Lipper Research Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN

Tuesday, July 12, 2005

A. Excellent point. We talk a lot about performance and expenses, and fundmergers, and money flows -- but this is also important.

Q. So, what has happened in response to the problems?

A. The good news, as we can document from our database, is that thefrequent trading in mutual funds was turned off very quickly and is nolonger going on. I wish that were also true in variable annuity andvariable life contracts, but some of it continued there.

Q. Have investors started getting some compensation for their losses yet?

A. As we predicted from the beginning, that phase of it has been slow.Lots of consultants and lawyers are involved, and in many cases the fundsneed court or regulatory approval before paying out the restitution. We sawrecently that MFS has made some actual payments, but for most investors thewaiting continues. Fortunately, the average loss per average-sized accountis pretty small.

Q. What are the various reforms that have come about as a result and howare they going?

A. Well, the first thing has been largely voluntary, or a logicalbusiness-practices improvement: many boards of directors are requiringadditional information from fund managers, so they can monitor trading andits effects on portfolio turnover. Once the light got turned on, directorsand their attorneys quickly figured out that they can't go without thisinformation and do their jobs properly.

Q. What reforms have occurred?

A. Well, some have occurred, and some are still in the debating stage. Thebiggest one was the creation of a Chief Compliance Officer (CCO), whichevery advisor must have. They have significant power, and report to theboard rather than to the management company. They are like a high-poweredauditor on 24x7 duty.

Q. How has the CCO's coming affected the industry and the funds?

A. This, we now know, was necessary -- and the only downside is that theexpense of the salary and the support staffing and the added legal bills isa significant burden on smaller funds shops. Some will exit the businessand others will be acquired, meaning some loss of choices for investors.But overall, the bottom line is that investors are better protected frompossible abuses than earlier.

Q. You said some other reforms are still "in the debating stage?"

A. Right. One is implementation of the so-called "hard 4 p.m. close" whichmeans that funds need to set up stringent procedures to be sure no ordersto create or redeem fund shares get filled if they are placed late. Thisseemed like a simple enough item but all sorts of technical objections andpossible exceptions have been raised, so it is still not a new rule inplace yet. That is disappointing, at least to me. How hard can that be?

Q. How about imposing mandatory charges for people who trade funds overshort periods?

A. Mixed results in this area. Some funds companies quickly put in placeredemption fees of 2% or more without waiting to see what might becomerequired. To me, that shows statesmanship and the right attitude. Theoverall rule was almost adopted by the SEC, but then they got soft andended up merely requiring that fund boards formally consider creatingmandatory-redemption charges. There was a lot of flack from some companiesin the industry, and I personally think the response should have been firmand clear. Excepting the very few brands that have always openly welcomedtraders, the case for a blanket rule seemed pretty compelling to me, so Iam sorry it has not been put in place. It's a good protection forlonger-term investors.

Q. And what else is going on?

A. Well, 75% of the board of directors must now be independent of themanagement company. That is in place and is a positive move.

Q. Any more?

A. Yes, and this one is not very good looking to me. The SEC adopted a rulesaying that each fund must have an independent board chair, a person notaffiliated with the management company. That is much stronger than just 75%independent members. The Chair is the one with the top authority, and thatperson can demand certain info on the fund from the advisor. The Chair setsthe agenda for what is discussed. Fidelity and some other big firms in theindustry have opposed this one from day one. The U.S. Chamber of Commerceactually sued the SEC for not properly considering the question and overwhether they even had legal authority to pass such a rule. The Chamber wonits case. So the SEC went back and reconsidered it, shortly before ChairmanDonaldson left office, and passed it again. And the Chamber is back suing asecond time.

Q. In your view, what's the problem there?

A. It just looks very bad, at least to me, to have major business groupsattacking something that does cost the fund companies money but is arguablya net good thing for protecting individual investors. I know there arearguments about how you find enough qualified independent people to bechair, but I think the industry should work on that problem rather than tryto kill the rule.

Q. Any other good or bad news?

A. Yes. We believe that about 20 fund brands whose data indicate theirfunds were probably involved, have not yet even been named. It would bebetter for investors if this information could get out in the open and movetowards being wrapped up. After nearly two years, some of the executivesinvolved may start to think they have slipped under the radar!

Q. Bottom line on the reforms?

A. Slow progress, some net gains, but overall: 'moving at Washingtonspeed.'

#

Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).