Mutual fund cleanup: Washington's surprisingly slow-motion efforts at reform

International Economy, The, Wntr, 2004 by Roger M. Kubarych

A less radical alternative would be to retain mutual fund boards, but give them real responsibility and teeth. That would require limiting the number of boards a director could serve on, much in the same spirit as the Financial Institutions Reform Recovery and Enforcement Act (FIRREA) does for depository institutions (banks and thrifts), and making the independent directors personally liable to the shareholders for gross negligence by the fund manager. One could also combine the two, installing a Master Trustee for the fund complex and independent directors for individual fund boards, but have the Master Trustee rather than the fund manager responsible for appointing directors.

At a minimum, we should force independent directors of mutual funds to write an explanatory letter to all shareholders for funds that underperform their benchmarks by more than a specific percentage for three successive years. Among other things, the letter should disclose the questions they posed to fund management about the bad performance and the steps taken to improve it. A discussion of excessive management fees, including the kind of questionable soft dollar commission bundling that Robert A. Schwartz and Benn Steil have been writing about, would also be appropriate.

This does not in any way exhaust the list of possible remedies. Retail shareholders have a right to having their interests protected. The SEC should take the lead, with broad bipartisan support from the Congress, in making sure they are. But if the SEC does not do it, I suspect that the only alternative will be to let in the trial lawyers. That surely will be the outcome if the housecleaning, reforming corporate governance of mutual funds, and improving oversight is not done quickly and well.

Roger M. Kubarych is Senior Economic Adviser, HVB Group, and Henry Kaufman Adjunct Fellow, Council on Foreign Relations.