While the wave of enforcement referrals and deficiency letters from the Securities and Exchange Commission seem to have begun to slow down, the industry may have to get ready for yet another battle, this time over 12b-1 fees.
When the SEC last year invited comments on whether the use of 12b-1 fees, which has meant so much to the growth of the industry, should now be brought to an end, it got 1,650 letters, most of them defending the status quo. Over and over, the subject will get an airing this year. The Mutual Fund Directors Forum has a 12b-1 project in the works. So does the Independent Directors Forum. Perhaps most importantly, an NASD Task Force on Mutual Funds is going to make 12b-1 its big project for 2005. That panel's report, when it comes, could set the stage for an SEC decision, assuming that William Donaldson remains chairman.
Since congressional interest in the fund scandals waned, Donaldson has called the shots on what to do about the biggest breakdown in mutual fund regulation since the 1930s. Toward the end of 2004, a wave of rumors that he might be forced out was followed by a second outcropping of speculation that he would stay but cease doing controversial things for fear of provoking those who might have the power to oust him. Donaldson says he will stay for so long as he thinks "we are making a difference."
Whether Donaldson stays or goes, the betting lately has been that Paul Roye, the top mutual fund regulator under the chairman, will be leaving early this year for lucrative private law practice. As 2004 ended, Roye, the director of the agency's Division of Investment Management, punctuated a long run of criticizing the scandals with a bouquet for fund firms, saying "I believe that the mutual fund industry has shown a desire to 'clean house.'"
Perhaps the chairman's legacy will endure no matter what. "Under any scenario," says David Tittsworth, executive director of the Investment Counsel Association of America, "what's been put in motion is revolutionary. I don't think you will see it rolled back."
Playing Catchup
Even if Donaldson departs and there are only a meager number of new regulatory initiatives it will be quite a while before fund compliance officers and agency officials lack for something to do. "It will require an enormous amount of consolidation," said Robert Zutz, partner in Kirkpatrick & Lockhart. "The ripple effect will go deep into 2005." As new disclosure requirements kick in regarding market timing or selective disclosure of portfolio holdings or factors considered in renewing advisor contracts, the SEC staff will review every single prospectus update from every fund company. The Compliance Rule is seen as perhaps the biggest challenge. "It is a changing, evolving thing," Zutz said.
For mutual funds, regulatory refinements at the SEC may not be the only focus of Washington interest in 2005. Right now, while the limits of Republican power in the new 109th Congress have not yet been tested, is when President Bush's second term agenda on taxes should have its best chance. Almost every presidential election has been followed by a big tax bill early in the succeeding year. While the president's supporters would like to make many changes in the tax system, big budget deficits may limit the White House to a relatively few top priorities. High on his list is changing the sunsets on the dividend and capital gains tax cuts he persuaded Congress to pass. Given the more GOP makeup of the Senate this year, action on the sunsets threatening the 401(k) and Section 529 tax incentives passed during his first term is also possible. If the president is willing to settle for just three-year extensions of the sunsetted items, Senate rules will allow measures for that purpose to be passed as part of the annual budget resolution with just a 51-49 margin rather than the 60-40 margin necessary to block a Senate filibuster.
As far as the industry is concerned, any good news out of the capital will be a change from 2004. Looking back late in that year, Stephen Roth, partner at Sutherland Asbill & Brennan, summed up the previous 12 months as "an unprecedented year--absolutely mind-boggling."
Not all the action at the SEC was regulatory. SEC enforcers also produced headlines. Donaldson came into the office with a reputation for believing vigorous enforcement was a good way to keep markets honest. Measured either by numbers of cases or dollars, the enforcement agenda in 2004 was "extraordinarily full," said Richard Marshall, partner in Kirkpatrick & Lockhart, with a progressively widening range of targets as the year went on. By August, Stephen Cutler, director of the Enforcement Division, was signaling that "gatekeepers"--accountants, lawyers and independent fund directors--were potentially in the cross hairs along with executives.
Stormy 2004 has left behind all kinds of loose ends. Chairman Donaldson has instituted an Office of Risk Assessment, intent on spotting the next mutual fund compliance breakdown before it happens. There are also several SEC fund-related task forces whose significance should be determined this year--on such broad topics as investment advisors, self-reporting by fund groups and the search for a way to write fund disclosure documents so that unsophisticated investors will be more willing to look at them. Other questions include:
* What impact will there be from the Mutual Fund Directors Forum's pursuit of a "best practice" standard for fund directors holding multiple board seats (in other areas "best practices" have sometimes evolved into regulatory requirements)?
* How can the SEC satisfy congressional interest in having 529 plans do better by investors?
* What will happen to a lawsuit filed against the Commission to block the independent chair rule?