United States: Fee-Disclosure Pitch Would Boost Transparency, Competition

The Securities and Exchange Commission's Investor Advisory Committee recently urged the agency to increase mutual fund cost disclosure to help investors understand how much their mutual funds cost them over time.

The commission is not required to act on the committee's recommendation. But giving investors better cost data would obviously be positive and directors should support that cause.

Prospectus and annual shareholder report disclosures have been unsuccessful. Too many shareholders do not read them or understand them. Putting more relevant information in an individual account statement in dollar terms will enhance shareholder knowledge and could prompt more to read the documentation they receive. Investors make more appropriate decisions when they have clear, transparent and comparative information.

Although any rule adopted by the SEC is unlikely to impose a direct burden on board members, they will be – as always – tasked with ensuring that shareholders are informed. A requirement to allow specific dollar expense data will help them achieve that goal because individual shareholders will simply understand their costs better. Boards should encourage the SEC to consider all the relevant factors to ensure that any proposed rule will be worthwhile to shareholders, especially whether the benefits outweigh any costs. Directors should make clear to the SEC that the rule isn't worth it if the costs are too high.

In addition, the board will be tasked with overseeing fund management's compliance with any eventual rule, as it would be for any other new regulation. Directors should pay close attention to whether the SEC standardizes disclosures across all similar types of funds. It's possible that there will be different rules for different types of funds, and boards should be prepared for the possibility that disclosures will need to be tailored for each.

The committee provides a strong set of suggestions. For decades, the industry has given investors hypothetical performance figures commonly referred to as "mountain charts," which reflect fund performance over an extended period of time, net of fund expenses. Yearly expense ratios are also already shown in shareholder annual reports. The committee wants that same standard applied to cost data so that shareholders can understand how much they are paying and how this impacts their individual investments over an extended period.

The committee raised a few possible examples of the types of information that can be provided. Though directors won't be able to fully assess the extent of their duties until the rule is finalized, they should pay close attention to the specific data required, because any new rule could potentially impact their fiduciary duties. Directors should focus on the data format that the SEC requests. That format must be clear, concise and understandable for the typical shareholder. If the format requested is shorter and clearer, then it's more likely that shareholders will read the information.

It's possible that funds will be required to disclose their costs, benchmarked against the average cost of similar funds that are placed in the same category. This would help investors determine how their own costs compare to similar funds. The SEC should explore the feasibility of such an approach. They will have to define fund categories, what they use as the cost benchmark for those categories and how best to present that information. Such disclosures could be even more effective if they also were to show approximately how much each investor would pay over various time periods, relative to the category average. Some funds already voluntarily provide this information.

The SEC could also require funds to present a graph that displays the impact of investor costs. It would show the impact on total accumulations of the fund's actual expenses and the category average expense, using an assumed rate of return and over an extended holding period. This would allow investors to understand the total dollar amount of fees that they are paying over longer holding periods.

The SEC must balance the costs of providing this information and the benefits of doing so. Then it's up to the board to help make sure that shareholders fully understand what they are buying, the costs involved and the substance of the data. The biggest benefit to increased transparency is that shareholders would be better informed. On the flip side, this transparency is what will create the biggest increase in oversight duties for board members.

One interesting committee view is that even if shareholders disregard the proposed cost per account disclosures, whatever rule is proposed may create more competition in the industry because of the transparency that is created. The recent Department of Labor fiduciary rule – although limited to Erisa – will also move the industry to be more competitive, especially regarding expenses. The transparency afforded in the fee-disclosure proposal would create expanded competition beyond just Erisa accounts. Costs are often a factor in shareholder decisions, but above-average, long-term investment performance will always be the primary basis for the choice of mutual funds.

The industry and the SEC have continuously worked to give investors relevant information before they make investment decisions and while they are shareholders. Summary prospectuses and improved shareholder reports have all been instituted to that end. The committee has determined that these current disclosures have not been effective.

The Investor Advisory Committee's proposal is a work in process that will take time to develop. Though not perfect, it is a strong start, and it sets the stage for a continuing objective of educating shareholders.

Originally published by Board IQ

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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