Commentary

‘Reforms’ Miss the Mark

This article originally appeared in USA Today on April 21, 2004.
The so-called mutual fund scandals involved favoritism and poor disclosure among 4% of mutual fund families, with respect to ”market timing” and ”late trading.” Many proposed new regulations of mutual funds are at best irrelevant to these overblown concerns.

The Securities and Exchange Commission (SEC), for example, wants to require that three-fourths of fund board members — including the chairman — be nominally independent from management. Yet there is no evidence that board independence matters. A recent survey conducted for the Federal Reserve Bank of New York concluded that ”board composition, as measured by the insider-outsider ratio, is not correlated with firm performance.”

Requiring the chairman to be an outsider, however, means requiring that this key job be held by someone with neither the incentive nor the expertise to do a good job. Putnam Investments, which in November settled with the SEC over allegations that at least six employees profited from inappropriate trades in its funds, had an independent chairman. Fidelity and Vanguard, two highly successful and respected fund companies, do not have independent chairmen.

Another SEC proposal would require mutual funds to advise shareholders twice a year about typical costs of $1,000 invested. Yet self-styled ”reformers” demand more details more often, meaning more costly paperwork. Some want disclosure of brokerage fees. This would be information overload. If fees are unwarranted, a fund will perform badly and lose customers.

Low fees are nice, but high returns are nicer. Some 42% of mutual fund money is in the 100 biggest funds, nearly all of which have outperformed the Standard & Poor’s 500 for five to 10 years.

The apparent intent of recent efforts to increase regulatory harassment is to put pressure on mutual funds to minimize their fees. Unfortunately, the easiest way to cut fees is to cut administrative costs by using high minimum investments and transaction fees to keep out small investors. The added expenses from such new rules would hit smaller investors the hardest.

The real scandal is not that there is too little regulation of mutual-fund-investment choices open to small investors, but that there is far too much.

Alan Reynolds is a senior fellow at the Cato Institute, a free-market think tank.