Two elder statesmen of the fund industry are proposing ways to fix the fund industry's flaws. Jon Fossel, former CEO of OppenheimerFunds and Don Powell, former CEO of Van Kampen Investments released their proposals on Monday. Both Fossel and Powell are former chairs of the Investment Company Institute.

"Expenses must be lowered, fund returns must be improved, and disclosure must be far more open and timely," said the two CEOs.

The executives said that they are "appalled" by the scandals uncovered by state and federal investigators and noted that recently some in the fund industry have "too often appeared to put their desire for asset growth and profitability ahead of the needs of their shareholders." They also applauded the "soft dollars" and "directed brokerage" reforms proposed by current ICI Chairman Paul Haaga and the ICI's board of directors.

To reform the industry, Powell and Fossel recommended eleven steps they believe would address the current issues and help restore full confidence in the industry. They are:

Amend rule 12b-1 to exclude all marketing and "service" payments. Requiring existing fund shareholders to pay for the distribution cost of acquiring new shareholders, or the expense of having financial advisors "service" shareholder accounts is unfair. These marketing and "service'' payments are a costly burden on shareholders and, if necessary, should be paid by fund management companies.
Eliminate all "soft dollar" payments for research. Soft dollar payments are like soft money in politics, a pervasive evil that confounds every effort to curtail their many abuses. Soft dollar payments are nothing but the use of shareholder assets to pay for "research" that advisors decline to pay for out of their own pockets. With trading commissions averaging 1-2 cents per share, soft dollar "research'' costs can add 0.10 to 0.20 percent or more in annual expenses to shareholders. This is a cost that should be paid out of investment management fees, not a hidden expense to fund shareholders.
Add fund commission expenses to the comprehensive fee table in the prospectus. Trading costs are such a significant expense to shareholders, often 0.25 to 0.50 percent or more annually, that they must be disclosed along with management fees, 12b-1 expenses, and transfer agent expenses. This expense ratio should also be disclosed more frequently in quarterly reports and marketing materials.
Require quarterly disclosure of after-tax fund returns. Trillions of shareholder dollars are held in taxable accounts. Investors cannot easily compute their after-tax returns due to the difficulty of identifying the effect of long and short-term gains on their performance. Taxable investors need to be able to compare their returns to other comparable funds with substantially different turnover rates. High turnover has a substantial negative effect on taxable investors who are forced to pay high short-term capital gains rates. High turnover funds can cost taxable investors at least 0.50 to 1 percent of after-tax return annually.
Require fund companies to adopt the industry's "best practices" code of ethics that was recommended by an ICI blue-ribbon committee several years ago. The code requires that all senior executives, portfolio managers and analysts pre-clear all trades and regularly disclose all personal stock and fund holdings in their funds' complex. Since the opportunity for conflict between management and the fund shareholders in IPO allocations, front-running, etc. is considerable, full and timely disclosure is appropriate. Annual prospectus disclosure is not adequate.
Disclose all portfolio holdings in excess of 1 percent within 15 days of the end of each month and all sector weightings within 10 days of the end of each month. Such disclosure would enable investors and their advisors to have a better understanding of the risk and return characteristics of each fund.
Support high fees on all redemptions made within 10 days after purchase of any non-money market fund. Such fees, 4 percent on equity funds and 2 percent on fixed income funds, should be collected and paid to the fund. Eliminating market timing that takes advantage of short-term market pricing anomalies or insider information is essential. However, it is also important to preserve the legitimate right of shareholders to actively rebalance their portfolios to take advantage of significant shifts in valuations of asset classes or market sectors.
Require all fund board chairmen and all board committee chairmen to be independent directors. Also require that independent directors comprise at least two-thirds of each fund board.
Prohibit fund management company payments for "shelf space." Brokers and other financial intermediaries have a fiduciary duty to their clients to make investment recommendations based solely on "suitability" and should not be influenced by hidden payments received by them or their firm from fund management companies.
Adopt rules to address potential money manager conflicts that could arise within an organization managing other types of investment accounts in addition to mutual funds, such as pension accounts, hedge funds, private accounts etc. Require disclosure to mutual fund directors all other accounts managed by each mutual fund portfolio manager and all holdings, transactions and investment performance of the other accounts.
Require compensation structure disclosure so that shareholders can ascertain whether their manager's compensation is consistent with shareholder objectives. Also require that specific portfolio manager and manager team compensation be disclosed to fund directors to be used in their consideration when approving management fees.

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