After scandals: a hard look at mutual-fund fees

When the dust settles from the mutual-fund scandals, average investors will be better off.

At the very least, controversial trading techniques - used by some big traders to the detriment of small, long-term investors - will be banned. That reform should put a few extra dollars in the hands of some shareholders. The big question is whether the shakeup will push fundamental reform in the mutual-fund industry, especially in the area of fees.

If it does, long-term investors could see a small but significant increase in the annual returns of many of their funds.

But don't hold your breath. Those reforms face big opposition.

The mutual-fund industry, which manages $7 trillion in assets, and its lobbying organization "are clever, well-heeled, driven, and used to getting their way," holds John Freeman, a University of South Carolina Law School professor. He worries that Congress will leave reform to regulators at the Securities and Exchange Commission, and that the SEC will remain in a friendly partnership with the industry's lobbyist, the Investment Company Institute (ICI). The end result: only a little reform and the half of American households that own fund shares continuing to be overcharged some $20 billion per year in various fees and expenses, he says.

Not so, counters Matthew Fink, ICI president. He claims such estimates are based on faulty studies. In reality, the costs of investing in stock funds have actually decreased by 43 percent since 1980, he claims.

In any case, the pressure is on fund companies to trim their fees, thanks to the unfolding "late trading" and "timing" scandals revealed by New York Attorney General Eliot Spitzer last fall.

Late trading involves buying or selling mutual-fund shares after the 4 p.m. stock-market close, the time when the net asset value or share price is set for the next day. The SEC proposes that in the future any mutual-fund transaction must reach the fund, or another SEC-registered entity, by 4 p.m. to be valid for that day's price. Late traders either used dodges or got permission from fund officials to escape the regulation.

Timing is the quick purchase and sale of fund shares during trading hours to take advantage of news events. It is not necessarily illegal, but it often violates a provision in a fund prospectus promising to discourage this from happening. The SEC proposes charging a 2 percent redemption fee on any sale of fund shares within five days of their purchase. That would probably make timing unprofitable.

The agency also wants mutual-fund groups to appoint a compliance officer to report regularly on the group's adherence to laws and regulations to the "independent" directors on a fund's board.

Only a year ago, Mr. Fink of the ICI bragged to Congress that the industry's governance and investor-protection standards could serve as a blueprint for corporations in other industries. Today he admits to being totally surprised - like regulators and people in Congress - by the "breach of trust" to shareholders of a minority of the nation's 400 or so mutual-fund groups.

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