United States: Investor Advocate Turns Attention To Mutual Funds' Fee Disclosure

The SEC's Office of the Investor Advocate released a report outlining its objectives for the 2017 fiscal year (which begins Oct. 1, 2016). Rick A. Fleming, the "Advocate," set out an agenda that includes an enhanced focus on mutual fund fees, municipal market reform, public company disclosure and a variety of other topics across the asset management industry.

Formed in 2014, the Office of the Investor Advocate (the "office") acts as a semi-independent body within the SEC. The office has four core functions: providing a voice for investors; assisting retail investors, studying investor behavior and supporting the SEC's Advisory Committee. The office reports annually to Congress on its activities from the preceding year, as well as its upcoming objectives, and its report may subsequently influence both the SEC's and Congress' focus in the months ahead.

Mutual Fund Fees

The Advocate noted that while mutual funds remain popular among retail investors, some investors don't seem to understand the fees charged by funds, the services received by shareholders, or the impact of fees and expenses on the value of their investments. In FY 2017, the Advocate intends to "take a closer look" at mutual fund fees and expenses to identify ways to improve investors' understanding of these costs. The report highlights two recent SEC pronouncements: the Division of Investment Management's January 2016 staff guidance on mutual fund distribution and sub-accounting fees, which encouraged clarity in evaluating and disclosing non-distribution-related service fees; and the April 2016 Investor Advisory Committee's Recommendation on Mutual Fund Cost Disclosure, which highlighted the need for improved focus on "the efficacy of various mutual fund cost disclosures." The Advocate said his office will be actively involved in investor testing, which would evaluate investor perceptions around mutual fund fee and cost disclosures.

Significantly, the report highlighted recent Morningstar research on open-end mutual funds and exchange-traded funds (ETFs), which found that fund fees and expenses weren't necessarily decreasing, despite a decline in average fund costs in 2015. This was because the strong inflows into institutional share classes came through retirement platforms and to ETFs via fee-only advisers, which added another layer of fees and expenses that ultimately create a higher total cost for investors. The Advocate said it was "reason for concern" that mutual fund investors weren't receiving the full benefit of the lower-cost trend, while also recognizing that some investors "derive value from professional financial advice and the advisory services that financial intermediaries provide, particularly where those investors lack the time, expertise or inclination to attempt investing on their own."

The report also drew attention to fees paid to financial intermediaries that provide shareholder and record-keeping services to mutual funds, noting that investors may not be aware of or fully understand the cost of such services, including related management fees, custodial fees, transaction fees and commissions, and the impact of these costs on investment value over time. The Advocate intends to explore ways of improving the disclosure of these expenses in FY 2017.

Municipal Market Reform

The Advocate also pledged to probe the municipal securities market, because these securities continue to be prevalent in individuals' portfolios and are increasingly important to retirement plans. Municipal market reform is one of the office's priorities again in FY 2017, for the third straight year.

Specifically, the office will continue its efforts with the SEC and other self-regulatory organizations ("SROs") to work toward reforms that will benefit investors. In particular, the Advocate expects to focus on potential reforms covering markup disclosure, pre-trade price transparency and specific problematic practices in the municipal securities market, including the timeliness of continuing disclosures, lack of bank loan disclosures and trades below the minimum denomination. The Advocate will continue initiatives focused on best execution and actively participate in ongoing rule-making proposals covering markup or markdown disclosure and pre-trade price transparency, and will monitor SEC and SRO efforts to enhance disclosure and transparency.

Public Company Disclosure

The Advocate also explored the issue of public company disclosure, which he called a "cornerstone of the securities laws and the capital markets." He also raised the question of whether the robust and complex disclosure requirements for public companies are properly calibrated to effectively communicate vital information to investors. The SEC is also examining this issue and the office will represent investors as the process continues. Separately, the report highlighted three main areas of focus for the coming year: investor outreach, structured data and scaled disclosure.

Equity Market Restructure

The Advocate expects to continue monitoring developments in the structure of the U.S. equity markets, which have become dispersed and complex, partially due to the implementation of technologies that reduce manual trading practices. Due to increased technology-based trading, U.S. equity market structures are the subject of review by the SEC's Equity Market Structure Advisory Committee, and the Advocate will continue to monitor this review and proposed changes. The report also discussed efforts to amend Rules 605, 606 and 610 of Regulation NMS, and the Advocate expects to continue to evaluate the effect of any proposed changes in securities offering rules for their impact on individual and institutional investors.

Corporate Governance

Finally, the Advocate will study issues involving shareholder rights and corporate governance in the year ahead. Specifically, he will seek to remove obstacles that inhibit shareholders in voting proxies and will protect shareholder rights in submitting and voting on shareholder proposals. He will also examine proposed changes to exchange listing standards, including whether they would adequately protect the interests of public shareholders, especially when listed companies are required to provide shareholders a say in corporate actions that significantly impact their interests.

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