LETTERS ON CURRENT ISSUES
[Text only of letters sent from the Commerce Committee Democratic Staff.]

October 20, 1998

The Honorable James F. Hinchman
Acting Comptroller General
General Accounting Office
441 G Street, N.W.
Washington, D.C. 20548

Dear Mr. Hinchman:

This is with further reference to my letter of September 29, 1998, asking the General Accounting Office (GAO) to take a comprehensive look at mutual fund fees and report back to Congress with your findings and recommendations.

At a staff briefing last week, GAO agreed to do this work. As promised, within the broad outline laid out by GAO staff, I am submitting the following questions to clarify the issues to be covered:

Background Information Relating to Statistics and Methodology

1. The total costs of fund investing vary depending upon the "distribution channel" chosen by an investor. Please describe these different distribution channels, the varying services they provide, and the reasons(s), cost and otherwise, investors choose one channel over another.

2. Please estimate the annual sales levels and market share of mutual funds attributable to the following distribution channels: (1) with the advice of a financial intermediary (e.g., broker, financial planner, bank representative); (2) directly from a fund or otherwise without advice (e.g., through a discount broker); and (3) through defined contribution retirement plans.

3. Please identify all applicable expenses and explain how fees are set. Please describe the relationship between the structure of a mutual fund and the various fees that are charged. What portion of mutual fund fees is used to compensate financial intermediaries (e.g., brokers) and what portion compensates the fund management company and how is this determined?

4. What is the best way to measure trends in equity mutual fund fees given the following factors: (1) the shift from front-end loads that are not included in expense ratios to asset-based (12b-1) fees that are included in a fund’s expense ratio; (2) enhancements in services provided to investors; (3) the entry of new mutual funds into the business; and (4) changes in investor preferences (e.g., increasing proportion of sales in international funds, and decreasing proportion of sales in certain domestic stock funds)? Are there other factors that complicate the ability to accurately assess the overall trend in the total costs of mutual fund investing? On balance, does the available evidence reveal a trend over the last five, ten, or fifteen years?

Competition/Economies of Scale

5. Does the mutual fund industry exhibit characteristics of a competitive industry?

6. With respect to equity mutual funds, does competition on the basis of fund investment performance provide competitive pressure to restrain fees?

7. What role do (and should) the independent directors who sit on every fund’s board play in keeping costs down? [See, e.g., "Fund Fees Are Rising. Who’s To Blame?" Business Week, October 26, 1998, at p. 162.]

8. Do existing professional or academic studies establish a correlation between strong performing and/or highly rated equity mutual funds and sales of equity mutual funds? To what extent do popular ranking and rating systems take into account the costs of mutual fund investments?

9. The industry contends that the notion that substantial economies of scale should be realized simply because the industry has grown very rapidly is simplistic and flawed. Under what conditions are meaningful economies of scale usually realized? For funds that do experience economies of scale, are savings realized across the board in all aspects of a fund’s operations or in only some areas of operations? Do the cost savings associated with economies of scale go on as long as the fund continues to grow, or do they begin to diminish at some point?

10. Economies of scale are one source of downward pressure on fund fee levels. Are there other sources of downward pressure? Please determine whether there are also sources of upward pressure on fee levels. If so, please describe the sources and extent of this pressure.

Regulation/Practice

11. Please describe all of the relevant laws, rules, and regulations governing mutual fund costs and their disclosure.

12. How does the disclosure regarding fees that is required by law for mutual funds compare to the requirements that apply to similar financial products? How does the level of mutual fund fees compare with the fee level of these other products?

13. The mutual fund industry contends that in the growing 401(k) market, it is required to provide more disclosure about its fees and costs than its competitors. In its 1992 study of the Investment Company Act, the staff of the Securities and Exchange Commission acknowledged the uneven nature of fee disclosure to 401(k) participants, and advanced proposals to improve the information provided to participants. Please evaluate whether (1) mutual funds are in fact providing better disclosure about fees and costs than other 401(k) providers; (2) whether individual 401(k) plan participants are receiving adequate and useful information about the costs of their investment options; and (3) whether there are any steps that should be taken to improve participant receipt of information as to fees and costs.

14. Please evaluate overall prospectus disclosure and sales practices regarding disclosure of costs and their effect on returns.

15. Please evaluate the mutual fund fee table that is required at the front of the prospectus. Does the fee table present information about the cost of fund investing in a user friendly way? Does the fee table make it possible for investors to make meaningful comparisons among the funds they may be considering? Does the fee table enable investors to develop a reasonable understanding of the impact that fees can have on their investment over the short and long term?

16. Fund Profiles are a new SEC directed initiative designed to address the concern that investors may not be reading the full length disclosure documents that are provided to them, even when those documents are prepared in plain English. Please assess whether Fund Profiles will enhance the ability of mutual fund investors to understand the total costs of mutual fund investing.

17. To the extent that this can be determined, do investors want to know each individual component of mutual fund costs, or do they find the overall cost to be more useful information?

I understand that GAO is proceeding with a design phase to determine the availability of data, the extent of cooperation you might receive, and specific issues to be addressed. GAO staff will meet with Committee staff in January 1999 to set forth the study objectives and a completion date for the design phase.

Thank you for your cooperation and attention to this request.

 Sincerely,

JOHN D. DINGELL
RANKING MEMBER

cc: The Honorable Tom Bliley
The Honorable Michael Oxley
The Honorable Thomas J. Manton

Back to the Public Record Home Page