SEC Approves New Rules for Mutual Funds : Disclosure to Be Required on Performance, Fees

The Securities and Exchange Commission on Thursday approved two rules that are likely to make it far easier for investors to evaluate mutual fund fees and performance.

In a long-awaited decision, the agency approved strict guidelines that will require advertisements for income and equity funds--if they choose to display performance figures at all--to disclose at least their annualized total returns over the most recent one-, five- and 10-year periods.

Income funds, which invest in bonds and other fixed-income securities, also will be required to advertise a uniform annualized yield over the past 30 days as well as the total return numbers.

Money market funds were excluded from that ruling because they already have a standardized rule requiring disclosure of seven-day yields.

The SEC also voted to require mutual funds to identify all “loads,” or sales charges, and management expenses and other fees in a standardized table located prominently in the prospectus. The rule also requires funds to demonstrate in the table how these expenses can affect a hypothetical investment over time.

The new rules, which go into effect May 1, were immediately praised by investment advisers but received a lukewarm endorsement from the industry’s chief trade group.

‘Difficult to Compare’

The rules address one of the most controversial--and longest simmering--topics affecting mutual fund investors. Investment advisers and investors have long complained that many mutual funds have advertised performance over only those time periods that showed them in the best light, giving investors a misleading view of funds’ track record and making it harder to compare performances of different funds on a standardized basis.

“There were a variety of ways used to calculate performance and yields and this made it extremely difficult for investors to compare one fund to another,” said Kathryn McGrath, head of the SEC’s investment management division, which oversees mutual funds.

Critics also have complained that some income funds failed to disclose total return numbers, instead sticking just to yields. Yields, which show only how much the fund earns from interest income from bonds, always are positive and generally don’t fluctuate substantially.

Total return, which shows yield as well as how much bonds gain or lose in value due to rising or falling interest rates, are a much more realistic measure of what an investor earns in the fund. But because they also show much more volatility, particularly for funds holding bonds with longer maturities, some funds may not advertise them.

Critics also have attacked many funds for obscuring their myriad sales charges and other fees in mumbo-jumbo language, often buried deep within a prospectus.

The advertising rules adopted Thursday were the result of considerable comment and input from mutual fund industry officials and others between September and December of 1986, following release by the SEC staff of preliminary proposals that the industry considered more burdensome.

Some SEC commissioners still objected to certain aspects of the rules.

Two of the five SEC commissioners, Joseph Grundfest and Charles Cox, said total return figures could mislead investors. That is because in a period of declining interest rates--which was largely the case between 1982 and early 1986--total returns were unusually high because those falling rates boosted bond prices. Some less sophisticated investors might erroneously expect to get comparable returns in the future, Grundfest argued.

Some investment advisers, however, said the new rules could make funds more honest about their fees and performance records.

“This will help investors a lot,” said Kurt Brouwer, president of Brouwer & Janachowski, a San Francisco investment advisory firm that helps clients select funds. “It will put a spotlight on fees. When they’re hidden, it’s much harder to get a handle on them.” But under the new rule, “if they have a high 12b-1 fee, it’ll jump out and grab investors.”

(A 12b-1 fee is a type of annual charge that goes to pay for marketing and advertising expenses.)

Brouwer suggested that forcing funds to display fees more prominently may prompt some to reduce those fees as is already happening with some funds in the wake of investor resistance stemming from the stock market crash. “They will be worried about a backlash from investors,” he said.

Brouwer also noted that requiring funds to standardize their advertising of yields and total returns will make them more cautious about how they advertise. Since the crash, he noted, some funds have stopped advertising their performance because it has been so disappointing, focusing instead on safety and convenience issues.

Industry View

However, Brouwer said, other measures are still needed to protect investors. He suggested that the SEC adopt rules governing what brokers must disclose to clients about loads on funds--an area fraught with misinformation and inadequate disclosure, he contended.

Some fund industry officials agreed that the new rules will help investors.

“There are some things we are pleased about but others less so,” said Sarah O’Neil, associate general counsel for the Investment Company Institute, a Washington-based trade group for the mutual fund industry. As an example of what the group was pleased with, she noted that the SEC’s formula for calculating 30-day yields on income funds appeared to be virtually identical to a formula proposed by the institute. She said the industry generally agreed that more standardization of yield information was needed.

O’Neil added, however, that the industry was not entirely pleased with the proposal on including total returns in advertising, saying, among other things, that it was not necessary to include equity funds under the rules since there have never been widespread complaints about misleading practices among them.

“However, it’s better than what was initially proposed,” she said of the rules, noting that the SEC originally proposed disclosure of several other total return numbers that were left off the final plan adopted Thursday.