[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
MUTUAL FUND INDUSTRY PRACTICES AND
THEIR EFFECT ON INDIVIDUAL INVESTORS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE, AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON
FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
MARCH 12, 2003
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-11
87-798 U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2003
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpr.gov Phone: toll free (866) 512-1800; (202) 512�091800
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice JULIA CARSON, Indiana
Chairman BRAD SHERMAN, California
RON PAUL, Texas GREGORY W. MEEKS, New York
PAUL E. GILLMOR, Ohio BARBARA LEE, California
JIM RYUN, Kansas JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois CHARLES A. GONZALEZ, Texas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
MARK GREEN, Wisconsin JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona MIKE ROSS, Arkansas
VITO FOSELLA, New York CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MELISSA A. HART, Pennsylvania JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota RAHM EMANUEL, Illinois
TOM FEENEY, Florida DAVID SCOTT, Georgia
JEB HENSARLING, Texas ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey
TIM MURPHY, Pennsylvania BERNARD SANDERS, Vermont
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises
RICHARD H. BAKER, Louisiana, Chairman
DOUG OSE, California, Vice Chairman PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware GREGORY W. MEEKS, New York
PETER T. KING, New York JAY INSLEE, Washington
FRANK D. LUCAS, Oklahoma DENNIS MOORE, Kansas
EDWARD R. ROYCE, California CHARLES A. GONZALEZ, Texas
DONALD A. MANZULLO, Illinois MICHAEL E. CAPUANO, Massachusetts
SUE W. KELLY, New York HAROLD E. FORD, Jr., Tennessee
ROBERT W. NEY, Ohio RUBEN HINOJOSA, Texas
JOHN B. SHADEGG, Arizona KEN LUCAS, Kentucky
JIM RYUN, Kansas JOSEPH CROWLEY, New York
VITO FOSSELLA, New York STEVE ISRAEL, New York
JUDY BIGGERT, Illinois MIKE ROSS, Arkansas
MARK GREEN, Wisconsin WM. LACY CLAY, Missouri
GARY G. MILLER, California CAROLYN McCARTHY, New York
PATRICK J. TOOMEY, Pennsylvania JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia JIM MATHESON, Utah
MELISSA A. HART, Pennsylvania STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota BRAD MILLER, North Carolina
PATRICK J. TIBERI, Ohio RAHM EMANUEL, Illinois
GINNY BROWN-WAITE, Florida DAVID SCOTT, Georgia
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
C O N T E N T S
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Page
Hearing held on:
March 12, 2003............................................... 1
Appendix:
March 12, 2003............................................... 59
WITNESSES
Wednesday, March 12, 2003
Bogle, John C., Founder, The Vanguard Group...................... 7
Bradley, Harold S., Senior Vice President, American Century
Investments.................................................... 13
Gensler, Hon. Gary, Co-author The Great Mutual Fund Trap, former
Under Secretary for Domestic Finance, Department of the
Treasury....................................................... 18
Haaga, Paul Jr., Executive Vice President, Capital Research and
Management Company............................................. 16
Montgomery, John, Founder and President, Bridgeway Funds......... 11
Riepe, James S., Chairman, T. Rowe Price Associates, Inc......... 20
Wagner, Wayne H., Chairman Plexus Group, Inc..................... 10
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 60
Clay, Hon. Wm. Lacy.......................................... 62
Emanuel, Hon. Rahm........................................... 63
Gillmor, Hon. Paul E......................................... 65
Hinojosa, Hon. Ruben......................................... 67
Kanjorski, Hon. Paul E....................................... 68
Ney, Hon. Robert W........................................... 70
Bogle, John C. (with attachments)............................ 72
Bradley, Harold (with attachments)........................... 134
Gensler, Hon. Gary........................................... 155
Haaga, Paul G. Jr., (with attachments)....................... 168
Montgomery, John............................................. 193
Wagner, Wayne H. (with attachments).......................... 202
Additional Material Submitted for the Record
Fidelity Investments, prepared statement, March 12, 2003......... 210
United States General Accounting Office, prepared statement,
March 12, 2003................................................. 216
MUTUAL FUND INDUSTRY PRACTICES AND
THEIR EFFECT ON INDIVIDUAL INVESTORS
----------
Wednesday, March 12, 2003
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance and,
Government Sponsored Enterprises
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to call, at 10:07 a.m., in
Room 2128, Rayburn House Office Building, Hon. Richard Baker
[chairman of the subcommittee] presiding.
Present: Representatives Baker, Ose, Gillmor, Castle,
Royce, Manzullo, Oxley, Kelly, Ney, Fossella, Biggert, Kennedy,
Tiberi, Harris, Kanjorski, Sherman, Meeks, Inslee, Frank, Lucas
of Kentucky, Ross, Clay, Baca, Matheson, Lynch and Scott.
Chairman Baker. [Presiding.] I would like to call this
meeting of the Subcommittee on Capital Markets to order, and
welcome those who are here in attendance today.
Today, the subcommittee will examine mutual fund industry
practices and the potential effects on individual investors.
This hearing is a next step in the committee's continuing
efforts to protect America's investors and help in the
restoration of public confidence in the performance of the
capital markets. This effort began some time ago in the last
Congress, with hearings in this subcommittee on the conduct of
securities analysts and a series of others, culminating in the
passage of the Sarbanes-Oxley legislation. The statute once
adopted addressed not only analysts' conduct, but strengthened
oversight and the responsibilities of accountants, attorneys
and corporate officers. It was a very important beginning.
Last month, we examined the collection and investor
restitution efforts by the SEC. I am personally anxiously
awaiting the outcome of the global settlement, hoping that it
will make significant provision for investor restitution. The
committee will continue this work. For example, it is my hope
in the near term to visit the credit rating agencies and
determine how their performance fared during the disappointing
market periods.
These actions are not without justification. Ninety-five
million Americans are now investors in mutual funds, with many
depending on long-term performance for their retirement. The
point needs to be made clearly. The responsible performance of
the markets and the equitable treatment of all investors is
essential for the economic vitality of the country. This
committee, and I hope this Congress, will take all appropriate
steps to restore efficient performance and ensure fair
functioning of the capital market allocations.
Today, we turn our attention to the mutual funds, a sector
of the market which during the 1990s experienced unprecedented
growth. We should examine whether investors really get what
they pay for, and determine whether investors know what fees
and costs they are paying, and then examine how the current
regulatory system either succeeds or fails in investor
protection. It is not, at least with my current understanding,
clear to me that all is well. The recent GAO report, which was
by the way initiated by request of this committee many months
ago, has reached a conclusion only yesterday that fees are up.
More troubling, investors are paying higher fees while
suffering from troubling fund performances.
According to the information reviewed in the last few days,
in the last 15 years the S&P index has outperformed almost 60
percent of the diversified equity funds. Another trend in the
industry which is alarming is the turnover rates in portfolios.
Currently, the average portfolio turnover for a fund is 110
percent, with average fund holding periods of 11 months.
Obviously, these are not investments made for the long haul.
This continual churning increases cost to the investor and
potentially generates additional tax liabilities. This short-
term, roll-them-in and roll-them-out strategy, as I call it,
certainly does not enhance the building of corporate wealth or
shareholder return, but appears to generate significant cash
flow in fees for somebody.
As troubling as the facts appear today, really they are not
that easy to get at. So I am, just like everyone else, hoping
to learn today about how to better understand how the market
functions. This lack of transparency certainly leaves the
average investor without an ability to determine what action is
in his own best interest.
Current disclosure in the prospectus that shows fees as a
percentage of assets, which is based on a hypothetical dollar
amount, may be somewhat instructional. But I am very hopeful
that the SEC will soon move forward on an enhanced disclosure
requirement and also give final approval to the pending proxy
voting disclosure rule. I think such changes will provide the
initial and necessary steps to strengthen the position of
individuals and certainly help build confidence in market
performance. But know from my perspective that these two steps
are really very rudimentary. They are only small steps down
what is, I think, going to be a long road.
I hope we can turn to the industry leaders to assist in
this effort. At the end of the day, everyone from the director
of a large fund to the smallest investor will benefit from a
market structure which is transparent, efficient and fair. We
must have a platform in which investors are willing to return
to the market with their dollars. Our economy and our nation,
will benefit from such enhancements. I, for one, will not
conclude my efforts until we have attained that goal.
Mr. Kanjorski, do you have an opening statement?
Mr. Kanjorski. Mr. Chairman, thank you for the opportunity
to offer my initial thoughts about mutual funds before we hear
from our witnesses. I want each of them, and you, to know that
I approach today's hearing and future discussions on mutual
fund issues with an open mind.
As we begin our examination of mutual funds in the 108th
Congress, I feel it is important to review some of the basic
facts about this dynamic industry. According to the Securities
and Exchange Commission, at the end of fiscal year 2002 mutual
funds managed $6.1 trillion dollars in investments,
significantly more than the $3.7 trillion deposited at
commercial banks. Additionally, the SEC calculated that 93
million investors living in 54 million households owned mutual
funds. The mutual fund industry has also evolved dramatically
in the last several decades. The number of mutual funds has
grown from 564 in 1980 to nearly 8,300 today. In addition, the
assets in mutual funds portfolios totaled just $56 billion in
1978. By 1990, this figure increased to $1.1 trillion, and by
the turn of the century mutual fund assets had expanded another
six-fold.
Today, mutual funds also represent about 20 percent of our
nation's equities market. Without question, we can therefore
conclude that mutual funds constitute a major sector of our
nation's economy.
As the mutual fund industry has grown, it has worked to
bring the benefits of securities ownership to millions of hard-
working Americans. Many securities experts have noted that the
typical investor would find it expensive and difficult to
construct a portfolio as diverse as that of a mutual fund. I
wholeheartedly agree. Mutual funds have clearly provided an
economical way for middle-class Americans to obtain the same
kind of professional management and investment diversification
that was previously available only to large-scale institutions
and wealthy investors. In short, mutual funds have worked to
democratize investing.
Despite this tremendous success, securities experts
continue to examine how we can improve the performance of the
mutual fund industry and advance the interests of U.S.
investors. Some recent public policy debates in this area have
focused on disclosing proxy votes to mutual fund shareholders,
modifying industry oversight through the creation of self-
regulatory organizations, and increasing the frequency of
mutual fund holdings disclosures. Although each of these issues
is important, today we will generally focus our examinations on
the cost of mutual fund ownership--an issue that many consider
is the most consequential.
As you know, Mr. Chairman, I have made investor protection
one of my top priorities for work on this committee.
Understanding the cost of operating a mutual fund and learning
how such expenditures affect investing is, in my view,
therefore very important. These fees and loads will, after all,
have a significant effect on investors' returns. A recent story
in USA Today, for example, determined that for government
securities mutual funds, the group with the lowest expense
ratios averaged a 43 percent gain over five years, while those
with the highest expense ratios grew by 34 percent during the
same time frame. Small differences in annual fees will
ultimately result in major differences in long-term returns.
During our deliberations today, I expect we will hear many
conflicting views on the issue of mutual fund fees. Some of our
witnesses will cite studies showing that these expenses have
increased in recent years, while other panelists will refer to
analyses demonstrating a gradual decrease in such fees.
Although each side in this debate will seek to use statistics
to its advantage, our job should be to learn more about the
industry today so that we can work to improve public policy in
the future.
For my part, I hope that these experts will answer a number
of questions that I have about mutual fund fees. I would like
to determine whether investors have obtained the benefits of
economies of scale as the size and scope of the mutual industry
has grown. I also want to learn more about the calculation of
12(b)(1) fees, the use of soft dollar arrangements, and the
effects of portfolio transaction expenses.
In closing, Mr. Chairman, I look forward to hearing from
our expert witnesses on these important issues. Mutual funds
have successfully worked to help middle-income American
families to save for an early retirement, higher education and
a new home. We need to ensure that this success continues. I
therefore look forward to working with you to examine these and
other matters related to the mutual fund industry in the weeks
and months ahead.
Thank you, Mr. Chairman.
[The prepared statement of Hon. Paul E. Kanjorski can be
found on page 68 in the appendix.]
Chairman Baker. I thank the gentleman for his statement.
Chairman Oxley?
Mr. Oxley. Thank you, Chairman Baker, for holding this
important and timely hearing. This morning, we will discuss the
state of the mutual fund business. Our inquiry is simple: Are
investors getting a fair shake? At last count, there were 95
million mutual fund investors in the United States. For most
Americans, mutual funds are the primary vehicle for accessing
the capital markets and building wealth. The rapid growth in
fund ownership over the past 20 years is unquestionably a
positive development. Mutual funds provide the opportunity to
invest small sums of money in return for a diversified
investment in stocks, bonds, and other securities. Selecting a
suitable fund can be a challenge for many investors. Some funds
buy large capitalization stocks; others buy small or mid-caps.
Some buy foreign companies or corporate or municipal bonds.
Still other funds invest entirely in one sector of the economy.
There are multiples classes of shares, different investment
styles and so on. Add to this the fact that there are now
almost 5,000 stock mutual funds.
All these funds are competing for investor dollars. While
there is clearly competition in the fund industry, some
question whether it is working the way it does in other
industries. That is to say, are costs going down for investors?
Recent data indicate that the answer is no. Fees and expenses
in fact are going up, and this despite the efficiencies created
by these enormous economies of scale. While investors have
become sensitive to certain fees like sales loads, other fees
are either hidden or opaque, escaping the attention of even
savvy fund investors. This precludes them from comparison
shopping--a strong market influence that would encourage fee-
based competition and would likely bring down costs.
What are investors getting in return for these increasing
costs? The evidence is troubling. Noted financial commentator
Jim Glassman has said, what is truly remarkable is that
hundreds of funds do worse than the rules of chance would seem
to allow. He adds that the low-cost Vanguard 500 index fund has
beaten 76 percent of its managed fund peers over the past 10
years, according to Morningstar. Even worse, the NASD and the
SEC have recently discovered widespread evidence that fund
investors are not even receiving the discounts on sales loads
that funds promised in their prospectuses. While preliminary
reports indicate this failure to provide break-point discounts
does not appear to be the result of fraudulent behavior, one
commentator is reported as attributing the problem to laziness
or sloppiness. That is simply unacceptable. I am pleased that
the regulators are acting quickly, and I urge them and fund
directors to take steps immediately to repair this breakdown
and to make investors whole.
Along with rising fees that are often hidden or not easily
understood, and chronic under-performance, this committee
intends to examine the role of mutual funds in corporate
governance. Last year, Congress passed the Sarbanes-Oxley Act
in an effort to help rebuild investor confidence in public
companies. New and mostly sensible regulations have been
enacted for accountants, corporate executives and directors,
investment bankers, research analysts, and attorneys. Until
very recently, though, mutual funds have not been the focus of
regulators and lawmakers, despite the fact that funds own about
20 percent of U.S. equities. The voting power represented by
these securities carriers carries great potential to influence
U.S. corporate governance. Whether mutual funds have used their
powerful position to do so is an important question that merits
attention.
Another important issue to this committee concerns the role
of independent fund directors. Are they looking out for the
best interests of shareholders in the fund, as is their
fiduciary duty? At least one prominent investor emphatically
says no. In his recent letter to Berkshire Hathaway
shareholders, Warren Buffett said that fund directors had an
absolutely pathetic record, particularly with regard to
removing under-performing portfolio managers and lowering fees
charged to investors. Some have asked, where were directors
during the frenzied creation of a multitude of tech funds
during the bubble of the 1990s that left so many investors
holding the bag? An article in yesterdays Wall Street Journal
observed that during the tech bubble, stewardship often gave
way to salesmanship. Borrowing a phrase from one of our
distinguished witnesses here today, Vanguard founder, Jack
Bogle.
In recent months, the SEC has acted on a number of
important mutual fund initiatives, often in the face of fierce
industry opposition, I might add. Last December, the commission
issued a proposed rule that would enhance portfolio disclosure
and help clarify fund fees. The commission also recently
required funds to disclose both their proxy voting policies and
procedures and their actual proxy votes. These are good steps,
but more needs to be done. I have the utmost confidence that we
can count on Chairman Donaldson to continue Harvey Pitt's fine
work on behalf of fund investors.
Mr. Chairman, I look forward to hearing the testimony of
this distinguished panel, and I yield back the balance of my
time.
Chairman Baker. Thank you, Mr. Chairman, for your statement
and your participation today.
[The prepared statement of Hon. Michael G. Oxley can be
found on page 60 in the appendix.]
Mr. Scott?
Mr. Scott. Thank you very much, Chairman Baker. I want to
thank you and the ranking member, Mr. Kanjorski, for holding
this hearing today regarding the mutual funds industry. I also
want to thank this distinguished panel of witnesses today for
their testimony.
Given that more than half of all households in the United
States now hold shares in mutual funds, any discussion today
will have an enormous impact on millions of investors and
billions of dollars. I firmly believe that the individual
investor is empowered when given the tools to compare varying
investment funds. Hopefully, this hearing will help us
understand whether mutual funds investors are receiving fair
value in return for the fees that they pay.
There are some serious issues and some troubling questions
that the American people certainly want answers to. For
example, how can mutual funds empower individual investors to
make the best decision about their money today? Some funds are
able to get away with overly high fees because investors do not
understand how fees can reduce their returns. We need to find
answers and make recommendations to clearly explain the
potential cost of fees to investors up front.
Another troubling issue is sloppy recordkeeping at
brokerage firms. What cost is that for mutual fund customers?
There is a cost that is estimated at more than $600,000 in
overcharges in one year alone. How can we get the mutual fund
industry to ensure that they have the capacity to charge
customers the right amount? These are questions I think that
the American people certainly want answers to, and I would hope
with our deliberations today that we can get some of those
answers.
Again, I look forward to this very important discussion.
Mr. Chairman, I yield back the balance of my time.
Chairman Baker. Thank you, Mr. Scott.
Mrs. Kelly?
Mrs. Kelly. Thank you, Mr. Chairman.
For many years, the public looked at the stock market as a
sophisticated, obscure type of crap shoot. When mutual funds
came into existence, the mutuals gave some investors the sense
that there was stability somehow, and that in unity they would
make out better. And they invested, and that was a good thing.
Those were the vehicles that brought a lot of investors into
the market. But recently, the public has been painting the
mutual funds with the same kind of distrust that they are
painting corporations and the stock market. I think that they
are looking at things like hyperactive turnover. They are
looking at sales techniques that are producing increases in
fees.
Personally, I think that if we can get some transparency
into some of these things, it will help investors make
intelligent decisions and it will bring people back into the
market. So I applaud you, Mr. Chairman, for having this
hearing. I look forward to the witnesses' testimony today.
Chairman Baker. Thank you, Mrs. Kelly.
Mr. Castle, do you have a statement? Ms. Biggert? Does any
other Member have an opening statement? Ms. Harris?
Ms. Harris. Thank you, Mr. Chairman.
I wish to express my appreciation for this panel today and
for the panel's testimony that is going to contribute greatly,
I am certain, to helping us understand and secure investor
confidence in the mutual fund industry.
Mutual funds have become a vital tool that millions of
Americans rely upon to ensure the safety of their investments
in U.S. capital markets. In fact, nearly half of all U.S.
households hold a stake in some type of mutual funds.
Reflecting on that dramatic shift in recent decades towards
investment alternatives, mutual fund industry assets raised
dramatically from $56 billion in 1978 to $6.4 trillion in 2002.
So as our nation confronts an array of daunting challenges
to restore and safeguard the economic security of every
American, that has to stay at the top of our priorities. We
cannot achieve this goal without examining the basic practices
of the mutual fund industry and the affect upon individual
investors. So in particular, we must verify the legitimacy of
the various charges that the industry levies, guaranteeing
their relation to the substantial overhead costs that mutual
funds encounter. Moreover, we must determine what action, if
any, is necessary to guarantee an adequate level of disclosure
and transparency so investors can make informed choices.
I look forward to your testimony this morning. Thank you.
Chairman Baker. Thank you, Ms. Harris.
I have been informed that we might expect a series of votes
about 11 o'clock. Certainly, any other member would be
recognized for a statement if you choose to make it, but let me
request you to do it briefly so we can give our panelists an
opportunity before the committee's work is interrupted.
Mr. Ney?
Mr. Ney. I am going to submit for the record.
Chairman Baker. Thank you, Mr. Ney.
[The prepared statement of Hon. Robert W. Ney can be found
on page 70 in the appendix.]
All other Members' statements will be submitted for the
record.
Without any other requests, I would move now to our
witnesses this morning, and call first Mr. John C. Bogle,
Founder of the Vanguard Group. Welcome, Mr. Bogle.
STATEMENT OF JOHN C. BOGLE, FOUNDER, THE VANGUARD GROUP
Mr. Bogle. Thank you very much, Chairman Baker, and good
morning. Thank you, Chairman Oxley. Thank you, Ranking Member
Kanjorski and thank you Members of the committee for coming
out.
I hope that my long experience in the mutual fund industry
will be of some help to you in considering the issues that lie
before you today.
Vanguard operates under a mutual structure in which our
management company is owned by the shareholders of our mutual
funds and operates on an at-cost basis. This is a unique form
of shareholder-oriented organization and has enabled us to
emerge as the lowest cost provider of services in our field. As
you see in the chart, the expenses of the average Vanguard fund
today come to just 26 hundredths of 1 percent of assets, a
reduction of 65 percent since we began in 1974, while the
expense ratio of the average mutual fund was 1.36 percent last
year, up almost 50 percent in that period.
Does this difference matter? Our cost advantage of 1.10
percentage points applied to our fund assets, presently at $550
billion, now results in annual savings for our fund
shareholders of $6 billion. Lower costs mean higher returns,
for what investors must earn and do earn is whatever returns
the financial markets are generous enough to provide, minus the
cost of financial intermediation. It is not very complicated.
The returns therefore earned by mutual funds as a group
inevitably equal the market returns, less the costs funds
incur, most obviously in money market funds.
Over the past five years, the money market funds with the
lowest costs earned a gross return of 4.8 percent, costs of
0.37 percent, net yield a little over 4.4 percent. The highest
cost funds earned 4.7 percent--not very different from the
lowest cost group--deducted cost of more than 1.7 percentage
points and provided a net yield of just 2.9 percent. Result?
Just by owning the lowest cost group, fund investors could have
increased their income by 51 percent, without any increase in
risk whatsoever.
While less obvious, the same relationship prevails in
equity mutual funds. Over the 10 years ended June 30, the risk-
adjusted annual return for the lowest cost quartile of equity
funds was 13.8 percent--three full percentage points higher
than the highest-cost quartile. This relationship, as you see
in the chart, appears to be universal, prevailing in each one
of the nine Morningstar so-called "style" boxes--large-cap
growth funds, small-cap value funds and so on. Great
consistency of advantage around the 3 percentage point level by
each of the nine style boxes.
In the long run, Mr. Chairman and members of the committee,
costs make the difference between investment failure and
investment success. Over the past two decades, and even after
the recent decline, the stock market provided an annual return
of 13.1 percent compared to a 10.0 percent return reported by
the average equity fund. For the full period, therefore,
$10,000 invested in the market itself grew by $105,000, while
the same $10,000 invested in the average equity fund grew by
$57,000--just half as much. That 3.1 percentage point
difference is largely a reflection of the costs that investors
incur. So yes, costs matter.
In the interest of time, I am going to skip chart five and
go to looking at costs in dollars rather than expense ratio
terms. That is a very important thing the committee ought to
consider. In 2000, for example, the actual cost of providing
portfolio management services for all of Vanguard's money
market funds, as shown in chart number six, came to $15
million. That is our known cost. Yet in another firm's money
market funds with the same $65 billion in assets, the funds
paid the investment manager for investment management services
only, $257 million. It is high time we looked into these issues
and had a government-sponsored economic study that follows the
money in the mutual fund industry.
That such a fee was approved by that fund's directors
suggests a monumental shortfall in the shareholder protections
sought by the Investment Company Act of 1940, which clearly
states that funds should be operated and managed in the
interests of their shareholders, rather than the interest of
their investment advisers, and subjected to adequate
independent scrutiny.
What is the case? Well, fund directors have two important
responsibilities: obtaining the best possible manager and
negotiating for the lowest possible fee. Yet their record has
been absolutely pathetic. They follow a zombie-like process
that makes a mockery of stewardship. Able but greedy managers
have overreached and tried to dip too deeply into the
shareholders' pockets and the directors have failed to slap
their hands. Independent directors over more than six decades
have failed miserably. I would not have the temerity, Mr.
Chairman, to use those words, so they are all a direct
quotation from Warren Buffett in his recent annual report.
One reason for the failure of directors is that the head of
the fund's management company is typically the chairman of the
fund's board as well. As Mr. Buffett has observed, negotiating
with oneself seldom produces a barroom brawl. So we need to
require that the fund chairman be an independent director.
Would it matter? Let me give you one example. That is the way
we operate at Vanguard, and since we began in 1974, the fee
rates that our Wellington Fund has negotiated at arms length
with its external investment adviser, Wellington Management,
have been reduced six times. Last year's management fee in this
$22 billion fund was 0.04 percent--four one-hundredths of one
percent of assets or $8.5 million. Without those reductions
over the years, that fee would have otherwise been $92.2
million. Active fee negotiations therefore saved the fund's
shareholders $85 million for that one fund, and enabled the
fund to catapult its returns over 90 percent of its balanced
fund peers. Yes, again, costs matter.
We need to awaken investors to the critical importance of
lower costs. We need information that encompasses all of the
costs of fund ownership, presented forthrightly in fund
prospectuses and annual reports, and we need to show each
shareholder the dollar costs that he or she is incurring in
their statements.
At the same time, we have got to empower independent
directors to live up to the standards of the law of the land
and protect the interest of the fund shareholders that they are
honor-bound to represent.
Thank you, Mr. Chairman.
[The prepared statement of John C. Bogle can be found on
page 72 in the appendix.]
Chairman Baker. Thank you very much, Mr. Bogle, for your
appearance and your testimony.
I failed to say it at the outset, but all witnesses' formal
statements will be incorporated into the official record, and
to the extent possible, if you can keep your prepared remarks
to five minutes, it would be helpful in getting to our question
and answer period. We appreciate your courtesy in being here.
Our next witness is Mr. Wayne H. Wagner, Chairman of the
Plexus Group, Inc. Welcome, Mr. Wagner.
STATEMENT OF WAYNE H. WAGNER, CHAIRMAN, PLEXUS GROUP, INC.
Mr. Wagner. Thank you, Mr. Chairman and Committee Members.
I want to talk about the transaction costs associated with
the management of mutual funds here. Several points--Are these
costs significant? How should they be evaluated? Should they be
disclosed to fund participants? And are the markets--a little
farther afield--are the markets optimally organized to keep
these costs low?
Bottom line, as Jack has said, costs hurt performance here.
They immediately reduce investor assets. They do not stay in
the portfolio to continue to perform. They impede the ability
to capture the benefit of research. They reduce liquidity and
interfere with capital formation. Congress and the SEC have
repeatedly attacked these issues here to make these better in
general here.
To me, it is impossible to argue that uninformed investors
are better investors. More information is better, as
Congressman Scott said. It is empowering for investors to know
the correct information here. As long as that information is
not misleading, of course, and when we are talking about
transaction costs, in particular, that can be a little bit
problematic here.
How important are these transaction costs? Very. I believe
they account for the difference as to why active managers have
such difficulty in maintaining performance to Mr. Bogle's fund
here. We have measured those on a regular basis for 17 years.
We measure them for 2002 as 1.5 percent, one-way transaction
costs. Multiply that by a buy and sell, multiply that by 110
percent turnover, and you can see we are talking about a great
deal of money.
I personally believe that these are the largest costs which
are borne by investors over time. Now, that may sound like a
very large number to you, and it is surprisingly large. To the
retail investor, the market looks like a vending machine. You
put your coins in, you push the button, and out comes your
selection. That is not true for institutional trading. It is
not true for mutual funds trading.
Could I have my first slide please? Thank you. We took a
look at our universal, which represents about 25 percent of
exchange volume. We divided it into five groups, where each of
the groups was sorted on the size of the trade. So the first
line on there is the smallest trades. There are three groups
omitted, and the last line is the largest trades that were put
out by mutual funds in their investing process. Each of these
is of equal importance to investors because each of them
represents the same amount of dollars being invested.
The top group is the smallest trades, and they are really
not that different from the retail market here. They are the
vast bulk of every trade, representing 11 out of every 12,
averaging 2000 shares, $53,000 in principal and less than half
of 1 percent of the daily volume. They cost about a quarter of
1 percent, but they are only one-fifth of the trading.
Concentrate for a moment on the largest trades here. This
is only one out of every 400 trades, yet it makes the same
impact on the performance of the funds here. They average two
million shares apiece, $77 million in principal, and over half
a day's volume. They cost in excess of 1 percent here.
Clearly, the vending machine analogy does not work for
these large trades. These are not trading events. They are a
trading process that links the portfolio manager and his
decisions to the trader, to the broker, and to the exchange.
They are really orchestrated into the market, and because of
their size they may take many days to complete. This stretched-
out process leads to delay in opportunity costs.
If I may have the other slide please? We have measured
these on a regular basis. This iceberg shows that not only the
costs are very obvious, the commission on the top of the
iceberg is very obvious and we all see what that is. The impact
cost is the cost of hitting in the marketplace. The delay in
opportunity costs down below stem from this orchestration
process where it is difficult to get the size through the
marketplace.
To our mind, this total cost is what investors need to
know, because you cannot ignore that 75 to 80 percent of the
cost, which is coming out of performance, and yet is really not
available in something simple like the commissions here.
Saying that, revealing the commission is sufficient to
reflect the cost, I do think is not enough. It is only 10
percent of the cost. It sends the wrong message that costs are
trivial, and that costs are comprised of broker payments,
rather than a measure of overall management effectiveness here.
Investors need to know basically which firms are efficient;
which ones are doing a good job of using their resources here.
This was the conclusion of the AIMR trade management
guidelines. I have a thousand copies coming. I will send copies
for the committee here. It defines best execution as the
trading process firms apply to maximize the value of client
portfolios. Rather than focus on costs in isolation, the
definition focuses on a cost-to-benefit ratio of trading. May I
suggest that this is a useful definition for the committee to
keep in mind.
With that in mind, I have overrun my time and I will cede
the mike.
[The prepared statement of Wayne H. Wagner can be found on
page 202 in the appendix.]
Chairman Baker. Thank you, Mr. Wagner. We appreciate your
participation today.
Our next witness is Mr. John Montgomery, Founder and
President of Bridgeway Funds. Welcome, Mr. Montgomery.
STATEMENT OF JOHN MONTGOMERY, FOUNDER AND PRESIDENT, BRIDGEWAY
FUNDS
Mr. Montgomery. Chairman Baker, Ranking Member Kanjorski,
and Members of the Subcommittee, from a recent news article, I
quote, "Mutual funds exist in a culture that thrives on hype
and withholds important information in a cutthroat business
that regularly misleads investors."
While I hardly think that this reflects the environment at
Bridgeway Funds, and while I believe that the mutual fund
industry is on the cleaner end of the spectrum in the
investment community, major criticism is well-deserved. As an
industry, we must do better if we are to serve the long-term
needs of this country's smallest investors.
After the most extended bear market since before World War
II, investors are starting to look under the hood of their
mutual funds, and they do not like some of what they see,
especially some of what they do not see and cannot find. Access
to key information is crucial to fair competition on which our
free enterprise system is based.
To be sure, progress has been made with the plain English
prospectus, simple and standardized fee tables, better
standards of performance evaluation, disclosure of the effect
of taxes on returns, and much more detailed information
available through the Internet. Soon, we will have disclosure
of proxy voting and more frequent disclosure of mutual fund
holdings.
My written testimony outlines better disclosure in 13
areas, but I would like to comment now on just four of these:
soft-dollar commissions, standardized industry operating
information, manager salaries, and board decisions on
management contract approvals.
First, disclosure of soft-dollar commissions. Apart from
the affiliated brokerage and directed brokerage, the practice
of soft-dollar commissions is one of the worst examples of
undisclosed conflicts of interest in the mutual fund industry.
The term "soft-dollar commissions" refers to an agreement
between a broker and investment adviser by which the broker
supplies a variety of products or services from research to
software, hardware, data or other services, in return for a
certain volume of business to the broker. The problem with this
legal arrangement is that the adviser receives the immediate
benefit, while the shareholder pays. There is inadequate
incentive for the adviser to keep soft-dollar commissions low.
A confirmation of this situation is the response of vendors
when we tell them that Bridgeway will be paying with our own
hard dollars. One salesman, a software salesman, looked at me
incredulously and asked, why on earth would you pay with your
own money when you could pay for it in soft dollars? The
problem with soft dollars, then, is that they are really hard
dollars. They just belong to somebody else. As a fellow Texan
said, if you see a snake, just kill it; do not appoint a
committee on snakes.
[Laughter.]
This would be one snake we should not disclose. We should
just kill.
Second, standardized industry operating information. When I
worked in the urban mass transit industry, there was uniform
data on system expenses, passengers and other very helpful
operating data, with enough detail to establish some best
industry practices. Twenty years later, there is no similar,
easily accessible database for the mutual fund industry. Some
information is in the SEC-EDGAR system, but it is not down-
loadable, expense categories are not standardized, and it is
terribly time-intensive to access information across fund
families. While this level of detail is not generally sought by
individual investors, use and analysis by academia, authors
such as Mr. Gensler, media, consultants and fund boards of
directors could greatly spur industry competition and
efficiency. The federal government is in the best position to
take the lead on this disclosure.
Third, disclosure of manager salaries. When we invest in
individual companies, we have the right to know the
compensation of the company leaders. When we invest in mutual
funds, we are in the dark. To the best of my knowledge,
Bridgeway is the only mutual fund company that voluntarily
discloses portfolio manager pay in its statement of additional
information. Compensation level, and especially structure, do
affect portfolio manager incentives and fund decisions. Our
industry's refusal to disclose it contributes to the aura of
withholding important information and misleading shareholders,
that some shareholders perceive in the current environment.
This disclosure would be easy and costless.
Finally, number four--board disclosure. Over the years, I
have examined the record of some of the consistently worst-
performing mutual funds and wondered, "where are their boards
of directors?" Unlike the boards of privately held firms,
nonprofit organizations and even publicly traded companies with
multiple constituencies, a mutual fund board exists only to
protect shareholder interests. Studying the worst-performing
funds over the last five years, for example, I identified some
funds that were poor performers for some years before. Their
average costs exceeded the entire average historical return on
the stock market. How can these funds hope to make any return
for their shareholders? Why doesn't somebody put them out of
their misery?
Each year, the independent members of the fund's board must
actively consider a number of factors before approving a
management contract. Why not disclose to shareholders the basis
for their decision? Here is an even more radical, but serious
idea: Require fund boards to consider alternative bids for
service when both fund under-performance versus a market
benchmark, and fund expenses, exceed extreme levels.
In conclusion, if mutual funds are going to address
increasing public distrust in the environment of a bear market
and if we are going to continue to play a major role in giving
access to the wealth of this nation through the fund structure,
we are going to have to earn it. We need to pursue the
interests of shareholders relentlessly, and we need to ensure
that adequate information is available for shareholders and
their advisers to make informed decisions.
Finally, I want to thank the committee for the opportunity
to testify this morning.
[The prepared statement of John Montgomery can be found on
page 193 in the appendix.]
Chairman Baker. Thank you, Mr. Montgomery.
Our next witness is Mr. Harold S. Bradley, Senior Vice
President, American Century Investments. Welcome, sir.
STATEMENT OF HAROLD S. BRADLEY, SENIOR VICE PRESIDENT, AMERICAN
CENTURY INVESTMENTS
Mr. Bradley. Thank you. Chairman Oxley, Chairman Baker,
Ranking Member Kanjorski, and all the Members of the
Subcommittee, I appreciate the opportunity to be here today and
talk. Some of my remarks, limited to soft-dollars, mostly, and
the use of commission dollars by investors, have been taken by
my colleague to the right of me. So what I would like to do is
walk through how it looks, but to say first that I am proud to
be associated with the fund industry and its strong record as
an effectively regulated and affordable place for investors. I
have been a trader and a portfolio manager and virtually all of
my investments are in a mutual fund, none of which are index
funds. The three-year bear market has been hard on all of us.
Me, too.
I represent American Century Investment Management. Along
with our industry, we are now looking in the mirror to see what
things we might do better. We have a long record of working
with the staff at the SEC of advocating more transparency
regarding market structure and trading practices, specifically
in the area of soft-dollar disclosures. We think Congress
should work to understand how its law, section 28(e) of the
1975 amendments to the Securities Exchange Act actually
encourages investment managers, through expansive
interpretation by the SEC, to use commissions paid by investors
as a source of unreported income to pay unreported expenses of
the managers. I would like to try and explain.
This is a picture of the typical five-cent-a-share
commission paid by the typical investor. That rate is
negotiated by the investment manager. The blue bar represents
our best guess, based on our experience, of what commissions
pay for in execution-only services, based on fees charged by
electronic venues, such as Archipelago or Instinct. The red bar
on top represents what is called paying up, or the value of
soft dollars in the commission's pot. It includes things like
broker research, fund expenses, access to IPOs, and in some
cases normal and customary business expenses, as in the
expansive definition now allowed by the SEC.
I am guessing when I estimate the size of these practices.
Some have called these largely undocumented practices the
frequent flyer program of the money management industry. Both
the number of miles, which equates to trading volume, and the
premium prices paid create cash-back rebates, or the free
travel equivalent for the investment manager. We need to better
understand the tangible benefit for the investors. I am told
there is far less documentation of soft dollar use and utility
since the 1997 SEC soft dollar sweep in this area. Furthermore,
I am told by our accountants that our auditors have told us
that if soft dollar deals were documented, it would likely
trigger accounting treatment on the investment adviser's books.
We do need some notion of fair value assessment here.
I will restrict my remarks specifically to third-party
payment of soft dollars and to the use of soft dollars to
obtain IPOs. Chart two, is a picture that shows the long-term
average commission rate paid by investment managers on behalf
of investors. It goes back 12 years. You can see on the top
line, the average commission rate paid by managers per share
traded that there has been little movement in a decade. It
looks a little bit like a flat line on a cardiac patient. It
does not move because of the embedded economics--it is not in
the investment managers economic interest to negotiate lower
rates. In other industry surveys, the average commission rate
remains above five cents per share traded. Meanwhile travel--
trading volume--is the chart that is increasing six-fold during
the past decade. The current situation is not unlike fixed
commissions that existed prior to 1975. The value of the
unreported and mostly uncategorized or un-catalogued "research"
services obtained by money managers, provides strong incentive
to keep per-share charges high.
Chart three. This is a busy chart that requires study. It
takes a simplistic example and shows the strong positive effect
of soft dollars on an investment manager's profits. They are a
powerful form of economic incentive. Furthermore, since fund
boards can only benchmark a fund's negotiated rates against
industry averages, there is little competition. If you are
paying a lot of soft dollars, you just do not want to be too
far under the industry average or too far above.
I think that there is a list of about 1,200 vendors in your
attachment, called third-party vendors, where commissions can
be used to pay for services through the commissions stream--
1,200. If you look at them, they include telephone companies.
It includes hardware vendors like Dell Computer, quote vendors,
the New York Stock Exchange. I would think that most investors
believe the management fee they say should be sufficient to pay
for stock quotes--a basic requirement to be in the business. We
think there is a problem, and it is a transparency problem. We
think specifically that commissions should be negotiated and
disclosed as a percent of principal, as it is done in markets
across the world. This will create more competition and
transparency, and meaningful measurement of trading costs.
Fund managers should identify and disclose the execution
only rate for each broker they use, to make explicit the
perceived value of services provided. The little blue bar on
that first slide, that is the real execution rate. We must make
explicit money manager use of commissions to pay third parties
for goods and services available to the public for cash, like
my Wall Street Journal.
Now, of course, these things that are paid for cash like
the Wall Street Journal, if in fact these were explicit
contractual commitments on paper as agreements for soft
dollars, they would show up as expense items already. They are
just not "real" today because they are not recorded.
We also think Congress should look at considering a new law
or rulemaking that removes the structural incentives based on
commission flows that have contributed, we believe, to the IPO
pricing and allocation scandals. We also believe that
underwriters should publish the size and identity of the 50
largest IPO allocations so that our investors can be assured
when they are told that by paying more, we get access to those
IPO allocations, that we really do. There is no transparency
there. We need transparency and we need accountability in these
poorly understood areas.
I really do believe that if we start to make progress a
little bit at a time, we will more quickly restore investor
confidence across all of our markets.
Thank you very much.
[The prepared statement of Harold S. Bradley can be found
on page 134 in the appendix.]
Chairman Baker. Thank you, Mr. Bradley.
Our next participant is Mr. Paul Haaga, Jr., Executive Vice
President, Capital Research and Management Company. Welcome,
Mr. Haaga.
STATEMENT OF PAUL HAAGA, JR., EXECUTIVE VICE PRESIDENT, CAPITAL
RESEARCH AND MANAGEMENT COMPANY
Mr. Haaga. Thank you, Chairman Baker, Chairman Oxley,
Ranking Member Kanjorski, Members of the Subcommittee, I am
pleased to be here.
I am Chairman of the Investment Company Institute's Board
of Governors, and I am a member of the executive committee, and
I am here testifying on behalf of the institute. My own firm is
the investment adviser to the American Fund, which manages $350
billion on behalf of about 12 million mutual fund investors. We
are the third largest mutual fund family in the United States
and the largest that sells exclusively through financial
intermediaries.
I appreciate the opportunity to continue to work with
Chairman Oxley, who first chaired a hearing on the fund
industry in 1998, as well as Chairman Baker and their staffs,
as the committee examines additional ways to bolster investor
confidence in our financial markets. With half of all Americans
owning mutual funds, fund companies can play a key role in
helping millions of middle-American investors to gain
confidence in long-term investing. Following today's hearing,
the ICI and the fund industry look forward to addressing any
questions or concerns members of the committee may have as we
continue to reinforce our commitment to meeting the needs of
the 95 million fund investors.
You have asked how the fund industry is serving individual
Americans who invest in our funds. We believe the answer is
very clear. At a particularly difficult and challenging time in
the history of our financial markets, we are serving 95 million
investors very well. We provide useful information, multiple
investment options, and valuable services to our shareholders,
and at much lower cost than ever before. We believe the cost of
mutual funds and the services they provide to investors are
lower than any other alternative financial services used by
investors.
I was at a press briefing this morning, and I was asked the
question, do you think that the hearings today will destroy
confidence in mutual funds? My answer would be a resounding no.
I think they will increase confidence in mutual funds. We
welcome them. We welcome regulation and we think investor
confidence will increase as they know that people are watching.
So thank you again for having this hearing.
We view strict federal regulation as an asset, not a
liability. Under the SEC's watchful eye and the effective
oversight of our independent directors, mutual funds have
remained free of major scandal for more than 60 years. We do
not think that it is an accident that historically mutual funds
have enjoyed unusually high levels of trust and support from
fund investors.
The hearing occurs as we approach the 37th month of one of
the worst bear markets in modern history. Our memory of costly
accounting scandals and corporate abuses is also still vivid.
Most individual investors holding stocks and stock mutual funds
have lost money over the last few years. Some have also lost
confidence. While stock mutual funds are not the cause of the
scandals or abuses, our responsibility to serve and protect the
millions of individual investors makes it imperative that we
work to devise and support solutions.
For this reason, we strongly supported the Sarbanes-Oxley
Act and many other reforms to our financial reporting and
oversight system, and in fact many of the corporate governance
reforms that were in the Sarbanes-Oxley Act and the follow-up
regulations came directly from mutual fund's longstanding
practices.
Let me turn to the issue of mutual fund fees. It is
frequently reported that the average stock mutual fund charges
fees at an annual rate of about 1.6 percent of assets. By
itself, that statistic is essentially true. But by itself, that
statistic is also very misleading. Although the average stock
mutual fund charges 1.6 percent in fees, an overwhelming
majority of stock mutual fund investors pay far less. At the
end of 2001, the average investors stock mutual fund had annual
fees of .99 percent, just under 1 percent. As illustrated in
the chart we brought with us, 79 percent of all mutual fund
accounts are in lower-cost stock funds. These lower costs hold
87 percent of all stock fund assets.
At first, it may not seem apparent that the average
investor could pay less than the average fund charges. But
consider a business that has two cars for sale--one for $20,000
and the other for $40,000. The average selling price of the
cars is obviously $30,000. But if 80 people buy the less
expensive car, and only 20 choose the more expensive car, the
typical buyer clearly does not pay the average price charged by
the seller. The typical buyer pays $24,000. This is 20 percent
less than the $30,000 average price charged by the seller.
Now, what do cars cost, I ask? Industry critics would say
$30,000, and they would point the finger at the cars that cost
$40,000. We would say they cost $24,000, and so would the GAO
and the SEC in their studies, which are asset-weighted, because
that is what the majority or the average of what shareholders
are paying. If you walk down the street and find somebody who
owns a car, the likelihood is that they will tell you that
their car cost $20,000, because that is what they paid.
The committee also expressed interest in the trend in
mutual fund fees and expenses. Since 1998, major fee studies
have been completed by the ICI, the General Accounting Office
and the Securities Exchange Commission. My written testimony
points out that these studies share many common attributes and
conclusions. Perhaps the single most important conclusion is
the finding that as mutual funds grow, their fees generally
decline, with the sharpest reductions apparent at the funds
that grew the most. The ICI study found that 74 percent of the
497 funds that they reviewed lowered their fees as they grew.
The average reduction amounted to 28 percent. The GAO study of
46 large funds found that 85 percent reduced their fee levels
and the average reduction was 20 percent. The SEC study found
that 76 of the 100 funds they looked at had contracts that
automatically reduced fee levels. They also found that stock
funds that had grown to exceed $1 billion in assets had fee
levels substantially lower than smaller funds. In fact, the SEC
found specifically that as fund assets increased, the operating
expense ratio declined.
We are pleased that all three studies on this subject--the
ICI, the GAO and the SEC--recognized that cost savings from
mutual fund asset growth can only be realized by individual
funds, not by industries.
It is equally important to understand that mutual fund fees
schedules cannot be increased without three separate actions
being taken. First, the fund's board must approve the increase.
Second, the board's independent directors must separately
approve the increase. And third, the fund's shareholders must
vote to approve it.
This positive news hardly means that our job is complete.
This is especially true in the wake of the corporate scandals
and abuses that have been revealed over the last 18 months. The
challenge of educating investors about diversification, asset
allocation, various types of risk and the impact of fees and
taxes, the need for realistic expectations and a long-term
focus is our constant responsibility and an essential element
in reinforcing confidence in our markets.
Thank you very much for helping us to ensure that we will
do that.
[The prepared statement of Paul Haaga, Jr., can be found on
page 168 in the appendix.]
Chairman Baker. Thank you, Mr. Haaga.
Our next witness is Mr. Gary Gensler, no stranger to the
committee as former Under Secretary for Domestic Finance,
Department of the Treasury, and the author of The Great Mutual
Fund Trap. Welcome.
STATEMENT OF GARY GENSLER, CO-AUTHOR, "THE GREAT MUTUAL FUND
TRAP," FORMER UNDER SECRETARY FOR DOMESTIC FINANCE, DEPARTMENT
OF THE TREASURY
Mr. Gensler. Thank you, Chairman Baker, Chairman Oxley,
Ranking Member Kanjorski. Thank you for having me here today.
It is a great honor to be back with you. It looks like there
are more seats, though, here in the front since I was last
here.
Needless to say, as the author of The Great Mutual Fund
Trap, I applaud this committee's willingness to look at the
mutual fund industry closely. There are great statistics that
have been named, but in each of your congressional districts
there are 125,000 households that own mutual funds. Middle
income, generally married, median age 46--sounds like I might
be a pollster, but I am not--but 125,000 households in each of
your districts. It counts to middle-income Americans what this
committee is talking about here today.
By any objective measure, however, mutual funds have been
failing millions of those investors, or hundreds of thousands
in each of your districts. That is understandable given $70
billion of annual costs--$70 billion--not small amounts of
money. In any other industry, we would take a close look at
that, and I think Congress would, and I am glad you are today.
Investors can expect costs totaling about 3 percent of
their money each year for investing in mutual funds. I actually
agree with the testimony to my right. It is about 1 percent a
year on average for the management fee. Where is the other 2
percent, you might ask? Well, it also comes in what is called
sales loads. About half of mutual funds are sold today with a
commission up front or at the back end, which is 4 percent.
Given our American nature of turning things over so often,
which is once every two and a half or three years, that adds
about 1 percent to 1.5 percent more cost.
Then there is the undisclosed cost, and those are dramatic.
Portfolio trading costs add about .05 percent of your money a
year, because these portfolios turn over on average pretty
quickly. I would use the median, and they on a median turn over
once every 15 months. That is pretty fast trading, and that
fast trading runs up short-term capital gains taxes--good for
the budget deficit, good for Treasury where I once served, but
not good for Americans. Better to go back to a buy and hold
strategy. Short-term capital gains taxes when markets are at
least modestly going up add 1 to 2 percent of your money every
year.
Take out 3 percent of your money each year, what happens
after 40 years of savings? You give up 42 percent of your
savings. We wonder about savings in America, and the retirement
of the baby boom generation, and the mutual fund industry has
done a tremendous job, but can do better if costs are lower.
I would also note that many Americans complain about their
$1.50 ATM charges, because they see it. It is direct. Mutual
fund charges, it is a wonderful thing--we do not see it. It is
just taken out and we do not have to write a check like we do
to our plumber or our mortgages.
What happens to the average? As you heard Mr. Bogle's
averages, I will not repeat them, but over the last 10 years,
Morningstar reports the average diversified fund is behind by
2.2 percent the S&P. But that does not count all the funds that
went out of business. About 5 percent of funds go out of
business every year. Add them, you are about 3.5 percent
behind, similar to the cost structure, as we have just noted.
Many Americans think, well, if I just buy yesterday's hot
fund, I will be able to do well in the future. The mutual fund
industry has figured out to advertise yesterday's hot fund in
all those January and February Money magazines, and Smart Money
magazine advertisements of the hot fund of yesterday. But
yesterday's hot fund usually does not do well in the future--
just a little bit better than random chads.
You have heard a lot about fund directors. Whose fund is it
anyway? It is the investors' fund, and the Investment Company
Act of 1940 set up a structure whereby investors actually have
a board of directors control that fund, and can fire the fund
manager--at least in theory, that is. In practice, when does it
ever happen? In fact, fund governance leads to the problem you
have heard about today--soft dollars. While I too am
recommending that you ban soft dollars, I am not suggesting
that you once again take up McCain-Feingold. This is not that
type of soft dollars.
These soft dollars are saying that fund companies, which
are distinct from funds, make profits, because the fund
companies ask Wall Street to pick up their expenses and then
charge them through higher commissions, as was earlier shown,
that nickel a share, the higher commissions, directly to the
fund companies. In fact, many fund companies who get the
benefit and have higher profits, direct commissions to Wall
Street's biggest houses. I would say ban soft dollars. I think
there is no room for it, no excuses for it.
The other recommendations that I outline in the testimony,
I would say start with the belief that Americans really have a
choice. I wrote a book for Americans to choose. If Americans
wish to choose the high-cost funds, that is their choice. But I
think transparency would add something. While I say six
recommendations in the testimony, let me just highlight a few.
One is to disclose portfolio trading costs. A hard job to
do, but important costs. Two, I think survivorship buys, as
tough as it is--all those funds that go out of business--it
would be helpful if fund companies put on their Web sites the
ones that went out of business and report their averages
including the failed funds. It would be sort of like asking
about those reality TV shows and forgetting about all the ones
that are kicked off the island. I think we need to know a
little bit about those as well. Thirdly, I think disclosure
with regard to all the revenue sharing arrangements, all the
conflicts that are inherent in the market, would do us well.
That is with brokers, as well as with corporations around
401(k) plans.
I too think that the SEC and Congress should consider
taking a close look as to why funds do not go out and try to
hire new fund managers. Seven thousand funds in America, and
can we name one that in 2002 fired their fund company? Can we
name one that went out to competitive bid? That is 7,000
companies. Would not we think that there would be five, ten,
fifty of them that might have, if fund directors actually were
fulfilling their fiduciary responsibilities?
Lastly, as you consider new 401(k) legislation, I know that
many in Congress think that there is a need for investment
advisers to be giving advice--that, too, raises new conflicts
of interest. As you grapple with that, you might want to
consider I would suggest adding that all 401(k)s and 403(b)s
have at least an alternative which Congress has for federal
workers--an index fund to add to the choice of investors so
that if they get this new investment advice, at least they have
one low-cost alternative in their portfolio.
I thank you for considering my thoughts.
[The prepared statement of Gary Gensler can be found on
page 155 in the appendix.]
Chairman Baker. Thank you for your participation, Mr.
Gensler. We are glad to have you here.
Our next witness is James S. Riepe, Chairman, T. Rowe Price
Associates.
Just by way of announcement, we do have a series of votes
on the floor. It would be my intent after Mr. Riepe concludes
his remarks that the committee would recess for about 15
minutes to go make the votes and come back.
Mr. Riepe?
STATEMENT OF JAMES S. RIEPE, CHAIRMAN, T. ROWE PRICE
ASSOCIATES, INC.
Mr. Riepe. Thank you, Chairman Baker, Chairman Oxley,
Ranking Member Kanjorski, and all the other Members of the
Subcommittee.
T. Rowe Price is a Baltimore-based investment management
firm. We manage over $140 billion of assets. About $90 billion
of that is in mutual funds, and we have been at it for about 70
years. Personally, I have been in the fund management business
for about 34 years, and I am happy to be here with you all
today to talk about this important subject.
Before I start, I want to note that as you conduct your
review of the fund industry, it is important to remember that
stock funds, although they get all the headlines--particularly
after three years of a severe bear market, represent less than
one half of the mutual fund industry assets, about 41 percent
specifically. The balance are in fixed income funds and money
market funds. Even when we look at just the equity fund portion
of the industry, less than one-fifth of those assets are in
aggressive growth funds--again the ones that get the most
headlines. So that means when we look at the mutual fund
industry assets, only about 6 to 7 percent of the entire
industry is in this aggressive end, which enjoyed the upward
volatility of the late 1990s and now suffered the downward
volatility of the last three years. I think just putting that
in context, that this is much more than just a growth stock
business. It also means that the vast majority of investors
have benefited from mutual funds in a very substantial way,
when one considers all the other kinds of funds in which they
are invested.
Individual investors do not typically trust all their
assets to just one fund or even one manager. The average T.
Rowe Price investor, for example, owns at least three of our
funds, and they also own funds offered by two or three other
managers as well. So clearly, investors understand the idea
that diversification is important, not only diversification
among funds and within funds, but among managers as well.
That has come across in the defined-contribution side of
the business. Again using our example, our typical 401(k)
investor has seven different investment accounts and about 50
percent of the assets are in equities, and then some more in
company stock, and then fixed income options. So as a result,
the 401(k) investor has done relatively well in terms of his or
her risk-adjusted performance during this recent down period,
and did well during the later years of the bull market as well.
Our panel has covered a range of subjects today, and I just
want to touch on a few of them. Several issues we are a bit
uncertain about, and others we view with some certainty. With
respect to disclosure, I do not know if mandating more
disclosure is the answer. I think we need to work harder in
determining what disclosure is illuminating to the investor and
what disclosure is obfuscating. As an industry, we are
committed to educating investors, and I think the evidence is
very clear that we have done that, both collectively and as
individual firms. We have done it quite frankly, because it is
in our self-interest to have investors who understand their
investment.
But disclosure for the sake of disclosure is not good. I
would use the example of owners manuals. Studies show that
people do not read owners manuals. One of their problems is
that the first 10 pages tend to be filled with disclaimers and
warnings, and then the book is too thick. If we do the same to
mutual funds, then we are going to turn away the average mutual
fund investor. So we need good, useful, focused disclosure; we
do not need simply more disclosure.
When we get into the world of trading cost evaluations, you
can tell from listening to a couple of the comments here, it is
incredibly complex, and very difficult to measure. There are
multiple ways to measure transaction costs, but there is no
consensus on which is best. And all the measurement models are
at their base speculative. I think we can be comforted in the
fund industry that however such costs are measured, we know
that the fund investor's return is net of all costs. I think
that is very, very important.
Some things we do know. The fundamental qualities of mutual
funds--diversification, professional management, relatively low
cost--have proven their merit during this bear market. Being
able to gain access to a diversified portfolio is critically
important for investors. When they invest individually in
individual stocks, they do not have such diversification.
Morningstar and all the critics have pointed out the value of
fund investments from a diversification perspective.
Mutual funds also provide better and much more useful and
more transparent disclosure than any other financial product we
service. As Mr. Gensler suggested, the disclosure always could
be better in mutual funds. But let's compare mutual funds to
other financial services. If I buy a certificate of deposit at
my bank, they tell me I am going to get 3 percent. They do not
tell me that they are going to lend that money out at 8
percent, use 400 basis points to cover their expenses, and keep
100 basis points of profit. That is the reason, ironically,
that you could not have hearings on the expenses of those
products in the way you can have hearings on mutual funds.
Because funds spell out all the expenses that investors incur,
and they spell out the bottom line, which is the net return the
investor receives after these expenses.
I think, too, there is an impression being left that mutual
fund investors panic easily, that they are skittish, et cetera.
One has to look under the aggregate redemption numbers, to find
that most fund investors are long-term investors. There are
certainly those investors who follow trends. There are
investors who think they can out-guess the market. They are not
the majority. They are not even in many cases a significant
minority, but they trade often enough that they affect the
overall redemption numbers. So I think it is misleading,
frankly, to look at aggregate numbers and try and draw
conclusion about 95 million investors. Mutual fund investors
are intelligent when they make their investments, and they hold
their investments longer than aggregate redemption ratios might
indicate.
Unlike many other financial relationships, and in contrast
to Mr. Bogle's suggestion, the interests of fund companies and
mutual fund investors are, in my view, very well aligned.
Investors and fund managers, they want good performance. We all
want good performance. That is how we thrive. That is how as
mangers we thrive and prosper. We want good service. We have to
have good service to be competitive and we are an incredibly
competitive industry. We also need to provide helpful guidance.
Investors select us on the basis of the kind of guidance and
intelligent advice we can give them. And they want all of that
at a reasonable cost.
As to the suggestion that almost no one beats "the index,"
nearly 80 percent of T. Rowe Price equity funds beat the
competitor Lipper Group and the S&P 500 over the last five
years. Almost two-thirds have beaten the market index over the
last 10 years. So the fact is, there are many funds out there
that have been successful in beating the indices. There are
many investors who would rather bet on health care or on
financial services, or on technology, than buy an index fund
that is going to provide them with the overall market
performance.
Having said that, T. Rowe Price manages billions of dollars
of index funds, along with our actively managed products. This
is not about religion. This is a matter of choice. Selection
depends on an investor's objectives and how he or she believes
they can best achieve them. Index funds are out there for all
those investors who want them.
Let me just say very quickly a word on governance.
Sarbanes-Oxley adopted governance practices that have existed
for mutual funds for many, many years. So we feel the corporate
world is coming closer to where we are now, and not vice versa.
Fund investors do not invest in boards of directors. They
invest in a fund manager--a company they know, a company they
have read about, a company they have talked to their friends
about, a company they have read in Morningstar or Lipper or
Money magazine. They do not expect directors whom they do not
know, and who do not necessarily have an investment expertise,
to decide to replace the manager they have picked. What they do
expect those directors to do is to monitor the funds's results
and make sure the managers act in a prudent way. If there are
funds that they believe have not performed up to reasonable
standard, they should urge the management to make appropriate
changes. But the idea that independent directors should start
replacing managers and putting out to bid contracts, when the
investor has already made the decision to invest with that
company, I think is neither appropriate nor expected.
In closing, when you ask about the effects that funds have
had on investors, the answer is that the mutual fund as an
investment vehicle for individual investors has been arguably
the most successful financial service in the 20th century.
Chairman Baker. Mr. Riepe, I hate to interrupt you, but we
are down to two minutes left on this vote, and members are
going to have to excuse themselves. We will pick up your train
of thought when we get back in probably 15 or 20 minutes.
Mr. Riepe. Great. Thank you.
[RECESS]
Chairman Baker. If I can ask everyone to take seats, we
will reconvene our hearing.
Before we took our recess, Mr. Riepe was concluding his
remarks. Members will be returning momentarily. I expedited my
trip. So Mr. Riepe, if you would, please?
Mr. Riepe. I appreciate the opportunity, and I will just
give you my closing remarks, Mr. Chairman.
When you ask about the effects funds have had on investors,
the answer is that the mutual fund--as an investment vehicle
for individual investors--has been arguably the most successful
financial service of the 20th Century. It has succeeded because
investors see value in it as an investment vehicle. Funds have
provided tens of millions of investors with diversified and
professionally managed access to stock, bond and money market
securities invested around the globe in every way, shape and
form that investors could want. Mutual funds have succeeded
without incurring major scandals or frauds during their long
history--a statement that not many industries could make, and
certainly not any other financial services.
That success, in my view, is attributable to a number of
factors, including the intensive regulatory scheme under which
funds operate. But most important to their success is the
transparency which our panel has talked about and which is
inherent in funds. And that transparency has been critical in
creating trust between tens of millions of investors and the
managers responsible for investing their hard-earned dollars in
these funds. It is a trust that all of us in the business know
could be lost very easily if we do not continue to earn it
every single day.
What you see is what you get in a mutual fund. The net
return on a fund is just that, return net of all the expenses--
whether they are in fact, the measurable ones or the more
difficult ones to measure. Our fund is measured every single
day. The results are posted in the paper, and are seen by
everyone. The evidence clearly indicates that investors value
this combination of transparency, diversification, and
professional management--all at a relatively low cost.
Thanks very much for the opportunity to express my views. I
appreciate it.
Chairman Baker. Thank you, Mr. Riepe. We also appreciate
your participation here today.
I will start off with questions to you, Mr. Haaga, and you,
Mr. Riepe, centered around a comment which you made about
performance of funds generally as contrasted with the S&P. When
we passed Sarbanes-Oxley, we had what I called--and this is a
congressional term--a coloring book requirement which posted
the individual stocks that an analyst would cover against his
upgrades, downgrades and price targets. That is required to be
prepared by the firm for whom he is employed on an annual basis
so that a shareholder interested in that analyst's performance
can look back at that coloring book illustration and understand
how his recommendations fared against the actual performance.
That leads me to conclude this, that current disclosure
requirements are not necessarily crystal clear. They are not
opaque. They are somewhere in the translucent range, in order
to help facilitate an individual investor's understanding of
fund performance. Also with the disclaimer, past performance is
not an indication of future, blah, blah, blah.
Would either of you object to a requirement on an annual
basis to have a disclosure of individual funds' performance as
cast against either the Wilshire, the S&P--you pick out the
standard index against the fund, so you could make a judgment
of that sort from the graph, without having to dig through
numbers and post it yourself. Is that an unreasonable request?
Mr. Haaga. Actually, we already have it. There is an SEC
requirement that our annual reports include our results in
comparison, and of course net of fees, in comparison with a
recognized stock index of our choice--Wilshire, S&P--
Chairman Baker. But is there an industry standard that
everybody does it against the Wilshire?
Mr. Haaga. All the funds do not seek to mimic the Wilshire.
There are many balanced funds, funds with--
Chairman Baker. Well, do we require multiple--
Mr. Haaga. Nearly all of them use the S&P--nearly all the
large, broad-based equity funds use it. We also can in those
disclosures compare against the Lipper averages, the averages
of other funds, and many funds do. So they will say, we were up
X amount; the Lipper average for our type of fund was up Y
amount, and the S&P was up Z amount. I think bringing it down
to a single comparative number would probably be misleading for
some of the funds. There really is a vast range of funds and
there is a vast range of what they do. Having said that, there
are only three or four recognized indexes that we use. So we
are almost there.
Chairman Baker Do either of you think there is any
additional disclosure standard required from your perspective
at this time, based on what you have heard from other folks
this morning?
Mr. Riepe. With respect to performance?
Chairman Baker. Fees, performance--you pick. We have about
five or six different topics that others have elicited comment
on. But generally from the read of your remarks, and do not let
me mischaracterize it, you feel generally the industry on
balance is performing well, and that investors have access to
the information they need to make informed judgments. If that
is your position, then do you think any additional standards or
disclosures are required, based on what you have heard this
morning?
Mr. Haaga. Yes, and in fact we have got that in writing,
because there are two SEC proposals out there. One is a
requirement that any mutual fund advertising or anything you
see in the paper include a cross-reference directing the
shareholder to go to the prospectus to find the fees and
expenses. That has not been there in the past, and we support
that. The other is an additional fee table. There is, as you
know, and several have mentioned, there is a fee table in the
prospectus that takes all the fees and combines them and puts
them in a standardized dollar amount. The SEC has proposed that
that be extended to the shareholder reports, and that in the
shareholder reports, unlike the fee table in the prospectus,
the actual investment results of the fund be used against a
standardized dollar amount to give the total. We support that
as well, so there are two additional changes we would like to
see.
Chairman Baker. And my last point, because I am going to
run out of time.
Yes, quickly.
Mr. Riepe. Mr. Chairman, I think the problem is not
additional disclosure, as much as it is getting people--it is
my owners manual analysis. It is getting people to look at what
is there, and having a better understanding of what the
characteristics of that particular investment are.
Chairman Baker. I liken it to the privacy disclosure
statement by financial institutions. By the time you read it,
you do not know what bank you are doing business with, much
less what your rights are.
Mr. Riepe. And after the first couple, you just throw the
envelope right out.
Chairman Baker. And what you are looking for is something
that says, if you give it to us, we are not going to do
anything bad with it, but lawyers will not let you do that. But
there ought to be some good faith disclosure which I do not
think, frankly--I do not any longer invest in mutual funds or
have any holdings in the stock market for a lot of reasons--but
I have looked at my son's.
I have got to tell you--I know I am a Congressman and that
puts me on the low end of the food chain--but I could not make
much out of his mutual fund statement to tell him really where
he was. That is what is troubling. I do not think people can,
despite good faith effort and a lot of expert counsel, on their
own take their information and determine what their actual
costs are, not to allege that the costs are inappropriate or
that you are not getting good service for the fees you pay.
Those are different issues. Right now, I think the question is,
can the average investor understand where he is with his piece
of paper and the holdings he has? T. Rowe Price is a great
firm, does a good job, makes money for people. I have no
complaint. But there are a lot of funds out there that do not
exactly have your model, and that is the troubling part.
I know I am over my time, but I am at least going to get
Mr. Bogle and Mr. Wagner in, because the representations made
on the other side are that your calculations of costs are not
exactly on target, and that somebody here is not--from my view
of the representations at the table, there are two pretty clear
distinct representations about fees and charges. I am leaning
toward writing my own letter. I have not had a chance to talk
to Mr. Kanjorski to see if he would sign onto it, but at least
from my own initiative, and we will ask other members if they
choose to do so, to sign onto a letter to the SEC outlining the
points made here today, and asking them for professional
guidance in sorting this out, and maybe reporting back to the
committee in some length of time to give us a real insight into
the issues raised.
If you were in our position, give me some good investment
advice. Where do we go to get this resolved in an impartial
courtroom?
Mr. Bogle. I think going to the SEC or an independent
consulting firm to look into the cost issue is a perfectly good
thing to do, a perfectly intelligent thing to do. I would
definitely tend to lean toward the SEC. They have a very good
staff. Although I have had a lot of trouble trying over the
years to get the SEC to do an economic study of this industry
that is really on thing that ought to be central to the work of
your committee. We need to follow the money in the mutual fund
industry. Not only these ratios, which we have probably bored
you to tears with, but the total dollars involved. This is an
immensely profitable industry. Mutual fund managers get paid
not only through their expense ratios, but through their use of
brokerage commissions for their own benefit.
Chairman Baker. Let me hit that point. I am really way
over, but let's just take simple examples. Let's assume it is a
$100 million fund; I am the investor; you are the portfolio
manager and you are getting instructions from your director to
do certain things. Let's assume, based on last year's
performance, the fund is down 25 percent from the date on which
I signed in. But you also assume we have had our 110 percent
turnover rate that has been elicited earlier in the comments,
and let's just use the average that they have used, the .99
percent transaction cost. Is there a way for you as a portfolio
manager in the current scheme of things, even when the fund is
down, to generate a profit for you or the directors from the
turnover in those fees?
Mr. Bogle. Can you as the portfolio manager or the
management company make a profit on turnover when markets are
down?
Chairman Baker. Based on the generation of the fees that
you are talking about. Where does the fee money go, even in a
down market? When you are rolling over my stocks at the rate of
110 percent, and assume the stock valuation has gone down from
the time I got in, but there has been a lot of turnover, a lot
of transaction costs, and it is not going to research and
market data. Where does that money go? You are saying, follow
the money, tell me where it is going.
Mr. Bogle. Okay. Let me just give you a simple example.
Take a $10 billion fund and the market drops--
Chairman Baker. I like your definition of "simple." Yes, go
ahead.
Mr. Bogle. Well, I want to make sure the numbers come out
in a decent way. I will start with it simple. Let's assume the
market goes down 20 percent. The fund is now $8 billion.
Annualizing that number, the total management fee at 1 percent
would drop from $100 million to $80 million. The manager at the
beginning of the year is making about $50 million. The pre-tax
profit margins in this business have been, at least at the high
market levels, very close to 50 percent. So his profit is going
to go down from $50 million of that $100 million of revenues,
to--I have got to make sure I have got my decimal points
right--from $50 million to $40 million. He will be making $40
million, assuming his costs, which are the other $50 million of
the original $100 million remain unchanged. So he makes less
money, but it is still 40 million even though the shareholders
have lost $2 billion--
Chairman Baker. That is my point. Is that I as the investor
have lost equity in my fund because of the market under-
performance, but the fellow with whom I am doing business is
only going to make $40 million as opposed to $50 million. My
heart goes out to him.
Mr. Bogle. Yes, mine does, too, sir.
Chairman Baker. I do not think we have focused on that
enough this morning. I have got to quit, because I am way over
my time.
Mr. Lucas?
Mr. Lucas of Kentucky. Thank you, Mr. Chairman.
I come at this from a couple of angles--32 years in the
financial planning business, so I was a supplier of these
services and also a consumer. But I think one of the things,
and I think it is healthy to have this hearing, and I think
that there can be some good come out of it. I would just hope
that we as a committee do not overreact to this, because it has
been my experience that people who have stayed in functional
allocation and in great diversification in mutual funds have
been far better off. I think you need to look at the end
result. Would the consumer be better off if he or she were
involved in function allocation and spread all around the
board? Would they be better off in the end paying these fees?
The net bottom line is, in my view, the vast majority of
consumers who were involved in functional allocation funds have
far more in their 401(k)s and profit-sharing plans and
individual portfolios today than some of those people who
thought they knew all the answers and were in individual
stocks.
So I do not think we should, although I think it is
important, as the Chairman said, to be able to know and
understand this, the information is there for those who want to
ferret it out. I think that competition works that one fund
wants to be more open and more competitive than any other. I
think those factors are there as well.
So I really do not have a question, other than I very much
am an advocate of this functional allocation. As I would tell
my clients through the years, we may not hit any home runs for
you, but we are also not going to strike out. Worst case, maybe
we will do some singles and doubles, once in a while a triple
maybe, in baseball parlance, but I think we have to look at the
performance of the funds as measured against the marketplace. I
know as a consumer who has a considerable amount of my net
worth in the market, even though it is way down, it is much
less down than people who are investing in individual stocks.
So I would just say, let's do not throw the baby out with
the bath water here, and let's not overreact. I am for more
disclosure as well, but there are two sides to this coin.
Thank you.
Mr. Bogle. May I comment, Mr. Chairman?
Chairman Baker. Certainly.
Mr. Bogle. I would just like to say, we have talked a lot
about the return of the average fund in these markets. We have
talked very little about the return of the average fund
investor. This industry, Mr. Congressman, has moved a long way
from being an industry selling diversified stock funds, to
selling specialty funds. In the recent bubble, technology funds
were very big. Internet funds were very big. Telecommunications
funds and aggressive growth funds owning those stocks actually,
believe it or not, sir, took in $500 billion in the couple of
years going up to the market peak, while fund investors were
taking $40 billion out of value funds at just the wrong time.
Investors had 75 percent of their money in stock funds at the
peak, and in round numbers just 50 percent in stock funds now
that the market is down--again too much risk at just the wrong
time.
So if we look at the returns of the average investor, not
the average mutual fund, we see something very different. A
study in one of my exhibits that is in your report shows that
in the last 20 years, one of the great bull markets of all
time, even after the decline, the stock market went up at a 13
percent rate. You saw that a little bit earlier. The average
mutual fund went up 10 percent, primarily because of that 3
percent are points of costs. But the average fund investor, as
far as the data we can find tells, and it is going to be very
good data, but not precise, made 2 percent annually in that 20-
year bull market. The average investor in equity mutual funds
earned 2 percent. That means if you started at the beginning
with a dollar and owned the market, you ended up with a profit
of $10.70. Starting in the beginning with an equity mutual fund
on average, you ended up with $5.70--just about half as much.
And if you earned that 2 percent that the average fund investor
appears to have received, you ended up with a 50 cent profit.
That just is not good enough. That is not one of the great
success stories of the 20th century. It may not be a scandal,
but I think it is close to one.
Chairman Baker. Let me offer time to the other side here.
Mr. Haaga did you want to make a comment?
Mr. Haaga. I sure did. I will not refute all those numbers,
but I will just say I do not agree with them. I guess if we
were giving people 50 cents over 10 years, I do not know how we
got to be $6.3 trillion in assets.
I wanted to thank Mr. Lucas for his comments, and buttress
them with some figures from Morningstar that really show the
value of diversification. Twenty percent of the stocks in their
database--that is 6,500 stocks they cover--20 percent of them
lost 60 percent or more in value in the year 2002. One-tenth of
1 percent of all equity mutual funds lost that much. So I think
that shows the value of diversification.
One other thing I would like to just set straight. The 110
percent turnover rate, I do not know where that came from. We
would like to check. It may be another one of those statistics
that is an average that is not what anybody is doing. Our
turnover numbers are way below that, but they are higher than
they used to be. When I asked our portfolio counselors how come
there is more turnover--our turnover is in the 20 to 30 percent
range, but it is up from below 20 percent--their answer is that
the market is so much more volatile.
I was reading in Business Week, that said how two out of
every five days on the NASDAQ, the market moves by 2 percent or
more, and one out of every five days I think it is the S&P
moves by 2 percent or more. Those numbers were unheard of.
There is just volatility. There were no 2 percent days in the
past. I think that is what is happening. I do not want to
defend 110 percent turnover number, because I do not agree with
it, and we do not have that kind of turnover, but I think we
need to know what the real number is and we need to have it in
context.
Mr. Gensler. As I do find that Paul and I might differ on
policy, we tend to agree on numbers. Turnover in the industry
is reported by Morningstar from their database. The median is
76 percent. The average is over 100 percent because there are
some funds that I do not even know, have 6,000, 7,000 turnover
that skew an average. Large diversified funds are probably
closer to 60 percent turnover. That is still selling all their
stocks every one and a half years. I do share your view that
financial planners have a great service to Americans in asset
allocation. All the studies that I have looked at show that
about 80 percent of American returns come from how you allocate
your assets. Do you buy stocks or bonds, and hopefully if you
diversify. If you are, as Mr. Bogle said, picking just a sector
fund, a technology fund, well then you are in for a wild ride.
Chairman Baker. Mr. Lucas yields back all of his time.
[Laughter.]
Chairman Baker. Chairman Oxley?
Mr. Oxley. Thank you, Mr. Chairman. It has been a most
enlightening hearing and we appreciate all of your
participation.
Mr. Riepe, you indicated at the end of your statement that
in your business what you see is what you get. That would seem
to indicate that the average mutual fund participant and owner
really understands and has all the information available to him
in understandable form. Is that really true? Do you think that
your customers really do have all of that information in front
of them in understandable form?
Mr. Riepe. I think, Congressman Oxley, that you perhaps
were not in the room when I answered Chairman Baker's comment
before, but those are two quite different things--having all
the information one needs, and understanding it. I believe that
investors get all the information they need to make an
intelligent decision about a fund. The challenge for us is to
get those investors to spend the time looking for that
information, if you will. Understanding it is the bigger
challenge. Finding it is not the big challenge.
Mr. Oxley. Do you think the SEC is on the right track,
then, with their proposal to take the proverbial $10,000
account and try to put some numbers to it?
Mr. Riepe. I will tell you two things on that. One, we as
an industry have supported that. Personally, I honestly have
some reservations about it because my experience over three
decades with investors is that they understand things they can
compare. Returns on mutual funds, returns on investments are
expressed in percentages. That is why the expense ratio has
always been the most simple and easily understood way to
express a cost. So if I am going to earn 10 percent in this
fund and it is going to cost me 1 percent, I can understand
that. If you tell me every quarter that it cost me $322 last
quarter, and this quarter it is $275, I do not know how to
compare that. I do not know whether I put more money in, I did
not put more money in, my asset value went up, my asset value
went down. I cannot compare it to another fund as easily as I
can in simple percentages. So I hope we will not lose the
percentages.
Mr. Oxley. If that is the case, let me ask you then, the
GAO study indicated an 11 percent increase in that ratio. Those
are relatively easy numbers to understand. Mr. Bogle, do you
have any comments on that? You heard Mr. Riepe say that the
more accurate definition would be the expense ratio, and yet--
Mr. Riepe. I did not say accurate. They are both accurate.
Mr. Oxley. They are both accurate?
Mr. Riepe. They are both accurate. The question is
understandable; which will be more useful to an investor?
Mr. Oxley. All right. Is it useful to an investor, Mr.
Bogle, to understand based on the GAO report that expense ratio
has gone up 11 percent?
Mr. Bogle. Yes, it is useful, and we ought to show
investors the dollar amount of their costs. I do not think we
should ever think of these things as mutually exclusive. In my
testimony, I recommend that each mutual fund shareholder
statement at year end, an annual statement, include a footnote,
printed in the statement, showing that the annual expense ratio
of this fund is 1.4 percent, say, and where he says the year-
end value is $11,000, just let that little computer multiply
1.4 percent times $11,000, and say on that basis your cost
would be $154 or whatever it comes out to. I do not see any
harm in that. You still have the expense ratio, and at least
the person can look at his direct mutual fund costs, previously
hidden, and compare them with his electric bill or his rent or
anything else he wants to compare them. He has the right to
ignore it.
Mr. Oxley. Or with other mutual funds, too, in terms of
cost.
Mr. Bogle. Absolutely.
Mr. Oxley. Mr. Haaga, is that a good idea?
Mr. Haaga. No, that is just the problem. He cannot compare
it with other mutual funds. He can only compare it with his
rent, if it is a non-standardized number. That is what we are
talking about. We are all interested in including all the
costs, reducing them both to a percentage and to a dollar
amount. The argument is only whether you should use a
standardized dollar amount or the actual dollar amount that the
person paid. The comparison you were looking for at the end of
your remarks, which is with other funds, can only be made if
you use a standardized amount, not the actual amount that Jack
Bogle is talking about.
You can translate that. If you really want to know that,
you could translate that yourself, but you would have to
remember if you have made purchases during the period, you have
to adjust for that. So we think it is much better to look at
standardized amounts, not actual individual amounts. It is all
about comparison.
Mr. Bogle. It does not take a mathematical genius to apply
the standardized expense ratio to the amount the investor has
in the fund and show the dollar amount of costs he would
expect. I do not see how that can even be controversial.
Mr. Oxley. Mr. Haaga, when you sent out the investor
account balance, that is net after fees, right?
Mr. Haaga. Yes, it is.
Mr. Oxley. You are able to calculate how much to take out
of my account at that point, to determine the fees and the net,
but can it also tell me how much in dollars it took out of my
account?
Mr. Haaga. We actually do not take it out of the account.
The fees are paid by the fund itself, rather than by the
shareholder. So we are not calculating that at the shareholder
level, nor are we deducting them from shareholder accounts. So
when the shareholder gets a statement, that is the net amount
they own, which is the net amount the fund earned after the
fund paid fees.
Chairman Baker. Would the gentleman yield?
Mr. Oxley. Yes.
Chairman Baker. I just wanted to ask, if somebody else is
paying the fee, where do they get the money from in the first
place?
Mr. Oxley. Yes. Those fees are obviously coming out of
somewhere.
Mr. Gensler. It really is a wonderful system they have, is
it not? It really is. It works well.
[Laughter.]
Mr. Haaga. The fund is paying the fee, and the investor's
account, the investor's earnings, the value of the investor's
shares are net of that. But the fund does pay the fee.
Chairman Baker. Mr. Chairman, if I may interrupt again, let
me understand. I put money up. You manage it for me. In the
course of managing that account, you are going to tell me I
have this percent of fees that deduct from my net check. Before
you get to that check, you have operating expenses that the
fund assumes on my behalf. But that offset of operating
expenses comes off the top of the distribution that comes back
to the investor. Even though it is not allocable to me
individually, it is allocable to the fund.
Mr. Haaga. That is precisely what we are disclosing.
Chairman Baker. Okay. I have got it. I yield back.
Mr. Oxley. Mr. Montgomery, do you have any comments in that
regard?
Mr. Montgomery. I guess I am in favor of some kind of
disclosure. I do agree with Mr. Haaga that the timing of
purchases and sales of a fund complicate it, unless you have
this footnote that Mr. Bogle refers to at the bottom of the
statement that says, assuming you held your fund for the entire
quarter, let's say, without any purchases and sales, it would
be this. If you made that assumption, then it is very easy to
calculate and I do not see why we cannot do it. If, however,
you want to be accurate, if you are telling shareholders that
this is the actual fee that you paid from your fund ownership,
then you do have to account for purchases and sales. It gets
very complicated. Bridgeway actually used to do this level of
account disclosure for returns. One of the criticisms of our
industry is that, yes, this is the return of the fund, but how
has my investment since I made it actually performed? That is
what I want to know.
So when we created our first account statement eight and a
half years ago, we actually told investors what that was. It is
a much more complicated calculation if you include the effects
of redemptions and purchases. So I am somewhere in between what
you have heard today. But if you make the simplifying
assumptions, it is a dollar amount, then people can compare it
with the ATM fees that Mr. Gensler talks about.
Mr. Oxley. Let Mr. Gensler respond. He looks a little
skeptical to me.
Mr. Gensler. The nature of the mutual fund industry is to
promote profits for mutual fund companies. Many of them are
public companies. The nature of Las Vegas is to promote profits
for the casino. I would make a note, and I find myself probably
agreeing with Mr. Riepe, who by the way is my twin brother's
boss.
[Laughter.]
Mr. Oxley. He brought the wrong twin.
[Laughter.]
Mr. Gensler. But I would note that if there is some genetic
flaw, then he must have it, too.
[Laughter.]
Mr. Gensler. Somewhat like Vegas, we Americans do not
really pick our funds on cost. So if we put more disclosure out
there, there is probably still going to be 85 or 90 percent of
Americans investing in actively traded mutual funds. It is
relying on experts. It is a sense of the buzz. It is a sense of
in my work-a-day life, maybe I, too, can get an excess return.
There are a lot of good things mutual funds do as well--the
service, the diversification that has been referred to. So I am
a little skeptical that added disclosures will help a lot. I
think there are some areas that disclosure should be
considered. I think, to comment on Chairman Baker's point
earlier, just like with analysts and Wall Street firms, it
would be helpful to know what the whole fund family has done,
even including all those dead funds. As Mr. Riepe has said,
many people pick by the fund family--by Fidelity or T. Rowe
Price. It would be helpful to see how that whole fund does, and
just put it on the Web site. Let the financial planners know
that information is on a Web site. It does not have to go out
in some thick owner's manual.
I do think at the core there is an issue about governance
in the mutual fund business, and all of these fund directors
sort of passively going along with the status quo. In many
funds, that is all right--probably the funds represented at
this table. But we all know with 7,000 or 8,000 funds out
there, there are a lot of really poor performers and high
churn, high turnover and high fee funds, and if none of them
ever change their managers--well now somebody in the press or
somebody will find one that did--but so few do. It seems
something is out of balance to me in that regard.
Mr. Oxley. Well, let me just complete this. That really
gets at the core of the whole issue. Why in the world would an
investor stay with an under-performing fund that you just
described, unless they had no idea what was going on? Why would
they do that time after time, when they have the ability to
take their money and run, or to vote with their feet and go
with somebody else?
Mr. Gensler. At the core, I think it is human nature. I
think I could quote various studies, and in this case not
financial studies, but the psychology of finance, that often we
Americans hang with our losers. We sell our winners and hang
with our losers, and all sorts of studies have shown this. It
is a little like the deer caught in the headlights.
Mr. Oxley. I could understand that with individual stocks.
It is hard for me to believe in a mutual fund concept, which is
just the opposite of individual stocks. You are buying a
marketplace of stocks. It is almost like staying in a bad
marriage, I guess.
Mr. Gensler. It is. Fortunately, I have a good marriage.
But it is like picking stocks. A lot of Americans will stay
with a bad mutual fund, hopefully not represented at this
table, and just stay and not open the monthly or quarterly
statements.
Mr. Haaga. Mr. Oxley, I have a good marriage, too, by the
way.
[Laughter.]
Mr. Oxley. This was not meant to be a quiz. This is not
Phil Donohue or even Jerry Springer, for that matter.
Mr. Haaga. Since he said it, my wife is on the Web cast and
I thought I'd better say it.
[Laughter.]
The truth is, the shareholders do move. We have talked
about the lowest cost funds getting the most assets. There is
kind of a circle of causality there. And we have also talked
about the lowest cost funds performing the best. Those are all
related consequences because the funds that do perform better
get more people, and then as the GAO and SEC said, they reduce
their fees. So they all cycle together. I do not want to leave
it on the record that shareholders do not move when their funds
do poorly. They move and they move quickly.
I also do not want to leave it on the record that they do
not go for the lower expense funds. I think as our slides show,
there has been a million man march in the direction of the low
cost funds. I think one of the reasons for that is because they
perform better. Another reason for that is because they are
lower cost and the people understand it. So I just wanted to
add that. Thanks.
Mr. Riepe. I would also add a specific example. We have a
growth fund that under-performed both the market index as well
as its competitive group in 1997, 1998, and 1999. It then out-
performed those same benchmarks in 2000, 2001 and 2002, and for
the six-year period it is in the top decile of all other funds,
and beat the market index as well as the competitors. So it is
in the top 10 percent. But that tells you that people are not
always confident they know when they should move, and too often
they move at the wrong time. Human nature is such that people
tend to give up at the bottom, and they tend not to have the
courage to go into something at the bottom. I think that is the
reason that we, and it was alluded to earlier, went out of our
way both as an industry and individually to try and highlight
during that bubble to investors the risks of moving into the
top performing stocks. But you cannot overcome human nature and
greed. They are powerful influences on people's behavior.
Mr. Oxley. My time has expired. I yield back.
Chairman Baker. Just barely, Mr. Chairman.
Mr. Kanjorski?
Mr. Kanjorski. Thank you, Mr. Chairman.
The comment was made that some have bad marriages. My
question is, should the government be involved in selecting
spouses?
[Laughter.]
Is not that what we are talking about here? I guess I am
interested in, one, I think the mutual fund industry represents
risk. It invests in risk. By definition, there are going to be
successes and there are going to be failures. I am more
interested to know from the panel, maybe particularly Mr. Bogle
and Mr. Gensler, is there any fraud or abuse that you see in
the mutual fund industry that we should be attending to? Or are
we just talking about poor judgment and boards of director that
are not necessarily actively involved in what someone thinks is
a standard of selecting new managers or new advisers? I am
curious whether you see actual fraud or abuse out here, to the
extent that it warrants government intrusion.
Mr. Bogle. Well, I am not sure we need additional
government intrusion, but let me answer categorically yes,
there is fraud, and yes there is abuse. Let me give you a
couple of examples of fraud by large managers with a great deal
of power in the IPO market because they are clients of the
brokers. They take those initial public offerings that they get
because they pay large brokerage commissions to those firms.
They direct all those IPOs into a new small fund, and the fund
goes up, say, 100 percent in a year, or even 100 percent in a
month, and they advertise that and put it out to the public.
That is what I would call fraud. I am not sure anybody else
would call it that, but I would call it categorically fraud.
Mr. Kanjorski. You mean they get the advantage of the IPO
because they are handling a larger fund, and then that is sort
of a backward payoff?
Mr. Bogle. They put the IPO's in the smaller fund where it
has a huge impact, and they do it over and over again.
Mr. Kanjorski. Should not it go into the same fund that
created the incentive?
Mr. Bogle. It is a curious thing. Of course, it is the
large fund's buying power that gets this free ride--a term that
will probably vanish after this great bubble--but of course it
should go there from the economic standpoint. But I am sure
that the manager argues that the big fund is a very
conservative blue chip fund, and I have this little speculative
fund over here, so I will put it there. That is a specious
argument, because the real idea is to pump up that return to
the fund, and then sell it to the unsuspecting public. We have
two documented cases where the SEC has taken them to
conclusion. Without the SEC having criminal powers, the
managers were fined. So this is right there in the record.
We have something else very close to that kind of fraud or
over reaching. If you open up the March, 2000 issue of Money
magazine, right at the market high, there were 44 mutual funds
that advertised their past returns. The public did not know
about these funds, so we advertised them and sold them to
investors. We created the funds. The average return for the
previous year of those 44 funds that were advertised in Money
magazine, the average annual return was 85.6 percent. Our ads
are saying, come and get your 85.6 percent. Oh, sure, there is
a hedge clause saying past performance may not be repeated in
the future. They should have said "will not" in this case, but
it is in tiny type, barely readable. We know that high returns
are what attract the public. Those ads, as it happens, produced
business, and that is fraud or abuse.
Other abuses is this pandering to the public taste by fund
managers, bringing out 496 new Internet funds, technology
funds, and aggressive growth funds in the midst of the bubble.
I do not know that anybody in the investment departments of the
fund firms wanted to do that, but I know the people in the
marketing departments did. I have been in this business for a
long time. I know what causes what. The great firm of Merrill
Lynch brought out two such funds at the peak of the market.
They sold $2.2 billion of these funds to their customers. One
was an Internet strategies fund. One was a Focus-20 fund. Both
funds went down about 95 percent in the market decline, and so
did customers' money. One fund has been put out of business so
its record will no longer be visible. Is that an abuse? Yes,
sir. I would argue that is a serious abuse.
Mr. Kanjorski. Of course, the NASDAQ itself went down 75
percent, Mr. Bogle. Is 20 percent a greater loss than that?
Mr. Bogle. You know, if you had started--it is a very good
question--if you had started, out of your marketing
opportunism, a NASDAQ fund when the index was at 5,048, and you
said, well of course the index went down 75 percent, and so did
the index fund. But, if you want to do that, and people did,
the reason you are doing it is not to help people invest
better. It is to bring money into the business. This business,
as everybody has observed, has become an asset-gathering
business, more than an investment management business. Just
read what people that are doing all these mergers of management
companies and acquisitions of management companies are saying.
The first thing they say is, here is the asset-gathering
capacity of the firm. I have never seen a word in one of those
investment banker's reports that say anything about mutual fund
performance.
Mr. Kanjorski. Should the government then get into the
business of maybe regulating how they advertise?
Mr. Gensler. Mr. Kanjorski, the government is in the
business. Sixty-three years ago Congress addressed itself to
the inherent conflict in the Investment Company Act of 1940.
Subsequently, the SEC has promulgated numerous rules and
Congress has come back. I think this hearing is just part of
the ever-going sort of finding the appropriate balance.
On the issue that Mr. Bogle raised, yes those very things
occurred, where large fund companies start up with what is
called incubator funds and by the roulette wheel some of them
will do well and some of them will do poorly. The one's that do
well, you advertise. Sometimes they try to help the roulette
wheel by putting in hot IPOs. Now, the SEC has addressed that
with some final rules on IPOs. We could debate whether it has
worked, but they have addressed that.
To your question, I grappled with it. I wrote a book for
investors. I did not write a book for Congress. I did not even
envision that there would be such hearings. But when I was
asked to testify, I sort of thought, Congress has grappled with
this for 60 years and the SEC has grappled with it. By and
large, I think there should be individual choice, freedom of
American choice. This industry, like other industries, has the
right to advertise its products. But I think on the margin,
some additional disclosures could be helpful and warranted, and
on the margin some addressing to governance, particularly
around these soft dollars where I do not think that is fraud. I
think it is well known. It has been going on for 10 or 15
years, but it seems out of kilter with what the funds really
ought to be doing.
Mr. Kanjorski. Can that be handled by the present
regulations in the SEC, or do we need additional statutory
authority?
Mr. Gensler. That is a very thoughtful question, one that I
have not thoroughly researched. It may well be that the SEC has
authority to address that, and if they did, I would hope that
they would, but it may well be the Congress giving them a
little added nudge along the way would help as well.
Mr. Bradley. Can I speak to that one?
Mr. Kanjorski. Yes.
Mr. Bradley. As I understand, if 28(e) was originally
interpreted by the SEC in a far more limited fashion. Managers
could not pay for services otherwise and customarily available
for cash to the public. The SEC has broadened that through
interpretive releases over time. There has been no rulemaking.
My concern would be, maybe it is time for rulemaking to say
what exactly constitutes paying up, and what exactly is the
value of those goods and services to investors.
Mr. Kanjorski. Tighten it up.
Mr. Bogle. I would like to add one other thing, sir, if I
may. I think the government is going to have to look into,
number one, a more express statutory standard of fiduciary duty
for fund directors. Number two, is building up even further the
independent majority of the board, for the present independent
director structure clearly have let investors down. And number
three, as I mentioned in my testimony, is to have the chairman
of the board, not the same person as the chairman of the
management company. The Investment Company Act of 1940 was
right when it said that investment companies are affected by a
national public interest, and all this talk about what buyers
do and what buyers choose is fine, but our law says, more is
required. It says, in effect, that mutual funds are not
toothpaste and mutual funds are not soap, and mutual funds are
not beer. They are people's retirement savings, children's
college education savings. It is not just a consumer issue, it
is a legal and governance issue that requires the boards of
directors of mutual funds to see that funds are operated
primarily in the interest of shareholders, and not in the
interest of managers. I believe that balance has been badly
distorted. The system that the law established isn't working.
Mr. Kanjorski. So that is something statutorily that we
could do.
Mr. Bogle. Yes, sir.
Mr. Kanjorski. The other thing that I am worried about in
terms of the evidence is no manager has been fired among 7,000
or 8,000 funds--that does raise a question. But it is sort of
our shining example of independence. I am just worried about
how many people we are going to put in charge of watching over
the board of directors, and then who is going to watch over the
watcher of the board of directors and how far can we go. Is not
this structure sort of the same structure, and there are
independent board members. Their job is to have a fiduciary
relationship. If they violate that fiduciary relationship, are
not they subject to class action lawsuits?
Mr. Bogle. We have had class action lawsuits and they have
been notoriously a failure for reasons that I think are in many
respects too bad, because the courts have judged the level of
one funds' fees by the level of other funds' fees. So if you
look at a management company with, say, a 1.5 percent fee, and
the range of fees is 1 to 2 percent, the court says, in effect,
" we are not going to interfere with that." As far as it goes,
that is okay, but it is almost the same issue as executive
compensation that has gotten so out of hand in this country. If
everybody is doing it, then I can do it too. But that is a new
standard, and not the standard established by the 1940 Act. The
standard of the 1940 Act is fairness to shareholders. Yet even
as fees go up, plaintiffs have not been successful.
Mr. Kanjorski. Mr. Bogle, I tend to agree with that, but
then does not it go contrary to our system? I mean, if we are
going to have the SEC approving salaries and activities, where
does it end? I mean, if I needed brain surgery, I would not
advertise as to who can give me the cheapest brain surgery. I
would want to hire the best brain surgeon in the country. I
assume that these funds are interested in growing and
attracting more investment money. So is not the natural market
incentive there to have the best managers and the best advisers
in the country?
Mr. Bogle. Yes, sir, and that is a wonderful question.
There are, say, 500 different management firms and 10,000
mutual funds, each of which is trying to be the best. But, it
is inevitable, given the mathematics of the marketplace, that
before costs are deducted, they are all average. When they
trade stocks, they trade with one another. I will use the
entire institutional community, not just the mutual fund
industry because most firms are doing both. So they are all
average before costs, but after cost, they are all losers to
the market itself. Beating the market, is, must be, and always
will be, a loser's game.
So what happens in this industry? Well, we will have
managers who look very good in the short term. The top 20
managers in the two years coming up to the boom, the peak of
the boom, were the bottom 20 managers in the two years that
followed, metaphorically speaking. Actually, they were not
exactly the bottom 20, but they were in the bottom 50 out of
5,000 funds. They looked like good managers, but they were just
speculators. So we have a system that is shaped the wrong way--
an opportunistic system.
Mr. Kanjorski. How do we correct that?
Mr. Bogle. Yes, that is a very good question. We need
education. Investors should know that the first rule of
investing is uncertainty. That the second rule of investing is
gross return minus cost equals net return. The third rule of
investing is, for God's sake, do not put all your money in the
stock market unless you are 20 years old and it is your first
$100 in a 401(k) plan, in which case it is fine. We need more
education like that. But above all, we need a structure in
which the people govern the fund, the directors, the
fiduciaries, the stewards of the fund--are called to task to
live up to their responsibilities.
Mr. Kanjorski. The funds that you show in your chart--the
Wellington Fund--you own your adviser group, so that is part of
the fund itself?
Mr. Bogle. No, let me explain that for a moment. Vanguard
is a mutual company owned by our shareholders. It is a unique
structure in the industry. We manage about 75 percent of our
money inside Vanguard. The index funds and our bond and money
market funds are pretty much all managed at Vanguard on an at-
cost basis. That was the main example. For the remaining
approximately 25 percent of our assets, we use external
investment advisers. We use Wellington Management, for one.
Actually, I think we use about 18 different outside advisers.
We go out and negotiate fees with those advisers. Believe me,
if you are legitimately negotiating, you can get a fee of four
basis points if the fund is large enough--and admittedly
Wellington Fund is large enough--just four one-hundredths of
one percent. Our Ginnie Mae fund, which I did not comment on
earlier, pays a fee on that is only nine-tenths of a basis
point. It is fractional, while other Ginnie Mae funds pay 50
basis points, 100 basis points--sometimes 100 times as much or
more. In the Ginne Mae case, it is very much of a commodity
fund, so we were of course the best performing Ginnie Mae fund
over time. We cannot do it otherwise. We cannot beat the Ginnie
Mae index, but we can beat almost everybody else just because
of one low cost. There is where our extra return comes from. We
have got to educate investors about the importance of cost in
shaping what they earn.
Mr. Kanjorski. Why is it that through either the mutual
funds themselves or the association or a cooperative formed
under that group, why can't you buy seats and trade yourself
and set your own cost? Would not that save a great deal, rather
than going through the established brokerage business?
Mr. Bogle. Well, we do not. I am not sure I fully
understand the question, but at Vanguard we do not do any
business with affiliated.
Mr. Kanjorski. How do you make your purchases on the
exchange?
Mr. Bogle. First of all, index funds do very little
transaction activity, but most is done on the New York Stock
Exchange. Counting all index funds together, they account for
maybe one-third of one percent of all exchange transactions.
Our 18 outside advisers do business largely with brokers. We
like advisers with low turnover, but they pretty much have to
do business with brokers.
Mr. Kanjorski. You have a significantly lower cost. What do
you attribute that to?
Mr. Bogle. I attribute that cost to--
Mr. Kanjorski. Other than your brains.
Mr. Bogle. Well, it is thriftiness, but it begins with
having a mutual company. Think about it this way. If the mutual
fund has a 1 percent fee and the pre-tax profit margin has been
about 50 percent, that means if we eliminate that pre-tax
profit margin by being mutual in nature and operate at cost, we
are already down from 1 percent to one-half of one percent. The
second thing is, we negotiate fees. We do not say to the
adviser, these fees are just fine. I have done a lot of these
negotiations and they are not entirely fun, but sooner or
later, you get a better fee, and we've done them five or six
times over 20 years for each fund. It pays off for the
shareholder and then we are cheap in how we spend our
shareholders money. That is the third part of the advantage we
provide.
Mr. Kanjorski. Do you think we should separate the
investment houses from starting the fund, and that may be an
internal conflict that has to be broken?
Mr. Bogle. I would love to do that, but I do not see how it
is practicable, honestly.
Mr. Kanjorski. I see I am shaking up a lot of folks here.
Mr. Gensler. I do not see how one would do that, but I
would mention your brain surgery analogy is a very good one.
Where it falls down, if I might say, is if you take the best
brain surgeons, next year you presume they are still going to
be very good brain surgeons. If you take the top 50 percent of
performers, next year 45 percent of them are in the bottom
half--close to what you would say is random chance. It is a
little better than random chance.
In terms of negotiating fees, just to give a little sense,
the best academic study in the last year done on fees showed
that pension plans, the big state pension plans, whether it is
Pennsylvania's or Louisiana's and so forth--the state pension
plans go out and negotiate fees. Their fees for advisory
services are one level, and mutual fund fees are 2.5 times that
level before considering all the administrative costs. So it is
not the servicing or the envelopes that there are plenty of.
Why is that? Many of the companies at this table and in the
industry actually provide both services. I would imagine that
many of them--if $1 billion from the Pennsylvania state pension
plan came in would probably manage that in the equity market
for 25 or 30 basis points, or if they had a good day, 40 basis
points. But the standard in the industry might even go down to
20 basis points. The mutual funds, if you take the standard $1
billion large diversified fund is 2 to 2.5 times that. There
just is not the competition. There is not the tension in our
commercial environment.
Mr. Kanjorski. How would we get it there?
Mr. Gensler. I think it is the hardest challenge--much
harder than disclosure. It may well be in fund governance. It
may well be. I do not have a specific recommendation that this
Congress and the SEC put more pressure on the deciders of these
fees; that the fund directors act in their fiduciary
responsibility that was first embedded in the Investment
Company Act of 1940.
Mr. Kanjorski. But is not that going to mean that it would
force them to a level of mediocrity for safety purposes?
Mr. Gensler. No, I do not think so. I do not think that the
public pension plans in America--by the way, if you take all
state pension plans in America, 57 percent of their U.S. equity
dollars are indexed. That is still 43 percent that are not.
Mr. Haaga. Maybe that is why their fees are lower.
Mr. Gensler. No, I am not talking about the index side,
because indexing for $1 billion you can get on a single-digit
basis points.
Mr. Kanjorski. Do you think out of the seven witnesses
here, we could come up with recommendations that the seven
witnesses could agree upon?
Mr. Gensler. I suspect not, sir, because I think the
industry group, as many industry groups in many industries,
will be more likely not to wish to embrace reform and change. I
would hope that they would, but it is not the customary way of
America.
Mr. Bradley. Could I speak to that quickly?
Mr. Kanjorski. Yes.
Mr. Bradley. I have a concern about the framing. Behavioral
finance teaches us a lot about how people frame the problem and
it actually frames the answers. When you think about the
purpose of markets, it is not to make investment companies
rich. It is to fund new ideas in America. It is to underwrite
small ideas that Bill Gates had in a garage out in California;
fund it with an investor's risk capital because the bank will
not do it; grow the company up so it becomes a mid-cap company
or middle-size company; then it gets large and then it gets in
the S&P 500. Even the S&P 500 in 1999 and 2000 added major
high-tech volatile companies at the top. So the idea that
capital formation is only about investor returns is too narrow
a perspective; it is a risk-return equation. I would argue that
mutual funds are a way for little people to help fund capital
formation in businesses in America and, in return be rewarded
over time.
Mr. Wagner. I would like to add to that. Sitting here
listening to this, I hear "governance" coming up all the time
over here. Most mutual fund boards that I have ever encountered
are toothless tigers. They are selected by the investment
manager and they do not report independently to the fund
holders, I believe in most situations. We have independent
directors for corporations that are really independent and do
represent the shareholders--
Mr. Kanjorski. At Enron.
Mr. Wagner. and I do not see a similar thing in the mutual
fund industry.
Mr. Kanjorski. But how far do you want the government to
get involved in what is a private decision, it seems to me, of
selecting or classifying or categorizing board members? I mean,
people have a right to be stupid. Is not that a principle--
caveat emptor?
Mr. Gensler. There is most certainly that in a free market,
and I very much believe in free markets. That is the burden of
all of us and the benefit of our system. But I think as
Congress saw 60-some years ago, there is an inherent conflict,
and at times it may be worthwhile addressing that balance and
just saying on the margin whether there are things to help the
system out.
Mr. Haaga. If I can jump in here, a couple of things--one
is my colleague Mr. Gensler says that it is not the American
way to reform yourself. I would say it is the mutual fund way.
You can just look back at history and look at our participation
in regulatory initiatives. I might also add that although the
1940 Act requires for most funds only 50 percent independent
directors, our best practices, which have been adopted by
virtually every mutual fund, call for two-thirds. So we are
almost at the point that Jack Bogle would have us go.
Lastly, I just cannot leave un-commented upon the
suggestion that has been made that the only way that you can
measure the independence and effectiveness of a board is by
counting how many times they fired the management organization.
That is a very unusual step. A few years back, we merged with,
actually bought, a management company and took over management
of its funds. Their board had told them that they needed to go
find a good home for the funds. They were tired of their
management. That shows up not as a firing that everybody is
looking for, but it shows up in the merger statistics that for
some reason Jack Bogle finds objections to. Let me tell you,
that was a firing and I think a lot of the other mergers that
have taken place are prodded if not ordered by directors.
Furthermore, we have talked about not firing advisory
organizations. Advisory organizations do not manage the
individual funds, but portfolio counselors manage the
individual funds, and plenty of those have been fired. Finally,
even without firing, as someone who has spent a lot of time in
boardrooms with a lot of boards, we get a lot of pressure to
fix things that are not going right. The boards, do it the
right way, they say--give us a special meeting about this fund;
we want to discuss its results and what you are doing about it.
And they listen to our answers. If they do not like them, and
sometimes they do not, we have another meeting and we come up
with different answers, until they are satisfied and until
things have turned around. Those will not show up in your
firing statistics, but they were a case of an active board
taking responsibility and putting pressure on the management to
make things better on behalf of the shareholders. It goes on
all the time in our industry.
Chairman Baker. Thank you, Mr. Kanjorski.
Mr. Fossella?
Mr. Gensler. I would just say that I stand corrected. I am
delighted that the head of the Investment Company Institute has
that constructive approach to reform. So I stand corrected.
Chairman Baker. Mr. Fossella?
Mr. Fossella. Thank you, Mr. Chairman. Thank you, all of
you for this healthy dialogue.
It seems to me in looking at more than 200 years of
experience in the industry, I would believe that all of you
have an interest to see the future of this industry and a
future of getting more Americans to become investors, you have
an interest in seeing that it flourishes. It also seems to me
that you are all looking at the same situation with varying
degrees of criticisms and applause. Some have written books
about it; others have made a lot of money in it.
It was alluded to before as to what can you all agree on. I
am not suggesting that you all have to agree on everything. But
is it not in everybody's interest that you establish a common
platform for just the industry, and then allow each of you to
compete--in my opinion, the American way more so--but on an
honest basis, with a sense of providing integrity and truth to
your owners? Mr. Bogle has been among, it seems, the most vocal
in his, I do not want to say criticisms, but what he thinks
would be a healthier future, where others feel that some of
those criticisms are unwarranted.
So I am curious to hear from the rest of the panel. For
example, Mr. Bogle just alluded to some possible, I am not
saying it is the right thing or the wrong thing, but some
possible statutory provisions regarding fund directors or
independent directors on the board, and the issue of whether
the chairman should be, or the title of the chairman, should he
be the head of the fund as well. I am curious as to what you
all think about that suggestion.
Mr. Wagner. Sounds like a good one to me.
Mr. Montgomery. I guess I could support that one, too. I
am, by the way, both president of the advisory firm and
chairman of the board of our board of directors of our fund.
Mr. Fossella. Mr. Bradley?
Mr. Bradley. I will yield to my colleagues.
Mr. Fossella. Okay. You mean you do not have an opinion?
Mr. Haaga. I am the chairman of our fixed income funds. If
they asked me to step aside, I would. I think that specifically
separating the role, making the chairman an outside director,
would not do much and I think it would be a problem in some
organizations, so I will not embrace that. But as I said about
the 80 percent thing, we are almost there, and we got there on
our own. So I think some things are best left to best practices
and industry developments, rather than legislated.
Mr. Fossella. Okay.
Mr. Gensler. Specifically to having the chair of the fund
be independent, I think on the margin that could be helpful. I
think at the core, it is questionable. At these funds, it is
not just whether they hire or fire, but also how they look at
fees and why they customarily would pay 2.5 times for advice
what the same service providers, the same T. Rowe Price's or
American Century's provide to institutional pension money. So
the same advice going to the state of Pennsylvania somehow, if
I am the Magellan Fund or I am T. Rowe Price's big, large
diversified fund has a higher fee--to ask those questions and
find some way to ask those questions and get satisfactory
answers.
Mr. Riepe. Let me just say that when I worked with Mr.
Bogle and he was chairman of the funds, he never held that
attitude.
Mr. Bogle. That is quite correct, by the way.
Mr. Riepe. Clearly, he has had a revelation.
Mr. Fossella. When did this revelation take place, Mr.
Bogle?
Mr. Bogle. May I just say that just because you have been
mistaken for most of your life does not mean you have to be
mistaken all of your life.
[Laughter.]
Mr. Riepe. Can I make my comment? If he starts again--
Mr. Fossella. I have been mistaken most of my life, or one
has been mistaken?
Mr. Bogle. Many--
Mr. Riepe. Let me just say that I think I would agree with
what both Mr. Gensler and Mr. Haaga said in the sense that it
could do something, but it is certainly not a silver bullet in
any way, shape or form. If we learned anything in this latest
corporate abuse experience that we have gone through, it is
that just putting independent directors in a room does not
guarantee that you are going to have a clean shop. Independent
directors can be duped; independent directors can fall asleep
and not do a good job. Either way, it simply is not an
assurance. I think it makes us all feel better and it seems to
make intuitive sense to have a majority of independent
directors overlooking management, but it certainly does not
protect one by itself.
I think in the case of investment companies, the job is
easier in the sense that one does not have to worry about
accounting frauds and things like that because they do not
happen in investment companies. So I think that the role of the
independent director is more narrow and can be more forceful. I
think this stuff about toothless tigers is a lot of malarkey,
when you are talking about the middle 75 percent of the bell
curve. I think as Mr. Gensler suggested, there are I am sure
smaller groups where a couple of directors are luncheon buddies
or something of the chairman. I do not know how one legislates
that. I think the SEC has to do it through rules.
Let me just comment very quickly on the pension question
that Mr. Gensler brought up, because we manage money for
institutions as well. I do not know where his statistic came
from, but I can only hope that our mutual funds were 2.5 times
what they are. Our experience is that they are higher than the
pension fees that we charge, but I will also tell you that we
could operate our company with about 80 percent fewer employees
if all we were in was the pension business. Although everybody
does not have 35 percent margins, as Mr. Bogle suggested, I
will tell you the pension managers have the highest margins
because they do not have all the other service requirements and
all the other people requirements that are associated with
taking care of an investment company. So there is a reason
there is a spread between those fees. If someone is getting 2.5
times in their mutual fund what they are managing their private
accounts for, then I think they have a very tough explanation
to make to their directors. I might add, that fee information
goes to our independent directors; and I think most every year
it is required as part of the annual contract review.
Mr. Gensler. Just to answer the question that was had, the
study, since it is not my work, it was two professors--one of
business and one of law--Stuart Brown and John Friedman. It is
called Mutual Fund Advisory Fees: The Cost of Conflicts of
Interest, published August, 2001, University of Iowa Journal of
Corporate Law. They excluded all of the amounts of money that
went to service the account and just looked at advisory fees. I
say that just in my conversations with the industry, generally
pension funds will shoot for 20 to 25 basis points, often will
pay 30, 35 basis points. That is about one-third of a percent
of their money for let's say $1 billion or greater large
capitalization, diversified, actively managed fund. If you look
at the management fees, advisory portion in the mutual fund
industry--somebody could check this with Morningstar--it is
going to probably be roughly in the 60, 70 basis points. But
again, if I am wrong, statistics will prove out what the real
situation is.
Mr. Bogle. Mr. Chairman, could I just respond to the
Congressman's question about when my conversion took place?
Chairman Baker. Certainly.
Mr. Bogle. My conversion actually took place in 1974 when I
was fired by Wellington Management Company, and started
Vanguard as a mutual company. As such, I was chairman of the
funds, and the chairman of the board of the adviser had no role
in the firm whatsoever. You saw the chart that showed in 1974,
our costs are down 60 percent and the industry's costs are up
60 percent, so maybe that is not such a bad idea to have that
separation. It has been a conversion that's lasted 28 years,
and I feel real good about the new Bogle as compared to the old
one.
Chairman Baker. Okay. Anything further, Mr. Fossella?
Mr. Fossella. If I may, and I know you have other speakers,
but I am just curious as to maybe not the focus of this, but to
what extent in all of these numbers and statistics does our
current tax system affect all of these numbers about movement
in and out of funds, or the decisions? I heard different
theories--behavioral, market analysis, all this other wonderful
stuff. But to what extent do you think the tax code and our
policies today affect individual decision making?
Mr. Bogle. I would like to just say one very interesting
thing which should be brought up at this point, and that is the
mutual fund is from an income standpoint the most tax-efficient
investment ever devised by the mind of man, because mutual
funds that happen to earn dividend income of about 1.8 percent
on their portfolios. Taxes take away about 1.5 percent, and
leave only 0.3 percent for the Federal Government to get its
hands on. From that standpoint, tax policy, even the
elimination of so-called double taxation, simply does not
matter to the average mutual fund investor. Half of the
shareholders pay no tax on their 401(k)s and so on, and the
other half are paying taxes on a dividend yield of over three-
tenths of one percent.
On that point, I want to add another comment about our
ability to look so favorably on fees when someone says, well,
it is only 1.5 percent of assets. That is the lowest number you
can possibly get when you look at mutual fund costs. You say,
what percentage is it of the market return? The 1.5 percent
cost is 15 percent of a 10 percent stock market return. What
percent is it of the mutual fund's income? While capital gains
come and capital gains go, income and expenses go on and on.
I want to give you an interesting example. It is in one of
my exhibits here. I got involved in this industry in 1949 when
I read an article in Fortune magazine called "Big Money in
Boston." The industry was a $2 billion industry then. The
article was about a firm called Massachusetts Investors Trust--
the oldest, the largest, and the lowest cost of all mutual
funds. That article reported that the independent trustees of
that fund had just reduced the management fee from 5 percent of
income to 3.2 percent of income. They did not calculate it on
the basis of assets. They calculated on the basis of income--5
percent to 3.2 percent. Last year, that same old Massachusetts
Investment Trust took not 3.2 percent of income and not 5
percent of the fund's income, but 87.5 percent of that fund's
income--87.5 percent of income was consumed by management fees.
One of the big concerns this industry has about putting the
dollar amount of fees in the shareholders' statement is that
shareholders can see that my fund's income last year was $40,
or was in effect $240 gross; the manager took $200 and only
left me with $40. That will be easily calculable in that
statement when you look at income.
Chairman Baker. Mr. Fossella, are you done? I want to
recognize Mr. Sherman for a couple of hours.
Mr. Sherman. Thank you, Mr. Chairman. I have so many
questions and so many ideas, I will try to get them in within
the two hours allotted.
One idea that has come out of these hearings, and I think
it is a good one, is that in addition to whatever basic
prospectus you mail out, there ought to be a required
supplementary prospectus posted on a Web page. Does anyone
disagree with that, knowing that we have to argue what would be
in the supplementary prospectus?
Mr. Riepe. No, sir. We put a great deal of information out
on the Web.
Mr. Sherman. It would just be good to standardize that, and
then of course you would have your non-standardized
information--the glossy thing with your picture on the cover,
which would attract a lot of investors.
Mr. Riepe. Our pictures are not in the prospectuses.
Mr. Sherman. Oh.
[Laughter.]
One thing I would like to focus on, because I think I have
been affected by it a bit, is what I call the lock-in effect or
the bait and switch. It goes something like this. You start an
index fund or a bond fund, with, say, a management fee of
around 20 basis points. You go out and market it effectively.
You get $100 billion. And then you raise the fee to 50 or 60
basis points. Now, with a certain amount of inertia, you can be
collecting the 50 or 60 basis points on the $100 billion of
assets because people thought it was a good idea when they
originally invested, and they do not bother to check that the
fees are doubled or tripled. But there is another lock-in
effect, and that is, if this is a bond fund or an index fund
and the value has gone up, then no sane investor, unless they
view themselves as immortal, is going to recognize a huge
amount of capital gain income just so that they can invest in
one of the fine funds represented here, and get out of this
bait-and-switch fund. That is because you are going to be
paying a huge fund just to avoid paying an extra 20 or 30 basis
points a year until that great step up in basis that occurs at
the termination of all of us.
So is there anything that--and I have oversimplified what I
think has happened to a small part of my personal portfolio--is
there anything that prevents this ruse from happening--
marketing a fund at 20 basis points, and then after you have
got a whole lot of cash in the fund, doubling or tripling the
fee?
Mr. Haaga. I think what you are referring to--well, the
truth is, there are two ways the fees could go up. One is, as I
discussed in my oral testimony--
Mr. Sherman. Let me add one more element to this. The way
they marketed the fund is they said, because the manager is
currently waiving so much of the fee, the fund in its first
year only paid a fee of 20 basis points.
Mr. Haaga. And they had to tell you what the return would
have been had they not waived the fee.
Mr. Sherman. Right. That is a bit of a warning to anyone
who has been through this process at least once.
Mr. Haaga. Right. And as I told you, if you bought our tax
exempt fund of California, it would not have happened.
Mr. Sherman. But is there any rule that says you cannot
wake up one day, having marketed a fund as the low-cost
California tax exempt bond fund, and change it to the 70 basis
point a year California tax exempt bond fund.
Mr. Bogle. There is no such law. It is cast in the light of
the marketing spirit of this great business, and that is, we
are going to do a nice thing; we have a 1 percent fee, and we
are going to waive three-quarters of it for you. Money market
funds have done this. I think over half of the money market
funds will move to wave fees when their yields go down. They do
not tell you when they do it. They do not tell you when they
put the fee back on. It is just wrong.
Mr. Sherman. What if you did not even do the fee waiver.
What if the official fee for 2003 is 20 basis points, and then
in 2005, the official fee goes up to 50 basis points?
Mr. Haaga. That would require a vote of the board and a
vote of shareholders, so you would have gotten a proxy saying,
do you want to do this or not, and some fee increases have been
turned down by shareholders and many by boards.
Mr. Sherman. So an increase in the management fee requires
a vote of the shareholders.
Mr. Haaga. Correct.
Mr. Sherman. So this fee being waived, that is a bit of a
warning that that fee may not be waived in the future.
Mr. Haaga. Correct.
Mr. Riepe. There is a table right in the front of the
prospectus that the SEC requires. If you have waived a portion
of the fees, and usually what gets waived first is the advisory
fee, there is a cap on expenses. Over one-third of the mutual
funds now tracked by Lipper have expense caps on them in one
way or another. This speaks really to the competitiveness of
costs.
Mr. Sherman. I would like to go on to the next question.
The other thing that you folks have brought up is the idea of
the roulette wheel and the incubator fund. It would go
something like this. Let's say you were going to start a low
cap fund. You do not start one small low cap fund; you start
three. One invests exclusively in corporations whose name
begins with A. Another one invests exclusively in companies
named with B; the third exclusively in companies with names
starting with C. You do not even have to identify it. You just
have that as a policy. Then at the end of a year, the A fund is
in the tank; the B fund is under-performing; and the C fund
tripled its money--not because of any brilliant idea; it just
happened that low cap companies with the C beginning their name
did very well. And then of course you advertise the hell out of
the C fund.
Would we benefit from a rule that said that when you go out
and advertise that C fund and its 300 percent rate of return,
that you also have to disclose the rate of return on a weighted
average basis of all funds in the same category managed by the
same company and its affiliates, so that you would disclose not
only the 300 percent rate of return of the Hasbro C fund, but
you would disclose the negative 2 percent rate of return of all
low cap funds administered by Hasbro.
Mr. Gensler. Mr. Sherman, you hit upon a very interesting
problem, not only incubator funds, which are legal and will
continue to be legal--that is the roulette wheel.
Mr. Sherman. And as you pointed out, you could enhance the
C fund by getting a good IPO into it.
Mr. Gensler. That may be a little bit beyond what is good,
healthy competition. But I think it does come back--your
suggestion is a variation, maybe it is a stronger one--of my
suggestion. It is just simply so that fund families can be seen
in their full glory. Some will do better than others, but that
they do not ignore the closed-down fund or that so many funds,
about 5 percent a year go out of business. They aggregate all
that performance data and at least have it on their Web sites
so financial planners can get that information.
Mr. Sherman. But if I want to invest in a low cap fund, I
do not care that Paul has done very well with bonds. I want to
know how well his company has done with low cap funds. It does
not do me any good to find out that all of the funds he has
managed have a rate of return of 6.2 percent. I mean, he could
be a euro-bond fund for which he is responsible.
Mr. Gensler. You raise a very good observation, and it may
well be helpful to have it broken down by major categories. I
do not know.
Mr. Sherman. Because otherwise this works perfectly well.
If I start 10 incubator funds, I guarantee one will do very
well.
Mr. Haaga. It works perfectly well, but the one you
described involving the IPOs that I think Jack Bogle said was a
fraud was the subject of an SEC enforcement action. That is why
we know about it. So I think the egregious case is taken care
of.
There is a great deal of analysis and information out there
in the Lipper and Morningstar and other things about fund
families investment results. So there is a lot to know, plus of
course the results of all our other funds are fully disclosed
and fully advertised. So I think there is a lot to know there
that even if it is, you know, you are hypothesizing that these
funds could get buried, they are out there in the fund family
data and they are out there in the historical data.
Mr. Sherman. I think it might be helpful, though, to have--
I mean, it is nice to say that if you just know where to go in
some Lipper chart somewhere on the Web, that the investor is
protected. We need to explore what things should be in the
prospectus, and perhaps the rate of return of all funds in the
same sector administered by the same management team ought to
be disclosed. Otherwise, the system I just--I realize enhancing
the system I just described by throwing in IPOs, that gets you
investigated by the SEC. But just starting three incubator
funds and then advertising the one that does well, while the
other two do poorly, it is not enough to just say "aha, " but
those who look at the Lipper report are going to be saved from
being misled.
Mr. Haaga. You also ought to remember that funds close for
a number of reasons. We started our first global investing fund
and the interest equalization tax came in and we closed it. So
there are changes.
Mr. Sherman. I think my first hour has expired.
Chairman Baker. I just learned that we may be having some
votes here in a bit, and there are other members who have been
here for a while. If we can, I will come back for a second
round.
Mr. Sherman. I just want to bring up one other thing, and
that is I think it is important to disclose this whole soft
dollar thing, but I am not sure that those advocating such a
disclosure have been able to tell us how to do it in a way that
is not avoided. What I have seen in another arena trying to
prevent or quash or disclose soft dollars is sometimes you just
drive things underground. One of the things--maybe you can
reply in writing to this, because we do need to go on to other
members--is the fact that you are dealing not with brokers, but
with broker-dealers. Thus, if we say you have to disclose
commissions, what about markups? I would hope that the
advocates for the disclosure of either what you are paying in
brokerage fees or what you are getting in free services beyond
execution, that those advocates would tell us exactly not only
how we are going to disclose this, but how does it get
disclosed if firms react to the disclosure rules, and for
example, instead of buying bonds on the market that have
already been out there with a brokerage fee, simply buy new
issues and can report a zero brokerage fee. There is a spread
for some, a brokerage fee for others, and I look forward to
seeing in writing your response to that.
I yield back.
Chairman Baker. Thank you, Mr. Sherman.
Mr. Tiberi?
Mr. Tiberi. Thank you, Mr. Baker.
Over the weekend, Mr. Haaga, I received a couple of things
that you might be familiar with. I got this little lovely piece
in the mail. I do not know if you can see it or not. You
probably can see this one a little bit better. You might
recognize that.
Mr. Haaga. Yes.
Mr. Tiberi. It is an Investment Company of America, but
this weekend I did. My question to you is this--
congratulations, by the way, on your election to the board. I
think I voted for you.
Mr. Haaga. Thank you.
Mrs. Kelly. Would the gentleman yield?
Mr. Tiberi. Yes.
Mrs. Kelly. What is going on here between the two of you?
Is he a constituent of yours, sir?
Mr. Tiberi. No. The chairman of the board issue came up
earlier, and the chairman of the board for Investment Company
of America is a gentleman by the name of Michael Shanahan, who
is also the chairman of the management company. As a
shareholder, can you tell me why that is an okay thing or a
good thing?
Mr. Haaga. I think if you look at the rest of the list, you
will see that we have over two-thirds of the directors are
outside directors. The act of chairing the board involves
putting together the agenda; it involves putting together the
materials, et cetera. I do not think, in fact I know in his
case, and it is certainly not in my case, it does not involve
dominating the meeting.
I would also add, and I did not get to add it before, so I
would like to add it now, that we have separate meetings of
only the independent directors in connection with reviewing our
performance and our contracts. We even have executive sessions
there. In those cases, the chair of the contracts committee
chairs those meetings. So we do have a chairing role and a
chairing function being performed by the outside directors.
Mr. Tiberi. So you would argue that we would not--as a
shareholder I should not be concerned about that potential.
Mr. Haaga. I would argue that the specific designation of
Mr. Shanahan as chairman of the board does not impede in any
way the independent activity and operation of our outside
directors.
Mr. Tiberi. Just following up on the question Mr. Sherman
had with respect to broker-dealers, there is something called
revenue payments that are sometimes paid to broker-dealers. Do
you believe that fund managers like yourselves should disclose
to investors what those payments are?
Mr. Haaga. The short answer is yes. The longer answer is,
where and how much and to whom. I do not call them revenue
sharing. I call them expense sharing.
Mr. Tiberi. Okay.
Mr. Haaga. Because that is a lot of what is going on. For
example, we have computers on the desks of broker-dealers that
they use to forward trades to us. They have information systems
that we put out information to them, and educational sessions,
and we split the cost with them. I do not know whether that is
revenue. It looks a lot like expense to me. So the question is
disclose what and to whom. We have worked hard at the ICI, and
when I chaired the NASD investment companies committee, on
finding ways to do that.
I think the issue would arise with what is called revenue
sharing if a substantial amount of the payments actually made
it to the selling broker, the one who was making the
recommendation to choose one fund versus the other. They
generally do not. They do not get out to the selling broker.
They are made to the management company.
I also think it is important to note that a lot of them are
not based on assets or sales. They are actually fixed-dollar
amounts, where we are paying for some service or the cost of
some facility that in effect both of us share. So I would like
to find a way to disclose it. The devil is in the details of
figuring out how to do it. I think if there were concerns, the
fraud would be if there were huge amounts of money paid to
sellers, either the firms or the individuals, to favor one fund
over another, and that was how they were selecting the funds to
be included in their group of sales. What happens is that they
request fees at a certain level for all funds, and then all
funds participate in paying them, so there is no skewing of the
recommendations based on the amounts that are being paid.
Mr. Tiberi. One of the devils in the detail is also
directed commissions that a lot of these revenue sharing
agreements have, that the brokerage has. It says that we will
give you good shelf space in our supermarket if you also have
the funds direct commissions--20, 25 percent of your total
commission dollars back to our trading floors. Those
arrangements I think are one of the devils in the detail that
hopefully could be added to this.
Mr. Haaga. What he described is prohibited by an NASD rule,
in plain English.
Mr. Wagner. I would like to point out the AIMR has
approached this four or five years ago and come up with soft
dollar standards that probably need to be updated, but at least
form a starting point.
Mr. Tiberi. Thank you, Mr. Chairman.
Chairman Baker. The gentleman yields back.
Mr. Bachus?
Mr. Bachus. Thank you, Mr. Chairman.
First of all, I want to commend you for holding this
hearing. Ninety-five million Americans hold mutual funds, and I
think it is important that these retirees or investors do not
pay excessive mutual fees, and that if they pay hidden costs
associated--well, that they really should not pay hidden costs
associated with those mutual funds without knowing it.
As you know, U.S. fund fees appear to be lower than the
vast majority of the funds in other nations, and there is
strong evidence recently that there has been more fee-based
competition. This being said, unfortunately academic studies
have shown that many funds have experienced an economy of
scale, and that they are not passing those savings on to the
shareholders. In addition, these same studies have noted that
shareholder insensitivity to costs may rest with widespread
investor ignorance about the various shareholder charges. In
other words, they are not opposed to them because they do not
know about them, and that is despite a request by the
Securities Exchange Commission to get the mutual fund industry
to properly disclose their fees.
With that background, I would like to start with Mr.
Gensler, and I would like to pose this question to you. Mr.
Montgomery states that the practice of soft dollar commissions
is one of the worst examples of undisclosed conflicts of
interest in the mutual fund industry. What is the conflict and
how does it affect fund shareholders?
Mr. Gensler. There is a conflict, and I think it is a good
question. Think of three parties--the investor, for this case
it could be me; the fund company, if that is all right, if that
is the chairman, just for a moment; and if you, sir, could be
the brokerage house. What happens in soft dollars is that I pay
you a commission--five cents a share, as Mr. Montgomery showed
earlier--and part of that is a barter transaction. Part of it
is that you are going to provide some services for Mr. Baker's
fund company. In providing those services, it could be real
estate; it could be data services; it could be a host of
those--was it 1,200 services that was on that list. Barter is
fine and it goes on in America. It is part of our commercial
world.
But here in this situation, there are three parties. I am
paying you, the investor or fund company is paying you, the
broker, five cents a share and you are picking up Chairman
Baker's real estate or some other expenditures. That is where
the conflict is, because it is not either disclosed to me in my
fees. I do not see it in that management fee, so the shortest
thing would be just add it to management fees. You could say
that barter arrangement should be added to management fees, or
go further and actually ban it because there is this inherent
conflict that Chairman Baker is going to make more profits, and
I am going to make less due to our barter arrangement.
Mr. Bachus. All right. Let me go to Mr. Montgomery and ask
you the same question. We are talking about soft dollar
commissions. What is the conflict and how does it affect fund
shareholders?
Mr. Montgomery. The conflict is that I have a choice as a
participant in the mutual fund industry or in the larger
investment community, when I have clients who do pay
commissions and all people working through a brokerage house
are going to pay commissions, so that is fine. But I have a
choice when I go to pay for my Bloomberg terminal for the
services of Mr. Wagner here, for many things, of paying out of
our own advisory fee and profit--and by the way, research is
one of the biggest ones of those--so I can pay for it out of
our own profits, which you could say come from the management
fee. Or I can pay for it with soft dollar commissions, which
means it is a cost borne by the fund, but does not affect my
own advisory fee expense structure.
So which am I going to do? One flows directly through to my
bottom line, and a dollar of expense there comes directly out
of my profit. Or I can pay for it with commissions, which does
affect our overall performance of the fund, but does not--
Mr. Bachus. And not even reveal that you had to spend that.
Mr. Montgomery. And that is key, and not even have to
reveal it. Nobody is going to see it; nobody is going to ask
about it. There are rules. The SEC in their examination when
they come in are going to be all over it. So it is not like no
one is looking. I promise you, during the examination the SEC
is all over this issue.
However, what are the incentives on my part to control
those costs? They are not good. The incentive is very clearly--
even if I have a 25 percent profit margin, I have four times
the incentive to push it off on my shareholders as opposed to
eat it myself. The only reason we do not do it at Bridgeway is
it is a conflict of interest you cannot take care of, and we
argue even by disclosure. It is too great a conflict of
interest. Just do away with it.
Mr. Bachus. Let me ask Mr. Bogle.
Mr. Bogle. The same question?
Mr. Bachus. Same question.
Mr. Bogle. I could not give an answer any better than John
Montgomery's. There is a definite conflict there, and I am not
sure disclosure vitiates it, but an awful lot of research is
paid for, and particular research is paid for through these
soft dollars. It is interesting that mutual funds themselves,
out of this $75 billion of revenues that I estimate that they
got last year--it is very fair estimate--probably spend about
$4 billion on their own research. All the rest of it is paid
for by the soft dollars with which they could otherwise improve
the returns of their clients. So it is a definite conflict.
Mr. Bachus. Okay. Let me move to a second question, and
this is for the whole panel. Should soft dollar commissions be
banned in the mutual fund industry? Or short of banning the
practice, what should regulators do to better protect the
interest of fund investors? We will just start with Mr. Bogle.
Mr. Bogle. I would say soft dollars create great problems,
but I would suggest that we should do away with them in the
entire system, and not just with respect to the mutual fund
industry. The abuse, believe it or not, may be worse outside of
the mutual fund industry than it is within it. We should be
when we execute a transaction, we should pay for the execution.
As one of the charts you saw earlier, we are paying for three
or four times that with other people's money.
Mr. Bachus. So you say prohibit it.
Mr. Bogle. Prohibit it.
Mr. Bachus. Okay.
Mr. Wagner. The miner's commission in the UK actually
recommended this, and that is certainly being experimented with
over there, so we will have some evidence on that fairly
quickly here. I think that, yes, they could go underground, as
Mr. Sherman suggested earlier, that they could go into unbilled
category of services that are available from the brokerage
firms. So it may not solve the problem. I would opt for
disclosure--what is being spent, to whom and what is being
received for that payment.
Mr. Bachus. Mr. Montgomery?
Mr. Montgomery. I am in the banning category, and I think
it is just an awful lot more efficient just to kill it. The
costs that go into, as a mutual fund company, whether it is the
adviser or the fund itself, of the regulators coming into look
over the shoulders of it. It is kind of like the worst part of
the tax system, with layer upon layer upon layer of loophole
and exceptions. We spend a tremendous amount of money just
trying to measure it and make sure that it is fair. Even if we
were absolutely honorable, have integrity and want to do a good
job, and maybe even disclose it--maybe somebody voluntarily
discloses it--it is still a tremendous effort and cost that
somebody has to pay to measure it, and I think that is
inappropriate.
Mr. Bachus. Mr. Bradley?
Mr. Bradley. I have a couple of comments that I would like
to frame. One would be that it is already underground. So the
fear that this would go underground, it is there. The reason it
is there is that in 1997, the SEC did a soft dollar sweep and
investigation of broker-dealers and looked at these bills they
pay, because that is the only audit trial. Two-thirds of the
documents at that time were unreported, undocumented. In my
earlier testimony, I stated that what we heard from our
accountants is, if they were documented it would create an
income and expense item on a fund management company's income
statement, potentially.
I think that I would be more in favor though, and I
answered a similar question earlier, that we should really go
back and revisit your law, section 28(e), and through
rulemaking define specifically what "paying up" means; gather
the execution-only rate from firms so that we can quantify what
they pay above that execution-only rate; and then put the
burden on fund companies to show their management company
through quantifiable results, the value returned to investors.
Mr. Bachus. Mr. Bogle?
Mr. Bogle. I apologize, Mr. Bachus, for interrupting you. I
was trying to make the following point. We are talking about
abuses. I think it is important to note that when the SEC did
their sweep a couple of years ago and found abuses, the only
people that they found doing that were investment advisers, not
the mutual funds. No mutual fund managers were caught up in
that. We are throwing the term around back and forth about
investment advisers doing that. Those were investment advisers
to individuals who were being caught with the abuses.
I guess in terms of what to do about--you asked the
specific question of should we ban soft dollars--and some
people answered we should ban it. I think you need to define it
first. I will not get into it here, but soft dollars includes a
lot of things that may not be wrong. The kinds of abuses that
Harold is talking about should be curtailed either through SEC
regulation or legislation--probably SEC regulation.
Mr. Bachus. And what are some of the areas that you think
are particularly abusive?
Mr. Bogle. In Harold's case, I think that the ones he
mentioned--that long list of things you could pay for. When I
was in private practice before 1985, I used to advise some
companies about interpretations of section 28(e). I once had a
portfolio manager assert to me that if a light bulb shined on a
guy doing research, that light bulb should be paid for out of
soft dollars because it was research. You can imagine where
that extends. There is just no stop to it.
Mr. Bachus. So research is an area of abuse?
Mr. Bogle. Research ought to have some intellectual
content. That is what is permitted under 28(e), and the abuse
is that people have taken research--you and I know what
research is; it has an intellectual content to it; it is a
study--and they extended it out to the light bulbs and the club
membership for the guys who do the research because they need
to relax after they have studied their prospectuses and things
like that. That is where the abuses are. I would not mind
getting rid of those abuses, but simply calling it soft dollars
or simply repealing 28(e) would not do it. There is something
going on that should not be going on, I will agree with that.
Mr. Bachus. And Mr. Gensler, I think you made--
Mr. Gensler. Even if that is at the risk of Chairman Baker
losing the soft dollars in my earlier example, I would probably
be on the side of banning it, or short of that, significantly
curtailing it and disclosing the remaining portion.
Mr. Bachus. Okay.
Mr. Riepe. Let me just say three things. One, I want to be
on the record as agreeing with Mr. Bogle on something.
Specifically, as Chairman Baker pointed out at the beginning in
his opening remarks, mutual funds represent only about 20
percent of the equity market. As Jack pointed out, the soft
dollar issue is not unique to funds. Some of the major pension
plans in the country use commissions that are generated from
their business, and direct advisers like us to pay certain
expenses that those pension plan sponsors have incurred,
presumably for the benefits of the participants in those plans.
So this is not a mutual fund-specific problem.
Secondly, I think, as Paul Haaga noted, the fund industry
and the SEC have been doing a good job of managing it by
examination and disclosure; but I do not think that is
adequate, obviously, in terms of some of the abuses.
And thirdly, a specific recommendation is that I think the
SEC could be asked to go back and answer that question and have
the time and the resources to delve into some of the nuances of
it that Mr. Haaga was referring to, and come back with a
recommendation on it. I will tell you that we can live with
whatever that recommendation is, and if it is a complete ban of
directed commissions, then fine. If it is something else, then
that is fine as well.
Chairman Baker. Mr. Bachus, it is my intent, based on what
has preceded us here today, to have a letter to the SEC
probably next week, outlining a series of issues for
resolution, one of which would include the soft money question.
I just make the announcement for members' interest. If they
want to sign onto that letter, just let us know. But I have
spoken to Mr. Kanjorski and he wishes to participate in the
letter as well. So it is bipartisan and it is merely to get
some factual determinations and also some definition in the
case of soft money, and in a recommendation with regard to that
definition. So we will do that.
Mr. Bachus. Can you note, as several gentlemen have said,
this is not confined to the mutual fund industry.
Chairman Baker. It is larger. Yes, sir.
If I may, let me recognize Mr. Castle. If we go to Mr.
Castle, we can get everybody done before we have to leave for
this vote.
Mr. Castle. Thank you, Mr. Chairman. I appreciate being
recognized and I apologize for being out of the room during the
question-answer, but I heard each of your testimony before I
left. Let me just say, I am an admirer of almost all of you,
and I agree with virtually everything that you said. I think
you are the cream of the crop. We went down about two or three
more panels and start to get into some of the more dubious
areas of mutual funds and what has happened.
I am just going to put together one question, and again I
apologize if some of this has been asked before, and then ask a
couple of you to answer, and then open it up to all of you. I
believe in consumer knowledge, and I believe the American
public is a heck of a lot smarter than often given credit for,
and the American consumer is, too, if they know what they are
looking at. I think it is very hard, frankly, when you look at
mutual funds to know what you are looking at. With all due
respect to Vanguard's ads about lower costs and saving more
money and everything else, I just think it is very hard to
figure this out.
So I have a couple of thoughts, and I do not know if this
has been asked before or not, but on the whole regulatory board
question, should there be a separate regulatory board for
mutual funds? It is a huge industry at this point. Or is that
not a good idea, because it becomes a captive board, as so many
others do, and perhaps it is better to be left in the SEC.
Another question I have is, what else could Congress do?
Talking about it here is great, and there are a couple of TV
cameras, but I have a hunch it is not going to lead the news
tonight and people are not going to know a heck of a lot more
after today. Perhaps we do, but a lot of other people will not.
I think we need to get that information out. So what else could
the government do in terms of regulations, laws, whatever it
may be? What do you think about the SEC? Any ideas you have of
getting the word out? I agree with the problems you stated.
What is our strategy to try to correct these things?
I would like to start with Mr. Gensler because he has some
experience in that. And I would like Mr. Bogle to answer this
just because he is Mr. Bogle, and I think he does have the
temerity of Warren Buffett. I disagree with what he said
earlier. And I would then open it up to anybody else who wants
to take a step at it.
Mr. Gensler. Congressman, it is very good to see you again,
by the way.
I think that the SEC has put forth what is called a concept
release on a possible new regulatory structure in this area.
With that, they raise some very thoughtful questions,
particularly internal compliance officers and how to address
compliance issues at mutual funds.
In terms of regulatory structure, I find myself torn. The
SEC, as best I can tell, has the authority to do that which
they need to do. So it may well be a funding issue that they
want to devolve this to what they call a self-regulatory
organization, with the hopes of assessing fees so that they do
not have to go through the annual appropriations dance that
every agency must and under our constitution ought to go
through. So I find myself feeling there are a lot of tough
issues here; a lot of issues that could hopefully be dealt with
around fund governance, and maybe some marginal additional
disclosure. But in terms of the regulatory structure, I think
at the core what the SEC is grappling with is probably more a
funding issue, and to devolve it to something just to assess
fees does not seem like their case has yet been made.
Mr. Castle. Mr. Bogle?
Mr. Bogle. Yes, sir. Thank you, Congressman Castle.
I would like to put this in a little broader context. It is
very clear that in corporate America we have moved from an era
of owners' capitalism to managers' capitalism, where companies
are run in the interests of their managers, rather than their
owners. We have to get back to our roots. That is a long and
complicated job.
The mutual fund industry really never has had an era of
owners' capitalism. In its first 25 or 30 years it had a
fiduciary-type orientation. That is why fees were so much
lower. The average equity fund fee back in, say, 1951, was less
than half of what it is today. Then, the fiduciaries took the
place of the fund owners, who are large and disorganized, small
investors and so on. But just like corporate America, we have
moved into an era of managers capitalism in the mutual fund
business.
Managers make a lot of money in this business. I am
reminded of Upton Sinclair's comment that it is amazing how
difficult it is for a man to understand something if he is paid
a huge salary not to understand it. That is really true. It is
a universal rule of life. How do we get back to our industry's
fiduciary roots? Well, we start off, I would say, by much
better disclosure--in shareholders' statements, yes, the amount
they pay; in annual reports with a dedicated page on the first
or second page showing the fund's returns relative to its
costs, turnover costs, turnover, dollar amount of fees--things
like that, every fund has to show on one of the first two
pages; and other disclosure issues that we have talked about
today.
Next, I think there is something we can do to improve the
structural imbalance between the rights of fund shareholders as
manifested through their fiduciary boards of directors and the
rights of the managers. That is, strengthen the board. The 1940
Act calls for that implicitly. One thing you can do, and should
do, is have an independent chairman of the board, just like we
are calling for in corporate America, because in both cases the
manager as chief executive has too much power. Another
improvement would be a larger number of independent directors.
Finally, I think, and I am not a lawyer here, which may make
this better or worse, is a federal standard of fiduciary duty
for mutual fund directors. That would open up a lot of
opportunities to have the fund owners served properly and
fairly.
Mr. Castle. Thank you, Mr. Bogle. Unfortunately, we are
going to have to cut it off. I am interested in the question.
If any of you have a written answer you would like to submit on
that--the whole issue of what can the government be doing to
help resolve some of the problems which we have discussed here
today.
With that, I yield back to the Chairman.
Chairman Baker. Thank you, Mr. Castle.
There is one further question I had. Mr. Haaga, does the
ICI have a formal position with regard to the SEC proposal now
pending with regard to disclosure of proxy voting?
Mr. Haaga. The proposal has been adopted. Our position
was--and I am glad you asked that, because we get characterized
as being against it. There were a number of parts of that
proposal, and we agreed with most of them--all but one of them.
We even suggested a more rigorous alternative to another one of
them, which is to include the independent directors to oversee
potential conflicts. The only part with which we disagreed was
that of sharing the individual proxy votes with, in the
original proposal it was anybody who asked in paper. Now, we
are gratified that we can put it up on our Web site or the
SEC's Web site.
Chairman Baker. And with that modification, does that--
Mr. Haaga. It has been adopted and we will live with it.
Chairman Baker. I know the SEC has adopted it, but the OMB
is in the process of promulgation, I believe, so it is not
effective.
Mr. Haaga. Right.
Chairman Baker. I just wanted to clarify the industry
position.
Mr. Haaga. Well, the industry, of course, we will live with
it. We want to make sure that the OMB and the SEC properly take
into account, costs. This was adopted in a great hurry, and I
think there was not, frankly, an adequate analysis of the
potential costs. If they do an analysis of the potential costs
and they adopt it, we will comply with it, as always.
Chairman Baker. Let me express to you and all the panelists
today my appreciation for your longstanding patience. This was
a lengthy hearing, but I think it provided members with a much
better insight into the areas that are performing properly;
into those areas where perhaps we need to make some
enhancements. To that end, I have conferred with Mr. Kanjorski
and Members, as I said repeatedly, we will get a letter out to
the SEC to try to get professional resolution of making that
statement. So all parties who are interested can make
appropriate comment. And then we would, at some future time,
return to this subject to try to bring some closure.
I think the most important asset of the hearing, as Mr.
Haaga indicated in his opening statement this morning, was that
we want to bring about consumer confidence that capital markets
are efficient, transparent, and most importantly, responsive to
shareholders. That is our goal, and we will work diligently
toward that end, and I appreciate your courtesies in helping
the committee get there. Thank you.
Our meeting is adjourned.
[Whereupon, at 1:34 p.m., the subcommittee was adjourned.]
A P P E N D I X
March 12, 2003
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