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Roye Calls on Mutual Fund Industry to Embrace Reform

The mutual fund industry is currently engaged in a process of cleansing, reassessment and restoration of confidence, according to Paul Roye, the director of the SEC's Division of Investment Management. He said that the recent scandals revealed a need to reform the industry and to reorient its focus on integrity and investment stewardship. In remarks at the Investment Company Institute's May 20 general membership meeting, Roye noted that the industry is being watched as never before. As an industry, this is a defining moment, Roye said, and the industry will be judged by its actions.

Roye reported that the SEC and state regulators have taken actions against nearly half of the 25 largest mutual fund companies in the past year. He added that despite that statistic, investors have continued to invest in funds. Roye cautioned the industry not to mistake those continuing inflows as investor confidence. He said that investors may forgive short-term poor performance, but not double standards, dishonesty or unethical behavior. Investors pulled significant assets from funds that were managed by scandal-tainted firms, Roye explained, while untainted firms received increasing assets.

Roye advised that some within the industry continue to avoid reform measures. Some have complained about the lack of guidance with respect to the obligation to fair value fund securities, he said, so the SEC sought comment on the form of guidance it could provide. It received little response, he said, which raises the question of whether the complaints were an excuse to avoid responsibility for applying effective fair valuation policies, in Roye's view.

Roye mentioned that fund managers also complained about their lack of ability to "look through" omnibus accounts to identify harmful market timers and to apply redemption fees to those transactions. The SEC issued a rule proposal in response, Roye advised, and received some "truly astounding" comment letters in opposition to the requirement that intermediaries provide fund managers with fund information. Roye said it left him wondering whether fund managers are unwilling to accept the responsibility of using this data to protect fund investors from market timers. These types of positions raise the question of whether the industry is merely paying lip service to what is in the best interests of fund investors, he said. Investor protection is not a competitive issue, Roye said, and should not be approached from a perspective of competition among firms.

Roye also addressed the SEC's controversial proposal to require independent fund chairmen. He acknowledged that there are interested fund chairmen who represent the best interests of fund investors while also serving as executives of the fund's advisers. The focus of the proposal, however, is on what is best for fund investors overall. The Mutual Fund Directors Forum has concluded that the independent chairman requirement is a best practice, according to Roye. He questioned whether fund boards would suffer if an interested chairman gives up his or her title while continuing to serve as a member of the board.

Roye said that ICI is also at a crossroads with its president retiring and new leadership coming on board. He asked what role ICI will play in the future --whether it will be limited to the narrow self-interest of its management companies or whether it will champion the long-term interests of fund investors. The SEC wants to work with ICI to prevent further scandals, Roye said. Winning back the trust of mutual fund investors will require a commitment to compliance, ethics and reform, in his view. He urged the industry to take action to restore its credibility.