most at risk.