[House Hearing, 109 Congress] [From the U.S. Government Publishing Office] MUTUAL FUNDS: A REVIEW OF THE REGULATORY LANDSCAPE ======================================================================= 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 NINTH CONGRESS FIRST SESSION __________ MAY 10, 2005 __________ Printed for the use of the Committee on Financial Services Serial No. 109-26 U.S. GOVERNMENT PRINTING OFFICE 24-093 WASHINGTON : 2005 _________________________________________________________________ For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001 HOUSE COMMITTEE ON FINANCIAL SERVICES MICHAEL G. OXLEY, Ohio, Chairman JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania DEBORAH PRYCE, Ohio 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 Chair JULIA CARSON, Indiana RON PAUL, Texas BRAD SHERMAN, California PAUL E. GILLMOR, Ohio GREGORY W. MEEKS, New York JIM RYUN, Kansas BARBARA LEE, California STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas DONALD A. MANZULLO, Illinois MICHAEL E. CAPUANO, Massachusetts WALTER B. JONES, Jr., North HAROLD E. FORD, Jr., Tennessee Carolina RUBEN HINOJOSA, Texas JUDY BIGGERT, Illinois JOSEPH CROWLEY, New York CHRISTOPHER SHAYS, Connecticut WM. LACY CLAY, Missouri VITO FOSSELLA, New York STEVE ISRAEL, New York GARY G. MILLER, California CAROLYN McCARTHY, New York PATRICK J. TIBERI, Ohio JOE BACA, California MARK R. KENNEDY, Minnesota JIM MATHESON, Utah TOM FEENEY, Florida STEPHEN F. LYNCH, Massachusetts JEB HENSARLING, Texas BRAD MILLER, North Carolina SCOTT GARRETT, New Jersey DAVID SCOTT, Georgia GINNY BROWN-WAITE, Florida ARTUR DAVIS, Alabama J. GRESHAM BARRETT, South Carolina AL GREEN, Texas KATHERINE HARRIS, Florida EMANUEL CLEAVER, Missouri RICK RENZI, Arizona MELISSA L. BEAN, Illinois JIM GERLACH, Pennsylvania DEBBIE WASSERMAN SCHULTZ, Florida STEVAN PEARCE, New Mexico GWEN MOORE, Wisconsin, RANDY NEUGEBAUER, Texas TOM PRICE, Georgia BERNARD SANDERS, Vermont MICHAEL G. FITZPATRICK, Pennsylvania GEOFF DAVIS, Kentucky PATRICK T. McHENRY, North Carolina Robert U. Foster, III, Staff Director Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises RICHARD H. BAKER, Louisiana, Chairman JIM RYUN, Kansas, Vice Chair 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 DENNIS MOORE, Kansas FRANK D. LUCAS, Oklahoma MICHAEL E. CAPUANO, Massachusetts DONALD A. MANZULLO, Illinois HAROLD E. FORD, Jr., Tennessee EDWARD R. ROYCE, California RUBEN HINOJOSA, Texas SUE W. KELLY, New York JOSEPH CROWLEY, New York ROBERT W. NEY, Ohio STEVE ISRAEL, New York VITO FOSSELLA, New York, WM. LACY CLAY, Missouri JUDY BIGGERT, Illinois CAROLYN McCARTHY, New York GARY G. MILLER, California JOE BACA, California MARK R. KENNEDY, Minnesota JIM MATHESON, Utah PATRICK J. TIBERI, Ohio STEPHEN F. LYNCH, Massachusetts J. GRESHAM BARRETT, South Carolina BRAD MILLER, North Carolina GINNY BROWN-WAITE, Florida DAVID SCOTT, Georgia TOM FEENEY, Florida NYDIA M. VELAZQUEZ, New York JIM GERLACH, Pennsylvania MELVIN L. WATT, North Carolina KATHERINE HARRIS, Florida ARTUR DAVIS, Alabama JEB HENSARLING, Texas MELISSA L. BEAN, Illinois RICK RENZI, Arizona DEBBIE WASSERMAN SCHULTZ, Florida GEOFF DAVIS, Kentucky BARNEY FRANK, Massachusetts MICHAEL G. FITZPATRICK, Pennsylvania MICHAEL G. OXLEY, Ohio C O N T E N T S ---------- Page Hearing held on: May 10, 2005................................................. 1 Appendix: May 10, 2005................................................. 37 WITNESSES Tuesday, May 10, 2005 Barbash, Barry P., Partner, Shearman & Sterling LLP.............. 23 Eisenberg, Meyer, Acting Director, Division of Investment Management, Securities and Exchange Commission................. 4 Miller, Michael S., Managing Director, Planning & Development, The Vanguard Group............................................. 25 Stevens, Paul Schott, President, Investment Company Institute.... 21 APPENDIX Prepared statements: Barbash, Barry P............................................. 38 Eisenberg, Meyer............................................. 56 Miller, Michael S............................................ 70 Stevens, Paul Schott......................................... 80 Additional Material Submitted for the Record Eisenberg, Meyer: Written letter to Hon. Richard H. Baker...................... 110 MUTUAL FUNDS: A REVIEW OF THE REGULATORY LANDSCAPE ---------- Tuesday, May 10, 2005 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 2:00 p.m., in Room 2128, Rayburn House Office Building, Hon. Richard H. Baker [chairman of the subcommittee] Presiding. Present: Representatives Baker, Ryun, Castle, Biggert, Kennedy, Feeney, Hensarling, McCarthy, Lynch, and Wasserman Schultz. Chairman Baker. I would like to call this meeting on the Subcommittee on Capital Market to order. This afternoon the committee meets for continued examination of practices of the mutual funds industry and the potential effect on the individual investor. As all members know, after the passage of the Sarbanes/ Oxley legislation, significant operation reforms were brought to bear on all sectors of the financial marketplace, including the mutual fund industry. This, of course, was a warranted action in light of some 95 million Americans who are now vested in mutual funds and depending on one's perspective, have some difficulty in always accessing comparability of the various mutual funds investments they may hold, and so we return again today pursuant to the GAO report issued last year, which raised continuing concerns about areas that have been under examination previously. In some cases, fees have continued to go up, turn over rates, in other words, turning rates remain unacceptably high. And transparency is still goal, which we all see, but are having some difficulty in clearly establishing. Against that backdrop, however, I want to say a word to those within the ICI, particularly Mr. Stevens, the new leadership there, for taking a professional and positive step forward in working with not only the committee, but with regulators in crafting a higher standard of professional conduct and expectations for all those who are fiduciaries within the industry. As we turn to the SEC, I am pleased that they have acted in such a prompt manner on so many areas, but there should be a constant balancing, in my opinion, between the new regulatory regime and the cost of compliance. I think it often missed in public discussions that whatever the cost may be ascribed to a particular compliance activity, that cost is ultimately charged against the investor's account. And so we have a due diligence responsibility, a fiduciary obligation to ensure that our regulatory standards bring about the needed disclosures, but at the same time are balanced against the cost against that individual investor's account. And so that ongoing analysis will likely be required in determining whether the disclosure regime today or one going forward is appropriate in light of these charges. I know there is internal discussion about the effect of the hard 4 o'clock closing rule and its prejudicial effect on west coast investors, pension fund managers, large 401(k)s, and that there may be some technological way to preclude the ill-advised late trading strategy, but not at the same time preclude trading by legitimate business interests who happen to be in the wrong time zone. I believe there to be some discussion about concerns over the sale point confirmation activities. Clearly enhanced transparency is something that most on the committee would find advisable, but in looking at what has been suggested, it takes me back to my real estate days in Louisiana where to close a first mortgage on a home purchase today will vary slightly from about 75 to 85 pages. I know from firsthand experience that most people don't read about 74 or 75 pages; they say tell me where to sign and wait on the 3-day rescission period to pass so they can get the closing done. We don't want to follow that path. I think that disclosure should be concise and clear. It shouldn't be so complete that it is convoluted, and I think that one should question the value of disclosures made simply for the purpose of having forms executed without at the same time conveying real information to the investor. I am hopeful going forward that we can continue a good working relationship with those in authority at the SEC. A fair, open, transparent market that enables working families to invest and build for their first home or college education is certainly a very important goal, and we should do it in the most professional environment possible, with consequences to those who just simply choose not to abide by the rules. With that, I would yield to Ms. Wasserman Schultz for opening statement. Ms. Wasserman Schultz. Thank you, Mr. Chairman. And no, Mr. Kanjorski has not had a magical transformation---- Chairman Bachus. Tis a pity. Ms. Wasserman Schultz. I will let that one hang there and send his regrets that he was called away unexpectedly. Chairman Baker and distinguished guests, it has been nearly 2 years since late trading and market timing scandals shook the mutual fund industry. In 2003, preliminary investigations found that up to 10 percent of fund companies were aware that some customers were late trading, nearly 25 percent of broker dealers executed orders for customers after 4 p.m., potentially in violation of SEC regulations, about half of the fund groups had some arrangements with favorite shareholders to engage in market timing, close to 70 percent of broker dealers were aware of timing activity by customers, and almost 30 percent assisted timers in some way; and finally, some mutual funds executives may have traded illegally in their fund securities, to the detriment of other investors. I hope today's hearing will shed light on the progress both the SEC and the industry have made to increase transparency, improve mutual fund governance and end abusive and unfair trade practices that undermine the integrity of our markets. More than 90 million Americans rely on these financial instruments to protect their investments, and investor protection must always be our highest priority. I expect that our panelists will have best practices they can share as they work to implement reform, but I realize there are still many areas that will need to be refined. I encourage both my colleagues and our guests to take this opportunity and engage in a meaningful dialogue. I hope our panelists will highlight areas that still need to be improved and strengthened, as well as the steps that we can take together to get there. Thank you, Mr. Chairman. Chairman Baker. I thank the gentlelady. Mr. Castle, would you have a statement? Mr. Castle. Well, thank you very much Mr. Chairman, I appreciate the opportunity. I have some guests here, by the way, the winning women of Delaware who are back there, one of whom is the attorney general in Delaware, Jane Brady, who is with us today. I always worry, though, when the attorney general starts following me around, to be very candid. I think, Mr. Chairman, that you in particular, and this subcommittee and our committee as a whole, have actually done a thorough and good job with respect to the mutual funds industry since the problems arose a couple of years ago. And I think that the SEC has followed through and done some things correctly as well. And I think the mutual funds industry has sort of, after initially sort of burying its head in the sand, has come toward and made some progress in this area as well. And I think as a result of that, when you start talking about some of the illegal trading that was going on, and some of the almost criminal problems that existed in the past, that we have made great steps. But I still worry about the vast majority out there. I believe the statistics are about 50 percent of Americans are somehow or another involved in the mutual fund industry, it may be in an IRA or 401(k), it may be so indirectly almost don't even know it, but nonetheless, it is a heck of a lot more than, say, 25 years ago--and obviously 50 years ago, and it is probably going to increase. The complexity of investing is so difficult that you sort of want to turn it over to somebody who knows what they are doing. But what you don't want do is to turn it over to somebody in a situation in which you don't know what the fees are that you are paying, you don't understand what the classes of mutual funds are, be it A, B, C, D or whatever, you don't really know what that means in terms of your costs. You don't know where your costs are actually coming from, how are they paying for their trading, how are they paying their other costs, or whatever it may be. I, for one, have been concerned about 12b-1 fees for some time. 12b-1 fees were created solely at a time when mutual funds were not doing that well in order to help with advertising and let people know about mutual funds. And at some point they transferred into a sales load, indirect, of some kind or another so that mutual funds are sold and brokers are paid back over a period of 5 or 6 years. I was amazed to find that a heck of a lot of these are charged on mutual funds that are closed, which means whatever you do is selling anything as far as I am concerned. I consider practices like that to be absolutely dead wrong, and they need to be addressed as far as our future is concerned. So my concerns, I guess, more relate not just to the clearly criminal activity that was going on before, but relate to just the transparency and the understanding of the average investor, which I would guess is 90 percent of us who invest in mutual funds, in terms of what we are getting into, what are we paying for it, what are the true costs going to be, what is our net benefit at the far end? Those are things that I think we need to better understand. And please don't ask me to read the prospectuses and all that stuff, first of all, I get bored to tears; and secondly, I stop understanding it about halfway through page one, so I don't think that is completely the answer either. So I just share that sort of every man's concern as to where we are going. And I do apologize, Mr. Chairman, I have to go visit the Mint for some interests that they have, another matter of interest to this committee. At about 2:40 I have to leave, but I appreciate the opportunity of being here. Chairman Baker. I thank the gentleman for participating. Mr. Hensarling, Mr. Kennedy, Ms. Biggert? There being no requests for further additional opening statements, it is my pleasure at this time to recognize our first witness, Mr. Meyer Eisenberg, who is the acting director of the Division of Investment Management of the Securities and Exchange Commission. STATEMENT OF MEYER EISENBERG, ACTING DIRECTOR, DIVISION OF INVESTMENT MANAGEMENT, SECURITIES AND EXCHANGE COMMISSION Chairman Baker. Welcome, sir. You may proceed at your own leisure. Your official statement will be made part of the official record, and you will have to pull that microphone close because it is not very sensitive. Welcome. Mr. Eisenberg. I thank the Chairman, members of the committee, before Congressman Castle goes, I feel like I am sort of at Delaware again at the Weinberg Center talking about corporate governance. So in any event, Chairman Baker--I gather Congressman Kanjorski is not here, but I think that in what we are going to go through, I will try to respond to some of the questions that have been raised by the chairman, that have been raised by Ms. Wasserman Schultz and by Mr. Castle, and hopefully I will do that in some reasonable order. I am Meyer Eisenberg, I am the acting director--and I stress acting--of the Division of Investment Management. In real life, I am a deputy general counsel of the SEC. And I thank you for inviting me here to testify before the committee today on the status of the Commission's mutual fund rule making reforms. I am pleased to be here on behalf of the Commission to provide an overview of the regulatory reforms the Commission has adopted in response to the recent unfortunate spate of mutual fund industry scandals that have involved some of the best known names in the industry, not just a few bad apples. These events sharply dramatized the need for additional measures to deal with the conflicts of interest inherent in the organizational structure of most mutual funds, to restore public confidence in the fund industry, and better safeguard the interests of fund investors in the future. I would also like to outline some of the additional regulatory initiatives that the Commission has undertaken in this area, that may be of interest to the subcommittee. Before I begin, however, I would like to take this opportunity, on behalf of the Commission, to thank you, Mr. Chairman, for your leadership on the issue of mutual fund reform. Many of the reforms ultimately adopted by the Commission address the important concepts included in the Mutual Fund Integrity and Fee Transparency bill that you introduced. I also want to thank committee Chairman Oxley, subcommittee and committee Ranking Members Kanjorski and Frank, as well as members of the subcommittee and the full committee for their leadership during this very disappointing chapter in the history of the mutual fund industry. Millions of Americans--now indeed over 91 million Americans--rely on these products to safeguard and grow their savings so they can achieve their dreams of a home, an education for their children and a comfortable retirement. Your support has been vital to their protection, and to the restoration of confidence in this important sector of financial services industry. Mr. Castle is correct, when I first joined the Commission staff many years ago, before I was in private practice, the whole mutual fund industry in the mid 1960s was $40 billion. Today there are over $8 trillion, an exponential increase. Several of the funds in some of the major fund groups exceed $40 billion, and many more people are involved than ever before. Last year, in the wake of the mutual fund late trading, market timing and revenue sharing scandals, the Commission implemented a series of mutual fund reform initiatives. The reforms were designed to, one, improve the oversight of mutual funds by enhancing fund governance, ethical standards, compliance and internal controls; two, address the late trading, market timing and other conflicts of interest that were too often resolved in favor of fund management rather than the interest of fund shareholders; and three, improve disclosures to fund investors, especially fee-related disclosures so that people know what it costs when they are investing. It is the Commission's hope and expectation that taken together, these reforms will minimize the possibility of the types of abuses that we have witnessed in the past 20 months from occurring again. I would like to briefly review for you the significant steps the Commission has taken to strengthen and improve the mutual fund regulatory framework. I have excerpted this from the longer written statement. First, with respect to fund governance reform. With respect to enhancing mutual fund governance and internal oversight, the centerpiece of the Commission's reform agenda was the Fund Governance Initiative. In July 2004, the Commission adopted reforms providing that funds relying on certain exemptive rules must have an independent chairman, and 75 percent of the board members must be independent. These governance reforms will enhance the critical independent oversight of the transactions permitted by the exemptive rules. Funds must comply with these requirements by January 2006. The fund governance reforms were designed to carry out the specific Congressional instruction in the Investment Company Act, that the resolution of conflicts of interest be in the interest of fund shareholders rather than the interest of fund managers. Our fund governance reforms are also designated to facilitate the implementation of other fund initiatives that we have adopted. In reviewing these questions, we need to step back and recall the statutory direction and the policy provision of section 1(b) of the 1940 Act as it was originally enacted 65 years ago. The Act states in that provision, it is hereby declared the policy and purposes of this title, in accordance with which the provisions of this title shall be interpreted, are to mitigate and, so far as is feasible, to eliminate the conditions enumerated in this section which adversely affect the national public interest and the interest of investors. Section 1(b)(2) of that statement declares that the national public interest and the interest of investors are adversely affected when investment companies are operated, managed or their portfolio securities are selected in the interest of their officers, directors or other affiliated persons. In addition to our fund governance reforms, other mutual funds reforms that the Commission has pursued include the requirements for compliance policies and procedures for chief compliance officers, codes of ethics, a directed brokerage ban under rule 12b-1, and a voluntary rather than a mandatory 2 percent redemption designed to forestall market timing where it is not authorized. The new redemption fee rule mandates that funds enter into written agreements with intermediaries operating omnibus accounts that enable funds to easy information from those intermediaries so that the funds can identify shareholders in those accounts who may be violating market timing policies. Under these arrangements, the intermediary and funds would share responsibility for enforcing fund market timing policy. There was ample opportunity for industry representatives to raise issues regarding this provision during and before the comment period. We would be interested in hearing the problems and exploring the ways in which those concerns may be resolved later. Now that I have outlined the Commission's adopted rules, I want to focus for a moment on the so-called Hard 4 proposal, which you raised, Mr. Chairman. To address those problems associated with late trading, which involves the purchase or selling of mutual funds at a time that the funds share prices are after 4 o'clock, but receiving the price for 4:00 and buying after 4:00, the Commission, in December of 2003, proposed the Hard 4 rule, that you had to have your order in by 4:00 eastern time. This rule would require that fund orders be received by the fund, its designated transfer agent or clearing agency by 4 in order to be processed that day. We received numerous comments raising concerns about this approach, in particular, we are concerned about the difficulties that a Hard 4 rule might create for investors in certain retirement plans and investors in different time zones. Consequently, we are focusing on alternatives to the proposal that could address the late trading problem, including various technological alternatives, electronic stamping and so on. Chairman Donaldson has instructed the staff to take the time necessary to fully understand the technological issues associated with any final rule, and the Commission is likely to consider this final rule later this year. You see, the comments of industry, institutions and shareholders are taken seriously, and proposed rules are, indeed, modified to accommodate real legitimate concerns. Let me now turn to the issue of mutual fund disclosure. Improved fund disclosure, particularly disclosure about fund fees, conflicts and sales incentive, has been a stated priority of the Commission's mutual funds program throughout Chairman Donaldson's tenure, even before the mutual funds scandals came to light. Thus, the disclosure enhancements have been an integral part of our reform initiatives. My written testimony discusses these mutual fund disclosure reform initiatives, including reforms related to the disclosure of portfolio holdings, the fund expenses and shareholder reports, disclosure regarding market timing, fair evaluation, selective disclosure of portfolio information, and disclosure regarding breakpoint discounts on front-end sales loads, board approval of investment advisory contracts, and portfolio manager conflicts, and compensation. In addition to these adopted reforms, the Commission recently requested additional comment on proposed rule-making brokers--on a proposal requiring brokers to provide investors with enhanced information regarding costs and broker conflicts, like when the fund managers direct payments to brokers for shelf space so that they should be featured, and the ones that don't pay don't get featured, don't get the preferred treatment, those kinds of conflicts associated with their mutual funds transactions, the so-called point of sale proposal which was referred to. Chairman Donaldson has stated that he is hopeful that the Commission can move on this initiative after we have had the opportunity to review comments and respond to that reasoned request. Having outlined the Commission's progress in the fund reform agenda, I want to highlight some additional mutual fund- related initiatives that Chairman Donaldson has indicated are on the near horizon. One of the most significant involves the use of soft dollars for research. Chairman Donaldson has stated that he believes it is necessary to examine the nature of conflicts of interest that can arise from the type of soft dollar arrangement which involves an investment adviser's use of fund brokerage commissions--which is, after all, a fund asset--to purchase research and other products and services. He has placed a high priority on resolving these issues. Consequently, he has formed a commission task force that is actively reviewing the use of soft dollars, the impact of soft dollars on our Nation's securities markets, and whether allocations of soft dollar payments further investor interest. And we will have the results of that task force from the Commission, I hope, in short order. Other upcoming mutual fund initiatives outlined in the written testimony include a staff recommendation that the Commission propose a rule to improve disclosure of mutual fund portfolio transaction costs, a thorough and reasoned review of rule 12b-1, which was referred to, and a top to bottom assessment of disclosure. Let me say a few words about cost benefit, with which I think you opened this hearing with, Mr. Chairman. I want to comment briefly on the issue of cost/benefit analysis, which I understand may be raised by certain industry representatives. The Commission is always sensitive to the cost and benefits imposed by its rules, and therefore engages in an extensive cost/benefit analysis in all of its rule makings. I want to emphasize that our Office of Economic Analysis, Division of Investment Management engage in a careful and thorough review when preparing the cost/benefit estimates in connection with these fund rules and submitted them to the Commission for its consideration. You must keep in mind, however, that in any analysis of the cost and burdens and anticipated benefits of a rule is, after all, only the best estimate of those costs and benefits. The Commission specifically requested and seriously considered industry comments, among others, in the course of the proposing and adopting process involved in the promulgation of these rules. However, if cost/benefit analysis is to be used as a strategy to stifle responsible regulatory efforts to address the types of abuse, the fiduciary responsibilities, particularly in conflict of interest situations, that we have seen over the past, the failure to act could, again, undermine investor confidence and impair the integrity of the market in the eyes of the investors, both large and small. Suppose, for example, that under section 404 of Sarbanes- Oxley, the financial certification rules, and an active compliance program now required by Sarbanes-Oxley had been placed at Enron or at WorldCom, there is a distinct possibility, if not probability, that the scandals that caused billions of dollars to evaporate overnight, from retirement plans and from the holdings of investors, might well have been mitigated or even largely prevented. The benefits would have undoubtedly outweighed the cost. But how can this be measured precisely or predicted when you were writing the rule? While cost/benefit analysis is a critical component of all commission rule makings, these types of estimates should not be dispositive when analyzing the utility of a particular regulation, although they are important in assessing what the costs or consequences might be. Legitimate use of cost/benefit analysis is important, but should not be used to undermine regulatory initiatives designed to prevent the kinds of conduct covered in the recent scandals. In conclusion, Mr. Chairman, let me thank you again for your support and for your leadership in the area of mutual fund reform. Under your leadership this subcommittee was at the forefront of recognizing the necessity that reform and initiating serious consideration regarding what needed to be done to restore investor confidence in this industry took place. Thank you again for inviting me to speak on behalf of the Commission. I would be happy, I think, to answer any questions you may have. [The prepared statement of Meyer Eisenberg can be found on page 56 in the appendix.] Chairman Baker. Thank you, Mr. Eisenberg. Let me compliment you as well for your long-standing service to the SEC and to the investing community. I do believe that committee and the Commission and the Commission staff have all agreed and identified on the points of concern that continue to be somewhat problematic. I think the only difference that might exist at all, if there is a difference, is in the resolution of how we address those concerns. Since you spent a little time on the cost/benefit analysis, let me, by way of example, give you the real estate parallel. When you sit across the closing table on that first mortgage loan closing there are innumerable documents which require innumerable signatures. Most consumers don't really fathom what they have just signed, nor the consequences of their rights, as a result of those disclosures. That has led me to conclude that a concise but clear consumer disclosure may be distinctly separate from the legal notification to which that consumer may require access at a later time. It leads me to conclude that a one- or two-page document that gives up front disclosure fees and all the appropriate agreed-upon things which most people would center on, with a notification of some electronic point where one could engage additional services at no cost at a subsequent time, and perhaps engage legal counsel, if necessary, most of that bulky rights and privileges don't come into play unless the market goes sour or it is just a fraudulent conduct, which means usually in retrospect, not at the time of closing. I would hope in the construct of these disclosure rules that some sort of mechanism to provide the clear and concise, with access to the more detailed, would be something that would be evaluated. I, frankly, do have concern, as a strong proponent of transparent disclosure, that it is missed sometimes that the cost of compliance is a direct hit against the rate of return for the investor. It is not just the management company that takes the lick, it is passed through. And we have an obligation, in a fiduciary nature, to those investors to make the regulatory framework effective, but get the cost down as much as is practicable. So I am not suggesting that the Commission should alter or stop or deter or forget any of the enumerated concerns that you brought to our attention today--I happen to share all of those concerns; I do have a considerable concern about the effectiveness of a very bulky disclosure regime. There is one other area that I wanted to explore, and it comes on the business side and regulatory approval side. It has been brought to my attention--and I think one of the witnesses later may bring up the subject, so in deference to your appearing here, to be able to address this question, there was an ETF exemptive request and it has been represented more than one, but this particular one was an association with a high- yield fixed income indices that the request has been pending now for almost 2 years. It appears that the regulatory deafness within the enterprise to respond to changing market conditions has also taken a hit as the regulatory side has gotten more burdened. Is this a leading indicator for me that we still need more staff, or is this something else going on with regard to approval processes on this exemptive side? Mr. Eisenberg. Well, let me--I think that what you talked about, about a summary prospectus in the first--or a summary that is made available to a shareholder that is a couple of pages and is comprehensible and is in English and is not in legalese, I think that is important. I think we agree with that, that there is an effort now, it may not be two pages, it may end up being four pages, but the point is to--and this has been done through focus groups of investors to get us to understand what it is they are interested in and to get a bottom line where an investor can tell before, at the point of sale, and that goes to the point of sale issue, that he or she can tell what it is that it is going to cost them and what the conflicts of interest are and what they should be looking at. There is also an investor education program, which is ongoing, Web sites and that kind of thing. And you are right, and I think we agree with you that that is an important priority, and I think we have tried to do that. With respect to the lagging exemptions. One of the things-- I just got to this position last month--one of the things I hope to do is to examine the lag in the processing of exemptions and to see what we can do to tighten that up. I think that any bureaucrat will tell you yes, we need more people, and I believe with what has happened in terms of the increased regulatory burden and the exponential growth of the industry and the problems that have been piled on top of it, we may well need additional people. But we have gotten some additional people, we have gotten some additional accountants, we have deployed them, and I think that question of who we need and whether we need them, both as a Commission and both as a division, that we may well come back and say yes, we really need these people. But nevertheless, addressing the gap, a 2- year gap in processing an application for an exemption, I mean, I will look into that. Chairman Baker. Thank you. And one last--because my time has expired. With regard to general policy and the responsibility of independent directors, I was an advocate of independent share, independent directors, I think that is a healthy thing to have the friction between the management company and the fund board, but on the other hand, the responsibilities of that director, I believe, are policy and broad-based. Is it the Commission's view, or if you can't speak for the Commission, your view that the director is really responsible for everything that happens in the company or in the fund, or is it a broader fiduciary responsibility, meaning do you have to get into detailed actuarials and really understand what contract X meant? I am concerned about the implications of service for people who may be overwhelmed with the potential liabilities contingent on the SEC view of that responsibility. Mr. Eisenberg. For a long time I was counsel--in my previous life I was counsel to management companies and I was also counsel to independent directors, I was independent counsel to them. And I think that the Commission, and I think we generally take a broader view that directors are not there to micromanage what goes on in the fund. I think one of the key things that a director needs to do is to ask the right questions and make sure the answers are narrowed down. The things that you discussed and things that the other members of the committee have discussed were overall broad policy questions, like trading, market timing, sticky assets, the incentives to use fund brokerage for distribution without disclosing them, those are things that in the normal course directors should be interested in. And they have helped because they should have independent counsel, they have got an independent auditor, and if the independent counsel and the auditor and now the compliance people do their jobs, they will find out about these issues and they will be able to act. And consequently, I think the brief answer to your question is they are not responsible for micromanagement, they are responsible for the overall policy and to see to it that the compliance issues are addressed. Chairman Baker. That is excellent. Thank you, sir. Mr. Lynch. Mr. Lynch. Thank you, Mr. Chairman. First of all, I want to thank you for all of your work on this issue. I know the spirit in which a lot of your work has been done, which is to restore trust and confidence in the industry. And director Eisenberg, I appreciate the work that you have done on this as well. I do have some concerns, and I would like to go right back to the issue the chairman issued about fund governance, and I would like to back it up just a little bit. I understand the potential conflict and the spirit of the, you know, Investment Company Act in your opening remarks, the principles that guided you, and I actually voted for an amendment in the last session to have a majority of the directors be independent. However, the rule that has been adopted here for companies who enjoy certain exemptions to have 75 percent of the directors be independent and the chairman to be independent, I am concerned with that, I am concerned with it greatly. And I am concerned that this is almost a purge, almost a purge of trying to get rid of everyone who might be best suited and most valuable and most knowledgeable from the board itself. And I am very, very concerned about that. And I think sometimes what we see is there is a crisis or a scandal, and then the pendulum swings harder the other way and we sort of cause as much damage as we are initiating a fix. And I would just like to get your sense of--is that a valid concern, or should I be happy with what is going on here? Because frankly I am not. Mr. Eisenberg. As I said before, I have been on both sides of this thing. I came back to the Commission about 6 years ago, and I was going to be there for 2 years and now it has been 6 years because of various things that have happened. I think, first of all, it is a concern, but I think the Commission was aware of the concern. And having viewed this from the inside and having viewed it from the point of view of the Commission, and also from the point of view of independent directors, there are two organizations, national organizations of independent directors. One is the directors forum, and the other is an ICI-sponsored independent director's council. Both of those organizations have written and supported both the 75 percent and the independent Chair proposal. It does not seem to have had the effect that some people feared that it was going to draw people out of the board room. As a matter of fact, most of the major fund groups that I am aware of, and there was a survey taken, they already had 75 percent of independent directors, and at most, with this proposal, would end up doing would be to have the affiliated Chair become just a member of the board and to promote one of the members who are independent directors or lead directors, to have them be the independent Chair. Now why is an independent Chair important? Well, at first, when you look at this I thought, well, it is not going to make a hell of a lot of difference; but looking back on my experience and others that we have spoken to, including meeting with the independent directors council and with the independent directors forum, the atmosphere in the boardroom is changed because there is a critical mass, you can't separate out just one of these elements, you have to take the reform generally. And that is an independent Chair, the 75 percent which gives you critical mass, you control the agenda, and I think Congress is a good place to indicate what the chairman of a group can do--that you control the agenda, and the communication is better. You also have given them an independent council, which has the right--says to them, these are the questions you really ought to ask at the meeting, we want to know from management if you are going to allocate brokerage, who you are doing it to and what you are getting for it and so on. So I think that there was a concern, and Mr. Lynch, I think it was an important concern, but I think that after it has been put into effect many of the fund groups are already complying can it. And some of the sky is falling, kind of--the view that you may have gotten from some of your constituents has not proved out. And consequently, I think this is an important reform, it is part of a package, it shouldn't be disaggregated from it. And I would say to you that the staff issued a report, which was transmitted to the Senate committee--Senate Appropriations Committee which requested it--on the independent Chair rule. And I would be happy to submit a copy of that report, which goes through this in detail. After you or your staff has had an opportunity to review it, we would be happy to discuss it with you further. And of course that goes for any other member of the committee, and this is that report. One more thing, and that is, we have been challenged by the Chamber of Commerce. The United States was sued, there was an argument about a month ago in the Court of Appeals for the District of Columbia. In the brief, of which I was one of the authors, I admit--we outlined the reasons for that independent Chair proposal. And rather than taking the time of the committee now, we would--I can submit excerpts from that brief for you. Mr. Lynch. Okay. And could I get a copy of the Chamber's briefs as well, the arguments---- Mr. Eisenberg. I would be happy to supply the chamber's briefs as well. Mr. Lynch. Thank you, Mr. Chairman. I just want to, in conclusion here. I understand the gentleman's remarks that some boards were sort of in that position anyway, having 75 percent independent directors and some are moving in that direction anyway. I am entirely comfortable if firms are doing that on their own, and that--in terms of the best result for the investor, and that leads us to that conclusion. The problem I have is that when you come up with a hard and fast rule, and you are now rule bound to exclude certain people, and among those people may be the very best people qualified to protect the investor's interest, and that is all I am saying. And it is 75 percent, and the director, and so you--I see a squeezing out of those people who might be qualified. I see limited seats available for those people. Mr. Eisenberg. Let me just say quickly in response to Mr. Lynch's question that you can still have an affiliated person or two affiliated people on the board, and that is what generally does happen. So they are not really being squeezed out. But there is a chart at the end of my testimony which shows the conflict of interest that exists. And given what has happened in the real world, and given where the question is, the restoration of confidence and of governance, the Act itself originally said that you have to have at least 40 percent, then it went to 50 percent. And the reason they picked for 75 percent is basically outlined in the staff's report. So I agree that--and this may not apply to normal--to corporations, but when you have the advisor and you have the fund and you have the directors of the fund charged with safeguarding that fund and negotiating a management contract, an underwriting contract, who is going to be the auditor and all of that, that there is some conflict, and it is better in practice and it looks better in the perception of the public if our interests are being protected. Mr. Lynch. Point well taken, I agree. I thank the gentleman for his testimony, I thank the Chairman for his patience. Chairman Baker. The gentleman's time has expired. Mr. Hensarling. Mr. Hensarling. Thank you, Mr. Chairman. Mr. Eisenberg, I want to follow up on a couple of questions that the chairman asked. And I beg your indulgence, I had to step out of the hearing room for a while, and it could be that you already covered some of this material, but for my benefit it would be helpful. I wanted to ask you about follow up on a disclosure issue, kind of a general philosophical question, and then one in specific. In the chairman's opening testimony, I think he talked about what he did in a previous life to sell real estate. I haven't sold it, but I have bought it. And last year, my wife and I purchased a small inexpensive condo in the area and I remember being presented with roughly 80 to a hundred pages of documentation, which clearly I chose not to read. I did out of curiosity ask my realtor how many home purchasers actually read the material, and she replied roughly one out of 200. I inquired who the one out of 200 was, and I was informed it is typically a first-year law student at one of the local law schools. So I guess as a general philosophical question, not only am I purchaser of real estate, but I am also an investor in a number of mutual funds. I have a tendency to read one, maybe two pages of materials. I have a tendency to drop in the round file the 30 and 40-page disclosure statements I receive from time to time. So I guess in a general philosophical sense, do we reach at some point the point of diminishing marginal utility and perhaps adding more disclosures without letting the more important ones really surface? Is there a point to where the less is actually more, and are we getting to the point where we are actually doing more harm than good to the investing public by adding more disclosures? Mr. Eisenberg. Well, less is actually more in this context, in many cases, and that is why in response to Chairman Baker's question, that the Commission is in the process of developing the kind of point of sale and materials which will, briefly and in plain English, describe what it is the investor is buying, what it is the investor is paying, and what it is he can expect. I think that is easier to say than to do. The Commission convened focus groups of investors to determine what they thought was important, what they were looking for, what the expense ratio means and how you can tell that, and where can you go to review what is being offered to you in terms of the funds, and there are independent places you can go, the Commission has a Web site that compares them. And we will try-- and we are embarked now in an attempt to develop the kind of material that both the Chairman and you have talked about. And I think we are working with the industry and we are working with OCIE, the Office of Compliance Inspections and Examinations and the Investor Education Group. It is a problem that has been with us for a long, long time because whenever you have additional regulation, the lawyers--and I was one of them--get on it and say we have got to disclose this and we have got to disclose that. And it is true. And I also say the prospectus is more than just informing investors of what they are doing, it is also a way of informing professionals and the Commission and analysts of what it is that is being offered. But I agree with you, I agree with the chairman, there should be a brief, clear outline for an investor that gives him the basic facts. Mr. Hensarling. Let me change subjects to the independent board member reforms or initiatives. You mention in your testimony that was adopted a little less than a year ago on a 3-2 vote of the Commission? Mr. Eisenberg. Right. Mr. Hensarling. There appears to be a fairly consistent pattern of 3-2 votes on the Commission dealing with a lot of major initiatives, and it appears to usually be the same three and the same two. We have heard a number of concerns about the practical impacts of the independent board member reforms, but I myself don't know about the dissenting views. Could you enlighten me as far as specifically what the minority views were of the Commission in adopting these rules? Mr. Eisenberg. Well, the two dissenting commissioners, Commissioner Glass and Commissioner Atkins have filed a letter with the report which indicates what their objections are. I have reviewed those and others have reviewed it, and I think that their points are not well taken. What they have said basically is, oh, you people have rehashed this whole business about the scandal, but you really haven't shown that an independent Chair would improve the performance or improve the compliance of the company. We have had our economist look at that, and it is reported in our staff report to the Senate committee, basically you can't disaggregate that one function, the independent Chair, and say it hasn't added to performance, there are too many variables the economists say--I must say they speak a different language, but there are too many variables to reach that conclusion. And the reason that the Commission did it was not necessarily in terms of proving that there would be better performance or not better performance, they did it because of the structure of the fund industry which sets up a conflict, and that conflict has to be managed. And that was recognized from the very beginning in 1940. And given the complexity and the new products and how many people are investing, those conflicts had to be managed. And one way of managing it is through fund governance. And giving that 75 percent independent directors and an independent Chair are just two elements of a much broader view of governance, which includes an inside compliance responsibility which includes an independent counsel so that they have the technical ability to deal with questions and the independent auditors. And if those people do their jobs, then that would certainly help in terms of resolving those conflicts of interest, otherwise, the Chair of the fund, if he is affiliated, is, in effect, negotiating with himself as to what the advisory fee ought to be, how it ought to be distributed, where the brokerage should be go. So that is basically the short answer, the longer answer is in the report. Mr. Hensarling. I thank the gentleman, thank you. Chairman Baker. Thank you. Ms. McCarthy. Mrs. McCarthy. Thank you, Mr. Chairman. We are probably going to go back to the same question that everybody else asked you. In your testimony you talk about the transition cost disclosure, and I know you have talked about it a number of times. And I see that the Commission started looking at this in December of 2003. Do you have any idea of when it is going to finally come through so that we can look for it? Mr. Eisenberg. I believe it will be before the end of the year. I believe Chairman Donaldson has indicated this is a priority. We have had a couple other things that we have had to deal with. And I think that we recognize now, and recognized then that this is something that should be addressed. I regret that it has taken that long to do this, but if you are going to do it, you have to do it right, and we will try to do that by the end of the year. Mrs. McCarthy. And I hope it is done very simply because I do happen to read the prospectus, and I still can't find what it is costing me. So hopefully it will be easy. Mr. Eisenberg. Yes. This has been an objective of commissions past that we are going to make it easy to explain. You are going to have a summary prospectus, you are going to stick it on the first part. And every time you do that, the lawyers say well, you need more, you need more. This is a serious effort to get that kind of information, the basic information that reasonable people can understand, to tell them what it is that they are buying and to inform them as to what the conflicts are that they are facing. I mean, you would want to know that the broker-dealer who is selling you this mutual funds interest is getting paid extra in order to push A rather than B, which may have better performance and so on, the so-called shelf space because mutual funds are just like soaps, so if you pay for the shelf space, that is okay, but mutual funds are not like soap, mutual funds are different, they are harder to understand because you can't hold them in your hand. So that is why we need to do that. Mrs. McCarthy. Should fund advisors or managers have the same fiduciary responsibilities as others in the financial sector; is the SEC moving in that direction? Mr. Eisenberg. I think you are referring to the broker- dealer investment advisor rule which is now--which we have tried to deal with. There are two kinds of responsibilities, and the question is, when are you an investment advisor? Or when does the broker-dealer cross the line from just giving advice that is incidental, to selling the shares that he is selling and become a financial planner? Or if he has discretion, he in effect becomes an investment advisor. And that line, which is fairly fuzzy, we are in the process of really, of defining that. And I think that is important because broker-dealers have more and more taken on the aura of being financial planners, of giving you advice, and not just the things which are normally incidental to the brokerage, and that is what that rule is all about. Mrs. McCarthy. And I appreciate that, because I will say that when you are working with your broker--and obviously there has to be some sort of relationship because they will call you and say hey, we think you should get out of this and go into it, and hopefully you will say fine, I mean, they are the ones that actually know why would we have it. I mean, I don't have time to start looking at what I am supposed to do with it. So I hope that we can have some rules up there. I mean, I happen to trust the guys that take care of my funds---- Mr. Eisenberg. Trust, but verify. Mrs. McCarthy. But I am in Congress, so they might be looking out for my investments, I have no idea. Thank you. No further questions. Chairman Baker. I thank the gentlelady. And Ms. Biggert. Mrs. Biggert. I thank the Chairman. I would like to come back, I think Mr. Castle had talked a little bit about the Hard 4 close. And I know that we had a hearing a couple of years ago that the question came up, and there was a feeling by people who testified that that would mean that in some time zones, it would be like 12 noon that they would have to stop trading the mutual funds. And I believe that there has been some development of some technology to have a time stamp technology that is now capable of doing that. Would that solve the problem, or are there other alternatives that you need to look into? Mr. Eisenberg. I did refer to that, I believe, in the testimony that yes, that there are technological advances which would have tamper proof stamps. But it is more complicated than that because there are some intermediaries which bundle the orders, and they are not subject to commission regulation. So that is the reason why there should be some arrangement, in addition to just the time stamping, because there is nothing that is foolproof, there has to be some arrangement where those intermediaries would report and would have to disaggregate those late traders. I mean, the late trading was so harmful and the sticky assets that the quick fix was the Hard 4 close. And I believe it is more complicated than that. Mrs. Biggert. And I believe it is more complicated than that. I understand that. I wonder if that technology has been put into place. Mr. Eisenberg. It may go a significant way in solving the problem; it may not solve the problem altogether. And that is what is being examined right now. The Chairman has indicated--the Commission has indicated that they are interested in, one, the technological fix, and two, whatever we have to do in terms of the intermediaries. Mrs. Biggert. Well, certainly the SEC has had a lot of criticism for failing to spot the late trading in the market timing scandals. But what is happening currently? Mr. Eisenberg. What is happening currently, that is, under active consideration, is that the hard close--the question of whether the hard close is really the solution. And we would need to work with the industry and with tech people to determine whether that---- Mrs. Biggert. You said that that would probably be finalized by the--in this area, later this year? Mr. Eisenberg. Yes, I think it is important that we do that. And to a large extent, the fair value of the securities, to some extent, would help as well. But those of us who were in the industry, I think, were pretty surprised at the late trading. I mean, market timing, you can say, well, some of it was legal. A lot of it was illegal. Late trading was pretty clearly illegal, and a lot of people just did not know that these kinds of shady deals were going on. Mrs. Biggert. If I could just turn to another issue that-- there was a settlement, the global settlement. And part of that was a direction for $52.5 million to set up the Investor Education Plan, and the investor education entity. I am very interested in this, because of the financial literacy that we are working on here in Congress, and with the U.S. Treasury and the Commission. But is that up and running? Mr. Eisenberg. I do not have up-to-date information about that. I would be happy to get back to you on that question. Mrs. Biggert. I would appreciate it. I think that the board was set up, but there have been resignations. So I do not---- Mr. Eisenberg. That is right. And my understanding is, they are going to fill those vacancies and that they are going to review the work of that body. It got held up because of, apparently, disagreements within the board. But further than that, I really cannot say. Mrs. Biggert. Thank you. Chairman Baker. Mr. Feeney. Mr. Feeney. Thank you, Mr. Chairman. I appreciate the testimony, Mr. Eisenberg. I thought I would try to touch on a couple of areas that have not been explored so far. I have read Mr. Steven's testimony. And he warns about, I think appropriately, some of the cumulative regulatory burdens placed on the industry, especially small mutual fund companies who will bear a disproportionate brunt of regulations if we go too far overboard. And he suggests at one point that, for example, treating mutual funds differently from other financial products has some problems. With respect to the independence of the board, it seems to me that we have got a very different story here, because in a typical corporation, including financial products, the role of the board of directors is primarily to protect the shareholders of the company. In this case, it is not only the shareholders of the company, but the customers of the company who consume the product. One of the concerns I had, as opposed to just simply the typical definition of an independent board member, is that with some mutual fund companies, we have got members of the boards serving on four or five or six or eight different types of family funds; and these are often fairly lucrative positions with some significant benefits to them. Has anything that the SEC has done looked into the propensity or the incentives to the board member that is serving on, let's say, five or eight funds in a particular family to essentially become a rubber stamp for management in return for the ability to serve on multiple boards? Mr. Eisenberg. The multiple board question is something that I am familiar with, and that we have looked into. There are boards who administer 100 different funds. And they often tend to meet longer and more often than boards with smaller amounts. That does not mean that they cannot be effective. What those boards basically do is they divide up the funds into categories, and a subcommittee of the board will deal with those categories. They will interview the portfolio managers and the management with respect to what is going on. Say you have an international sector, you have a bond sector, you have an aggressive growth sector, and an index sector. And what they will do is divide that up, and then they will meet together on the fees and on those other issues. I would hesitate to say that a member, a board member, could not serve on multiple boards so long as it was effective and so long as they were not rubber stamps. One of the things that I think would prevent that is that the regime now is where you do have certain--you have the independent counsel and the audit committee and all of that, an independent chair, that they have the incentive to ask the right questions; and if they don't get those answers, they will inquire further. And I think also the industry recognizes that it is in their interests to restore confidence. I do not think that banning somebody from serving on more than 10 mutual fund boards is something that we are about to do. I mean, you are not going to believe this, but there is a limit on what the Government ought to do. And if that really becomes a problem, then I think we will have to act. But before we do that, we will do what we did with the independent chair and the 75 percent. You look to see what is happening, you see what abuses are occurring, and you try to do something about it. Mr. Feeney. I have got two more questions. I see my time is running out. Would the Chair entertain a motion for unanimous consent to give me an additional minute? Chairman Baker. I do not see that anybody is going to object. Why do not you just take off? Mr. Feeney. At the most, I could offend three of my colleagues. That is--I have done a lot more than that on occasion. The second question I have concerns the disparate fees that are often charged by funds between large institutional investors and small individual investors. Sometimes the cost to the individual investor is as much as 3-, 4-, 500 percent more. It seems to me that there is some inherent unfairness, whether I am managing a dollar for a client that has invested a hundred million dollars with me, or a dollar for somebody who has got his or her 401(k) invested with me, you know, the marginal costs cannot be that great in my view. And while I am not inclined to limit fees, that is against my instincts, I am inclined--despite the warnings about 80-page disclosures, I am inclined to tell people that there are other customers that are getting an 80 percent discount, for example, to what they are paying, because I think it would have the ultimate effect of bringing some more balance and fairness in the fee structures. Mr. Eisenberg. Are you talking about the difference between what an institution or a fund pays for a stock? Mr. Feeney. No. I am talking about what the management fees are that customers are charged in--you know, per dollar managed, large institutions sometimes--well, individual investors are paying 4-, 500 percent more per share or per dollar than a large institutional investor in that mutual fund is paying. Mr. Eisenberg. When an individual invests in a fund, there are break points in terms of when his load, if it is a load fund, when the load goes down, so that, depending on how much the person is investing, you may get charged a full load or a partial load or very little. I think the whole question of whether or not there are economies of scale, which I take your question to be, that where there are in fact economies of scale, that there really ought to be significant break points for that service. And I think that the disclosure pretty much makes that--should make that clear. Now, the other--the question which you may be getting at is that while there are different advisory organizations that charge a load, there are some that charge no load, there are some that have a contingent deferred sales load--you pay 5 percent; you stay in for an extra year, it is 4; and if you stay in for 5 years there is no commission whatsoever. So there are different commission schemes that they have and they need to disclose what those are. Mr. Feeney. Well, I was under the impression, maybe wrongfully, that the annual management fee was at times treated differently between institutional investors and individual investors, and I may be wrong about that. Mr. Eisenberg. Because the institution is a much larger customer and it costs less per dollar to manage a large institution if you have a billion dollars or half a billion dollars. If you have someone that comes in with $100,000 or $10,000, and you have to pay individual attention to that person's objectives and policies, then that costs more. Also, you have the difference--you have wrap fees. I am afraid I am not answering your question. Mr. Feeney. Maybe--because I may not be able to stay for the bulk of the rest of the testimony, maybe some of the other witnesses could address that if they are able. Mr. Eisenberg. It would be nice if you can ask them that. Mr. Feeney. I have just done so. Then finally with respect to 12b-1 fees, my understanding was that the theory, at least in part, behind allowing 12b-1 fees for advertisement and recruiting new investors is that if I can take my fund from, say, $100 million of management to $1 billion, if I can multiply it tenfold, the marginal costs per share, or per dollar, of doing research declines. So the marginal cost to the individual to manage the fund, to do things like research, would decline. In other words, the original investor, the guy who has got shares when the fund is worth 100 million would be better off when the fund grows, because the marginal cost per share of doing research declines and, essentially, their management fees should decline. But, in fact, some of these funds have now closed. And I would like to know the status of what the SEC is doing to review the appropriateness of 12b-1 funds in general and for closed funds in particular. Mr. Eisenberg. I can try and answer that quickly. There is currently, right now, an ongoing review of 12b-1 fees. 12b-1 fees are fees that come from the fund to facilitate distribution. And what you are saying is that with--well, if there is no distribution when it is closed, why do you need a 12b-1 fee at all? I think that is a legitimate question. It is one which the Commission is interested in. But we are reviewing 12b-1 fees in general, because 12b-1 fees originally just were to facilitate distribution, to pay for advertising and that kind of thing. They have become, to some extent, a substitute for a load, so people--for a commission. The role of 12b-1 fees is much different today than it was in 1981 when they started. And that is really an area that needs to be looked at. I agree with you, sir. Chairman Baker. There being no further members to bring matters to your attention, I would like to, just for the record, acknowledge that some members, who did have to leave, have questions for you. We will submit them in writing, and a couple of points of clarification, we will follow up with you on subsequent to the close of the hearing today. But we express our appreciation to you for coming forward and continuing to work with us as we try to bring about an appropriate regulatory regime for this important sector of the economy. Thank you, sir. Mr. Eisenberg. I think it is important that we do work with you, with your staff, and with the committee. We will certainly respond to any questions. Thank you very much. Chairman Baker. Thank you, sir. And as appropriate, I will ask the members of our second panel to come forward. I want to welcome each of you to the Capital Markets Subcommittee this afternoon. As you are each very much aware, your official statement will be made part of the record. We request that you make your oral presentation, as best you can, within the 5-minute period. And our first witness this afternoon will be Mr. Paul Schott Stevens, President of the Investment Company Institute. Welcome, sir. STATEMENT OF PAUL SCHOTT STEVENS, PRESIDENT, INVESTMENT COMPANY INSTITUTE Mr. Stevens. Thank you, Mr. Chairman, and good afternoon. The subcommittee is aware that mutual funds are one of the largest financial intermediaries, and, of course, they play an important role in American's retirement security. The Institute has the privilege of serving as the national association of U.S. mutual funds, and our members have total fund assets approaching $8 trillion. They serve approximately 87 million shareholders. At the end of 2004, mutual fund assets accounted for nearly one-quarter of all retirement market assets in the United States. The importance of mutual funds is unquestionable, and I certainly commend the subcommittee for providing this timely forum to take stock of where we are and to consider mutual fund regulatory policy going forward, so that it will continue to serve in the best possible way the interests of fund investors. Now, I am personally very honored to have this, my first opportunity as the president of the ICI, to testify before the subcommittee, so ably led by you, Chairman Baker, my fellow Louisianan. Under your leadership and that of Ranking Member Kanjorski, the subcommittee truly has been active across an exceptionally broad range of important issues affecting not just mutual funds, but all of our capital markets. Prior to joining the Institute as its president, I spent much of my career in private law practice and served for many years as counsel to mutual funds, to independent fund director and fund boards, to investment advisors, and to fund distributors. Indeed, I attended my first mutual fund board meeting almost 25 years ago. From this longer-term perspective, I believe that our collective response to the market timing and late trading abuses that first came to light in 2003 is reassuring. Our legal and regulatory system has worked as designed to identify, correct and prevent misconduct, as has the congressional oversight process. Strong corrective market forces have been at work as well. As an industry, I believe we have recognized the seriousness of these abuses and worked very hard to implement the comprehensive reforms developed by the SEC under the leadership of Chairman Donaldson. The result has been to sustain the traditionally very high degree of public confidence in mutual fund investing and, thus, to preserve for average Americans an indispensable tool to achieve their long-term financial objectives. This goal, assuring that mutual funds remain a vibrant and competitive and effective tool for average investors, is one of utmost importance, but it cannot be taken for granted. In considering future regulatory action affecting mutual funds, I believe it is critically important to bear in mind, in addition to the protection of investors, which is paramount, certain business and competitive realities in the financial services marketplace. The SEC, in particular, must give due consideration to potential unintended consequences of burgeoning regulatory requirements that uniquely affect mutual funds. My written testimony analyzes two specific instances, one related to disclosure concerning fund portfolio managers and a second concerning proposed point-of-sale disclosures concerning mutual funds. Now, individually, these and numerous other requirements may serve valid and useful purposes, but if, however, when taken as a whole, the SEC's uniquely applied mutual fund regulations and the associated costs and risks discourage investment advisors from entering or staying in the fund business. If they discourage portfolio managers from managing mutual funds as opposed to other investment products, or if they cause intermediaries to favor less regulated financial products over mutual funds, then the SEC's regulatory regime is not effectively serving the interests of American investors. Now, closely related to this issue is a concern about the escalating costs of compliance with the SEC's mutual fund regulations. To be clear, the Institute and its members firmly support sound regulation and strong compliance. It is necessary in crafting regulations for mutual funds, however, that the SEC have a full understanding of the potential consequences, including the actual cost implications of different regulatory approaches and their impact on funds, fund managers and fund distributors. To do so, we believe the SEC must conduct a substantially more informed and rigorous cost-benefit analysis of its proposed regulatory requirements. Now, we for our part pledge to assist the SEC in this process, by conducting our own cost-benefit research to contribute to the body of learning that informs mutual fund regulatory policy. Only in this way, working together, can we assure that the costs of new requirements will not outweigh their benefits or add unnecessarily to the growing and unique regulatory surcharge applicable to funds. Now, we also recognize that success of the mutual fund industry relies in large part on a strong and well-managed regulator. An effective SEC is essential to help sustain the high level of trust and confidence that investors have in mutual fund investing. Toward this end, for many years, the ICI supported adequate funding for the Commission. As Chairman Donaldson has recognized, however, more money and more staff are not the whole answer. The larger and more difficult challenge is for the SEC to assure the effectiveness of its regulatory and law enforcement efforts. To his credit, Chairman Donaldson has committed to pursuing internal reforms that will improve the performance of the SEC. As part of these internal reforms, there are three areas we believe deserve priority attention. They are better coordination among the different SEC divisions and offices that deal with mutual fund issues, better coordination of and other improvements to the inspection process regarding funds, and improvements to the efficiency and productivity of the Division of Investment Management, especially in processing applications for exemptive relief. To ensure the success of any future regulatory initiatives, it is important that the industry and the regulators move forward collaboratively, and to that end, maintain an open, ongoing and constructive dialogue. Such an approach will inevitably yield the best results for investors. I greatly appreciate the opportunity to testify on these important issues. The Institute looks forward to working closely with you, Chairman Baker, with the subcommittee, with Chairman Donaldson and all at the SEC to achieve our shared objective, a strong mutual fund regulatory regime that protects fund investors and helps ensure that mutual funds remain a vibrant and effective tool for them to achieve their financial goals. Chairman Baker. Thank you very much, Mr. Stevens. [The prepared statement of Paul Schott Stevens can be found on page 80 in the appendix.] Chairman Baker. Our next witness is Mr. Barry P. Barbash, partner, Shearman & Sterling. Welcome. STATEMENT OF BARRY P. BARBASH, PARTNER, SHEARMAN & STERLING LLP Mr. Barbash. Chairman Baker, thank you for inviting me here today to discuss the costs and benefits of the SEC's recent regulatory initiatives in the mutual fund area. I commend the subcommittee for its desire to assess at this early juncture the effects of the SEC's recent actions. I see myself as bringing to the discussion today a fairly unique perspective in the fund industry, as I have had, within the last decade, the privilege of working on both sides of the regulatory process. I feel compelled to note that Mike Eisenberg has the same background, just in the name of full and fair disclosure. I served as the division director of the Division of Investment Management at the SEC for 5 years before I joined the law firm of Shearman & Sterling, where I head up the asset management practice group. My practice is broad and diverse, representing all of the relevant constituencies in the asset management industry. I represent no particular client or clients in speaking with you today. My views are mine and mine alone. In my practice I have witnessed firsthand the costs and complex undertakings involved in complying with the new mutual fund regulations adopted by the Commission over the last 2 years. At the same time, my prior experience as division director enables me to appreciate the challenges regulators face and the great responsibility they bear in responding to improper conduct and in crafting rules to protect the interests of investors. I will speak briefly today about three areas that in my judgment have been affected significantly by the Commission's initiatives: mutual fund disclosure, the role of mutual fund independent directors, and the development of novel and innovative investment management products and services. Many of the SEC's recent regulatory measures have resulted in more material about more subjects appearing in mutual fund prospectuses and statements of additional information. This bulking up of these disclosure documents runs counter to what mutual fund investors, fund sponsors and sellers of mutual fund shares all agree must be a fundamental principle of fund disclosure. That principle is, what works best for fund investors is straightforward disclosure on the basic topics that are central to investing in a fund: performance, fees, expenses, risks and key objectives and strategies. I agree with high-level policymakers at the SEC, including Chairman Donaldson, that the time is again ripe for a renewed effort to make prospectuses a more useful tool for investors. To my mind, a new and enhanced mutual fund prospectus should have two core components. It should be short, addressing only the most important factors about which typical fund investors care in making investment decisions, and it should be supplemented by additional information available electronically, specifically through the Internet, unless an investor chooses to receive the additional information through other means. In seeking to make prospectuses more useful, the Commission and its staff should, in my judgment, also carefully consider when and in what form the prospectus should be delivered to prospective fund investors. These were topics that we did not consider in the late 1990s when I headed a review of mutual fund prospectuses. The question often asked by those of us involved with the mutual fund industry is, for what are the independent directors of a mutual fund responsible? Many independent directors, with whom I deal regularly, see the SEC's new rules and recent actions by the SEC staff as answering the question by four words: Everything the fund does. I believe that answer is inconsistent with the long- accepted notion that fund directors best serve as overseers and not micromanagers of business. I suggest that the subcommittee consider supporting those who serve as funds' independent directors, by asking that the SEC reevaluate all of its rules contemplating action by those individuals. The goal of such a reevaluation would be to center the efforts of directors on matters of overarching importance to the interests of fund shareholders, such as conflicts of interest faced by the fund investment advisors, distributors, or other service providers. The SEC's resources in regulating the investment management business over the recent past seems to have been principally devoted to rules proscribing or limiting activities of mutual funds, compliance matters and enforcement. Although all of these activities have clearly been of critical importance, they appear to have caused the Commission and its staff to spend less of their resources facilitating innovative opportunities for the investing public. Innovation in investment management products and services often necessitates obtaining exemptive relief from provisions of the Investment Company Act of 1940. The SEC staff's consideration of that type of relief appears to have bogged down of late, resulting in some industry participants abandoning their efforts to develop new products and services. How can the SEC enhance its efforts in supporting innovation in the investment management industry? I believe two actions are crucial. First, the Commission should strongly embrace what Commissioner Cynthia Glassman recently described as the Commission's mission; that mission, according to the commissioner, is to strike an appropriate balance between two goals--shielding investors from harm and maintaining the integrity of the securities markets on the one hand, and not unduly interfering with investor choice or impeding market innovation on the other, a balance that seems to be missing of late and needs to be reestablished. Second, the Commission should dedicate staff with special expertise in markets and products to the Division of Investment Management exemptive review process. Just as the Commission has sought to keep abreast of potential problems in the financial markets and the securities and investment businesses by forming a risk management unit, it needs to encourage creative development in the investment management business by organizing a new product review unit. In closing, I appreciate this opportunity to assist the subcommittee in its review of the SEC's recent mutual fund regulatory activity. I hope that by sharing my perspectives and experiences with you, I have been able to illuminate some unintended but troublesome consequences arising out of the SEC's regulatory activity. The subcommittee's thoughtful reconsideration of the cumulative effects of the new fund regulations should help to ensure that the interests of mutual fund shareholders are furthered and not impaired by that regulation. Thank you. Chairman Baker. Thank you, sir. [The prepared statement of Barry P. Barbash can be found on page 38 in the appendix.] Chairman Baker. Our next witness is Mr. Michael S. Miller, managing director, Planning and Development, for The Vanguard Group. Welcome, sir. STATEMENT OF MICHAEL S. MILLER, MANAGING DIRECTOR, PLANNING & DEVELOPMENT, THE VANGUARD GROUP Mr. Miller. Thank you, Chairman Baker. As you know, my name is Michael Miller. I am a managing director of The Vanguard Group, based in Valley Forge, Pennsylvania. An important part of my responsibilities involves providing oversight of our firm's compliance functions. I am also responsible for a number of other areas, including corporate planning and strategy, portfolio review, which includes new fund initiatives and research, and shareholder communications. Vanguard is the world's second largest fund company with more than 18 million shareholder accounts, and approximately $830 billion invested in our U.S. Funds. We have a unique mutual ownership structure at Vanguard where our mutual funds, and therefore, indirectly, the fund shareholders own The Vanguard Group, which provides the funds with all management services at cost. Under this structure, all profits are returned to our fund shareholders in the form of reduced expenses. Investor trust and confidence in the fund industry have been tested over the past 20 months, and the relationship between regulators and regulated firms has been strained. Amid an atmosphere that at times could be characterized as mutual mistrust, interactions between regulated firms and regulatory officials at times has been somewhat a game of gotcha or regulatory one-upsmanship. In the face of intense public pressure, new rules have been proposed and adopted at a record pace, failing in some cases to allow for accurate study by the Commission or the industry to evaluate the practical impact of the measures. I believe that we are now at a turning point. Nearly 2 years after the market timing and late trading problems at some firms, investors continue to regain confidence in mutual funds. No doubt investors in the markets have been reassured by the swift enforcement actions by regulators. The marketplace, too, has been swift and unforgiving in delivering punishment to firms that betrayed investors' trust. As we turn to the next chapter in the evolution of mutual fund regulation, the Commission and the industry must work together to ensure that the regulatory framework that governs our industry fully serves the millions of investors who rely on mutual funds to build their financial futures. In the wake of an extraordinary period of regulatory activity, adjustments and some fine tuning will be necessary, and the SEC will surely be asked to interpret new rules and regulatory requirements. The Commission and the fund industry share responsibility for getting these interpretations right. Hippocrates once advised physicians to declare the past, diagnose the present, foretell the future, and to make a habit of two things--to help or, at least, to do no harm. We would do well to follow his teachings today. That some misguided or unprincipled people at hedge funds, distributors and mutual fund companies engaged in abusive business practices has been well documented, and the regulators have responded. Today, fund company legal and compliance staffs are dealing with at least 25 new regulatory requirements that have been proposed and/or adopted in the past 4 years alone. With so many new requirements, fund companies are facing difficult resource allocation issues. At times it seems that these new demands on operating budgets and senior management time and attention unduly strain financial resources and leave little time to develop new and better ways to serve investors' needs. And I am speaking on behalf of the industry's second largest firm. I can only imagine the difficulties and tough decisions that many smaller firms must be facing. A regulatory system that is in overdrive can create undesirable and unintended consequences, ultimately punishing everyone in an effort to address the abuses of the few. After we have a chance to step back and review the events of the past 20 months, I think we will find that some of the new rules adopted in haste may not serve investors well. All of this regulatory activity has been well intended, but actual experience must be taken into account. If new requirements are helpful in some measure, but exact a cost in human and capital resources that far exceeds the benefits to investors, we--and I refer here to both regulators and the regulated--have failed in our obligation to strike an effective cost-benefit balance for investors. To operate collaboratively, we must maintain mutual respect and an open dialogue. Unfortunately, the events of the last 2 years have led to a breakdown in the constructive communications that had existed between the industry and the regulators. We must reestablish these lines of communication. In large part, the fund industry owes its success to the legacy of good rulemaking and sound and reasonable interpretation of the law by the SEC over the years. Recently, the fund and securities industries have worked with the NASD, with the SEC staff participating on many issues, including sales charge break points, transaction costs, distribution arrangements and point-of-sale disclosures. There is so much sense to putting our heads together to develop solutions to our most challenging issues. The search for simple answers in a complex world is difficult and may not always be possible. Fund firms have become increasingly complex as they seek to meet the needs of investors. Mutual funds appeal to a wide range of investors, from individuals saving for retirement to Fortune 500 companies. Funds and fund operations have evolved to adapt to the varied needs of these different investors. Regulators and fund companies must therefore engage in thoughtful and constructive dialogue to pursue and achieve a disciplined process to developing effective rules that protect all investors. There will not be unanimous support within the industry for every specific rule change or proposal. It would be naive to expect otherwise. But there must be an open dialogue and rigorous debate if we are to achieve an effective outcome for the benefit of fund investors. Working collaboratively, we can ensure that regulatory measures are designed with a thorough understanding of the intricacies of the business. Working together, we can also avoid the pitfalls too often faced by regulatory efforts. A regulatory response that is disproportionate or poorly tailored to the problem it seeks to solve can do more damage than good. And no amount of regulation will ever replace a commitment from the industry to integrity and high ethics. But over-regulation does not prevent bad people from doing bad things. There will always be people who figure out how to evade the rules. Such individuals should be subjected to strong and swift enforcement actions. We must be wary of changing the rules without providing adequate time for the industry and the regulators to consider the ramifications of the changes. Recently with the regulatory system in overdrive, the fund industry has too often been given too little time to consider and comment on regulatory changes. Less than 60 days simply is not enough time to digest all of a proposed rule's operational and other implications. We need not look too far in the future to see some opportunities to become reengaged. In recent testimony before the U.S. Senate, SEC Chairman Donaldson described two issues that offer opportunities for us to join in productive dialogue: mutual fund disclosure reform and mutual fund distribution. Advances in technology and the high adoption rate of the Internet by mutual fund shareholders create new avenues for better disclosure and distribution to shareholders. We also hope regulators and the industry will take more time to reengage in new business development, work where the SEC plays a critical role. Just as fund firms have been coping with the weight of new regulations, so too has been the SEC. As a result, firms trying to develop new offerings that could provide greater flexibility and lower costs to investors have encountered delays and bottlenecks. The pace of new product review and evaluation needs to be reexamined. Many of our new regulations seek to achieve similar objectives. As a result, at times we now have multiple and sometimes redundant solutions pursuing a single problem. We should look at all of these solutions closely and in concert with each other. We should consider what works well and what does not, then take the best of it and leave the rest. Vanguard has always been willing and eager to come to the table with our regulators to discuss any issue at any time. And I am confident that any serious and responsible firm in our business would make this same representation. We are willing to share the expertise of all of our experts, all of our people, for the benefit of this industry and, more importantly, for the investors we serve. Thank you, Mr. Chairman, for this opportunity to testify. [The prepared statement of Michael S. Miller can be found on page 70 in the appendix.] Chairman Baker. Thank you, Mr. Miller. I will start with you. With regard to your analysis of perhaps unwarranted rulemaking or unjustified rulemaking. One of the reasons for the hearing is to get from industry perspectives on the modifications made and the consequences of the rulemaking environment for us to assess what could be done to make the market efficient while ensuring transparency. If there are specific actions that you have identified from a Vanguard perspective, that you could make known to the committee at some future point, as to the consequences of a particular action and why it was, in your corporate view, not warranted, those are the examples of rulemaking which we would like to assess. But let me quickly add, as Mr. Eisenberg indicated in his comment earlier, it cannot be simply a cost-benefit analysis that makes a rule justifiable or not; it is the context in which the cost-benefit is engaged. And perhaps there are two classes of rules that I see. One is the practical impairment to business process--the 4 o'clock hard rule comes to mind, that that merely geographically or technologically precludes someone from engaging in the same business enterprise that others are engaged in, and is prejudicial merely by where you happen to be. That is something that obviously has need of repair. The other issue with regard to point-of-sale disclosure is on the other end of the extreme, which is a business judgment to require certain ethical conduct to ensure the investor is, presumably, made an informed investor by this disclosure, needs to be looked at in the context of what does it cost that investor for you to prepare that analytical, get it in his hands, in relation to the overall earnings of the fund. That is what troubles me there. If you can be more specific about the points at which you have found the process not to be balanced or where the timeliness given to a particular consideration was not sufficient, that is really where we want to go with this, to make sure that we are getting it between the sidelines as well. Mr. Miller. Maybe, Mr. Chairman, I can give you an answer that is a broad answer, but I think it goes directly to what you are asking. And that is, let us step back; Mr. Eisenberg talked about this, and Mr. Stevens and Mr. Barbash also talked about this. If we consider the entire disclosure regime that we are facing today, I think we all concede that there is too much paper. There is too much disclosure. We want investors to be aware, we want investors to be knowledgeable, but we want investors to read the information that we give them. They won't read it when we make it so weighty and so overwhelming that they are deterred from picking it up and giving it a read. I think that what we need today--and we have to look at this in the context of the last couple of years--I am very sympathetic to the SEC. I am very sympathetic to the industry and the pressures that have built up over these last couple of years, the pressures to do more and more, enact more and more rules; and the pace of activity has been at times frantic. It has been a record pace. I think someone told me that in a given year, a normal year, if we had such a year, you would have two or three rules of substance that would be proposed for comment by the SEC and perhaps adopted. Over the last few years, as I indicated in my testimony, we have had 25-plus rules proposed or adopted. It is just an overwhelming burden that the SEC has had to manage, the industry has had to manage. I think today, if we can somehow take a breath, step back, look overall at this disclosure regime and work with the SEC, work with the Commission staff to find a way to make a more manageable set of information that we provide to investors, that would serve investors well, it would serve the industry well. Really, it is a win-win-win. It is a win for the SEC, it is a win for the industry, it is a win for investors. So it is not a specific answer, but it goes to this whole aura of disclosure. We all know that we need to have disclosure, we all know that disclosure is good, but if we do not make it workable and manageable, as an industry, we suffer. I think the Commission suffers. I know the investor suffers. Chairman Baker. Well, I think to a great extent the Congress has played a role in encouraging the SEC's actions, with the awareness of the business practices that were discussed over 2 years ago; and certainly the Agency has been trying to catch up in a regulatory sense to the world as it has passed them by. Principally, the mutual fund industry was, I think, one of the last places anyone was going to look for any misconduct; their reputations had been so good for so long. There were a lot of other arenas that were getting the headlines until the unfortunate news broke, perhaps to explain the Agency's intense actions. But I leave the door open for any specific things that you might want to bring to our attention. Mr. Barbash, you talk a little bit about the appropriateness of the disclosure regime today, and suggest that a more prospective reporting--perhaps I should use the word ``forward-looking'' statement--might more appropriate and helpful to investors. I have used the example on the public operating company side; the current paper-based, rules-based reporting system gives you information that it is at least 90 days old, maybe over that, and tells you where the company was and not where they are going. You seem to be indicating there might be value in not requiring that, but perhaps having more focus on what the investment strategy is, going forward. Was I understanding you properly in your written testimony? Mr. Barbash. Well, I call for--what I call for would be a document that gets to the basic points. It is shorter, goes to the point about what are the key investment objectives and policies of an investment company, and then would take advantage of the Internet to provide additional information to others who would want more information. So a shorter document would be the fundamental prospectus, and then it would be supplemented by other material that would be electronically available, so that interested parties would have mutual fund prospectuses and other information available; there would be access to a range of other information that would be on file with the SEC. Chairman Baker. There is a parallel reason for asking the question. In the financial institution world, within the FDIC, there is a software capability that operates behind the screen, the user doesn't know is there, Extensible Business Reporting Language, XBRL in the trade, and you enter your data, and then on the other side of the screen, whether it is a regulator, a competitor, a shareholder, or an analyst, they can get access to their data in real-time, in the format to which they are entitled. One of the things that seems to be difficult in this industry is comparability and having the average investor sit down with three different mutual fund annual reports and figure out who really did better. There has got to be a way, using technology, to provide for that kind of comparability, not only peer to peer, but peer to sector, however you want to compare it. I think that is what the typical investor--all he wants to know is, I am putting up $10,000; what happened to it, and how can I find out whether I can do better elsewhere? Is there a technology comparable to XBRL in the mutual fund world? Mr. Barbash. I can't really speak to technology, because I am technologically challenged. If I said otherwise, you would hear from all kind of constituencies complaining about what I said. But when we were looking at the prospectus back in the 1990s, one of our goals was greater comparability. We recognize what you recognize, which is that investors do want comparable information. The biggest change, frankly in the last 6 years, is technological. There is so much more information that is available that can be used. And I would hope, as the SEC goes forward, it looks hard at technology and sees what is available and what can be done. I think there is a very technologically savvy industry, the industry can also provide insight on that. Mr. Stevens. Mr. Chairman, I think it is a very key question. It seems to me the Internet is the way out of a real dilemma that the Commission has had for a long time. If you think historically, how we got where we are, there is, over time, more and more disclosure, which has quite appropriately been expected of mutual funds. It grew so large at one point we cut the prospectus in two, we created what we know as the prospectus, then there was the SAI. It continued to grow, and we put a summary in the first part of that, the prospectus, and now it is continuing to grow further, and with it increasing frustration. I think the industry and the SEC and commentators, and members of this subcommittee obviously, believe that we are wandering very far from what is a useful disclosure format for most investors. The Internet will allow, I think, for precisely what you described at the beginning of this hearing, will allow the SEC to focus on quality information that is concise, that is delivered to an investor, but also provide for the marketplace generally, for analysts, for commentators, for investment advisors, and for the do-it-yourself investor, a quantum of information on the Internet which can be maintained, which is current, and as I understand the technologies, is subject to a kind of search engine so that you can go to five different Web sites and pull down exactly the same information about five different families of funds. Now, I would tell you that if you look at mutual fund investors, it is going to be the exception rather than the rule that people are going to want to have that. Most are going to want to have that clear and concise document. Indeed, 80 percent of funds are purchased with the help of financial advisors. And it is their role to do most of that sifting and finding out. It is the exception, not the rule, where someone wants to look at three different prospectuses and make the choice for themselves. Chairman Baker. It is really innoculatory. It is for when things go bad. As long as the industry is returning 15 percent ROE, nobody is going to ask any questions. But it is when your fund, or the industry generally, has a downturn that everybody starts calling lawyers and finding out, well, why did you not tell me this? Maybe the answer is to have access to a point, a data point, where you can go find out anything you want, but the two-pager, as I requested, already up to four pages as a result of our testimony this morning, it tells you this is not a complete recitation of your rights and responsibilities, go to SEC.gov, or whatever it is, and there we will give you all that you want. So that you are not telling everybody, you have been fully informed, you have been given only the meaningful and minimal in order to get you in the game, if you want to go this route. Mr. Stevens. I believe that the key issue that will be before the SEC is, when we have reached the point of Internet familiarity and facility across a broad investor population, that the rule can switch, that is to say, that for an individual, the presumption will be, they can access that information over the Web, it would be delivered and available to them that way. But if they want to opt out, if they want to get the paper information, if they want to have it delivered in some other fashion, they can so indicate and the system can work for them. That sort of reverses what is currently the presumption, that everyone wants the paper and that minimizes utilization of the Internet. So I think that is a very important issue. And, of course, it has cost-benefit implications of significant degree not only in terms of our ecosystem--think of all of the trees me might spare--but also the effort that goes into producing disclosure documents which must be, to the industry's regret and the SEC's, I think, never opened in too many cases and never read. Chairman Baker. You raised one area I wanted to ask you about; that is the cost-benefit thing again. I am hesitant to say that it is the only measure by which a rule's effectiveness should be judged, but I think it is a component which should not be ignored. And going forward, as the rules are developed, should there be impacts that the Congress should be made aware of in our new communicative role here? In the post-Sarbanes-Oxley world, the committee feels responsibility to oversee and assess the effectiveness of the rules environment in which the market now functions, so if there are specific things or actions which have been taken which do not yield appropriate public benefit, we are reliant on those stakeholders and the industry to bring those to our attention--and, of course, with public explanation as to why these rules should be reevaluated. I certainly respect the work the SEC has done over a very difficult 2-year period. But it is not likely that everything that has been done is necessarily in the consumer's best interest. And to again state the obvious, that higher regulatory costs comes off the investor's return; it does not magically appear from the industry. You have the right and ability to pass it on to your investor community, and you do. So we have to look at this from sufficient information for a reasonable man to make a sound judgment, but at the same time, not taking $5 of his $10 investment to put it in regulatory costs. Therein is the problem. I hope you will take advantage of that opportunity to communicate with the committee as we go forward, because this is going to be an ongoing and difficult road, I am sure. Mr. Stevens. May I respond? As I look at cost-benefit analysis, you want to look at the benefits, too. I agree with Mr. Eisenberg. Some very simple things can have enormous benefits. They might even have very substantial costs, but the benefits could clearly outweigh them. It is the balancing of both of those. Some of them can be quantitative and tangible, some of them are going to be intangible, if you will, and are subject to more normative judgments. What I think is important, though, is that the Commission at least try its best to look at what the quantitative implications are. And I would say, in that regard, that that is an area where it is going to need assistance. I think commenters on rules, like the Investment Company Institute, have an obligation to come forward with that kind of analysis. To the extent we have not in particular cases, it seems to me that that is a defect that we need to remedy in our own input to our regulator. Indeed, it is now a priority for our research department. We have hired a new senior economist at the ICI that is going to be doing, as a priority, cost-benefit analysis of rulemaking. But I think, to be candid on the other side as well, if you look at the way that they have calculated costs in specific instances--and the redemption fee rule is a terrific example-- the analysis is simply inadequate by any measure. And when that is the case, I wonder if the Commission really has had sufficient information to consider, from a public policy perspective, is this the best way to go or might there be better alternatives for us to consider? Now, the issue of requiring funds to enter into contracts with every one of their intermediaries as a way of resolving the problem of market timing and imposing redemption fees was not one that had been proposed in an earlier rule; they simply asked questions, Gee, is that a good approach? And we at the Institute had told them, No, it is not a good approach, it is not promising, but it is the one that they have finally arrived at in the rule that they have adopted. We are working to communicate our views to the Commission in that regard. I offer it simply as an example of where the analysis of the costs and benefits in relative terms can fall down in a substantial way. Chairman Baker. I appreciate that. Mr. Miller. Chairman Baker, I also--I am going to step back again and--I think we should respond to your specific request. But I think it is also, again, important to step back and look at the entire regime, the entire regulatory landscape. When I hear about cost-benefit analysis, when I think what that means to the industry, I think in terms of everything that has been enacted, all of the rules that been proposed that have gone into effect, everything that the fund companies have to do today to comply with those rules. Some of those rules are good, but again I think that taken in the context of the overall picture, taken in the context of what is the cost of all of those things, it is people. I mean, there are more lawyers, there are more compliance people working today, that is clear. It is technology; I suggest, probably millions of dollars are being spent at Vanguard today on technology that in some ways is there in response to new rules that have been enacted, the PATRIOT Act, things that happened before the scandals of a couple of years ago. So all of those things in context. It is postage, it is paper, it is more and more communications to the fund shareholders. And, again, my hope would be that if we could step back, if we could work jointly with the Commission, the industry and the Commission hand in hand, have that dialogue, step back--maybe it is a blue ribbon panel; I do not know what it is precisely--but a way that we can look at these issues together, so that at the end of the day, hopefully, we have a more orchestrated regime from a compliance standpoint across the industry. Perhaps a few less rules, but no less in the way of the governance of the industry and investors, no less protection for investors. Then, I think, at the end of the day, again we have that win-win-win for the Commission, for the industry, for the investor. Chairman Baker. Well, it is a certainty that we have entered into a new economic arena in most financial service sectors, clearly in the mutual fund industry, and we cannot go back. We now have an overwhelming number of congressional constituents who are direct investors in your industry. That brings about a clear political accountability. So, unfortunately for the industry, the Congress is certainly not going to go away. On the flip side of that, with renewed assurances that the regulatory structure is adequate--and I suspect your view is, it is more than adequate today--that a confidence comes back to consumers to again place their money in your hands. That is a good thing. It is a good thing not only for the investor, but for the economy generally. And the balancing act going forward will be to ensure that the regulatory inhibitions do not forestall someone making a good investment decision or, worse yet, takes part of their investment dollar and needlessly spends it on regulatory compliance when they are not reading the documents in the first place. So it will continue to be a balancing act for us. And I hope that communication you talked about with the SEC from each of your perspectives will also be sent in our direction so we can do a better job of public policy analysis going forward, because this is an important part of our economic performance. It is a key, pivotal part of our growth going forward, and it is too important to idle off into a bureaucratic morass. So for those reasons alone, I am sure other members of the committee will join in supporting whatever steps might be taken from a Commission or from an industry perspective to ensure we reach the right balance. I just want to express my appreciation to each of you for your participation. Your remarks will be an important part of our work going forward. I am certain, as members indicated to me that they had other obligations, there will be written questions from other members coming to your desk in the next few days. Chairman Baker. Thank you for your courtesies, and our meeting stands adjourned. 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