The Financial Services Roundtable
1001 PENNSYLVANIA AVENUE, NW
RICHARD M. WHITING
February 23, 2004
Mr. Jonathan G. Katz
Re: SEC Concept Release on Measures to Improve Disclosure of Mutual Fund Transaction Costs; File No. S7-29-03
The Financial Services Roundtable (the "Roundtable") represents 100 of the largest integrated financial services companies providing banking, insurance, and investment products and services to the American consumer. Roundtable member companies provide fuel for America's economic engine accounting directly for $18.3 trillion in managed assets, $678 billion in revenue, and 2.1 million jobs. The Roundtable appreciates the opportunity to comment on the concept release issued by the Securities and Exchange Commission ("SEC") on the subject of measuring and improving disclosure of mutual fund transaction costs.
The SEC's concept release requests comments on whether mutual funds should be required to quantify and disclose to investors the amount of transaction costs they incur, include transaction costs in their expense ratios and fee tables, or provide additional quantitative or narrative disclosure about their costs. The SEC is also seeking comment on various accounting issues and whether or not mutual funds should be required to record transaction costs as an expense on their financial statements.
The member companies of the Roundtable support improvements to the disclosure that mutual funds provide to their shareholders. We believe that disclosure by funds should be periodic, timely, robust, efficient, uniform and easy to administer. Mutual funds have an obligation to provide investors with useful information about costs associated with transactions. However, we believe that these disclosures should be limited to those costs that are easily quantifiable and that present valuable information to the investor.
The SEC's concept release asks specific questions in four broad areas on mutual fund transaction costs; (1) alternatives to quantifying transactions costs, (2) accounting issues, (3) alternatives that provide additional information about the level of transaction costs, and (4) review of transaction costs by fund directors. The Roundtable would like to offer the following recommendations in these areas.
1. Disclosure of transaction costs should be limited to those costs that are easily quantifiable
Transaction costs are those costs associated with a mutual fund trading portfolio securities. These costs include commissions, spread costs, market impact costs, and opportunity costs. The SEC is seeking comment on whether to require disclosure of commissions only or whether to require disclose of the other types of transaction costs. The SEC is also looking for input on how these costs should be measured, in particular whether or not the disclosure should be included in fund expense ratios and fee tables.
The member companies of the Roundtable believe that disclosure of transactions costs should be limited to commissions, presumably expressed as a total dollar impact to the fund. Commissions are easily measured and can be disclosed in a fashion that is easy for the investor to comprehend. Commissions already appear on the confirmation of each transaction and funds report aggregate dollar amounts of commissions paid in their Statement of Additional Information ("SAI"). We believe that although commissions should not be detailed separately in the fee table, to the extent they are measurable, commissions might appropriately be reflected in the expense ratio.
We do not believe that it is practical to require disclosure of other costs. Capturing spread costs, market costs and opportunity costs would be extremely difficult. These costs are hard to measure in dollars and cents, and any attempt to do so would be costly and inconsistent. There is not one universal formula for analyzing this data which would be comparable among all different types of funds. The different methodologies vary among consultants and scholars. There are also no vendors or systems in place to handle such a complex task. Measuring these costs would require additional operational systems that will come at a great expense to the mutual fund industry and the investor. The average investor would not benefit from the disclosure of these costs because they would either be unable to fully understand the data or it would be unreliable.
2. Transaction costs should not be reflected as an expense in fund financial statements
The SEC has requested comments on whether to account for some or all transaction costs as an expense in fund financial statements. Although transaction costs are taken into account in computing a fund's total return, they are not included in a fund's expense ratio because under generally accepted accounting principles they are either included as part of the cost basis of securities purchased or subtracted from the net proceeds of securities sold and ultimately are reflected as changes in the realized and unrealized gain or loss on portfolio securities in the fund's financial statements.
In general, the member companies of the Roundtable believe that the accounting of transaction costs should be determined by whether or not the various costs are reflected in the expense ratio. To the extent that transaction costs are measurable and are reflected in the expense ratio, they could be accounted for in the financial statements.
However, the Roundtable believes that since most portfolio transaction costs, such as market impact and opportunity costs, are not easily quantified, it would be inappropriate to reflect these costs as a fund expense for financial reporting purposes. Also, even though commissions are generally quantifiable, a portion of the commission may be used to purchase research services or to pay fund operating expenses under directed brokerage arrangements. It would be difficult to separate these costs and reflect them in the fund's expense ratio and fee table. Therefore, although we support the additional disclosure of transactional costs in some form, we oppose reflecting these costs in a fund's financial statement.
3. The Roundtable supports providing additional disclosure information, including providing narrative explanations, for commissions, average commission rate per share and portfolio turnover rates
The concept release requests comments on alternatives that provide information about the level of transaction costs, including categorizing a fund's transaction costs under general guidelines the agency would establish; improving narrative disclosure of portfolio turnover; disclosing average daily net flows; disclosing average commission rate per share; and disclosing the effect of all costs combined on gross portfolio return.
Most funds provide investors with information about portfolio turnover rate and dollar amount of brokerage commissions. The Roundtable's member companies agree that commissions, average commission rate per share and turnover information are useful types of disclosure. However, we believe that this information should be put in context for the investor, such as providing a narrative explanation of the costs associated with portfolio transactions. For example, it is unclear if an average investor would know that 300% turnover is high or that low turnover is not necessarily a positive indicator. This information would need some context. Since most managers can estimate turnover, historical and anticipated turnover would be useful information to report. It also may be helpful to include a narrative explanation of the fund's portfolio turnover rate if it is a "material factor affecting the fund's performance" (the Form N-1A, Item 5A standard, which would include discussion of the effects (including cost) of high turnover on the fund's portfolio).
We believe another approach to disclosing information about the level of transactions costs would be to utilize the similar approach to disclosure to investors of fund expenses in dollars for a hypothetical $1,000 investment. This approach would allow investors to make comparisons and would be less costly to prepare than disclosing actual costs associated with the transactions. It would also make it easier for investors to compare costs of funds in which they have different amounts invested.
The Roundtable is opposed to the disclosure of average daily net flows. This information would provide no value to shareholders because it would be received on a significant time lag. We also oppose disclosing the effect of all costs on gross portfolio return because it would create a cost burden for the fund with little benefit to the investor. And, it is unclear how investors would use this information.
Finally, we disagree with the system suggested in the concept release in which the level of transaction costs would be placed in rated categories such as "very high, high, average, low or very low." As previously stated, it would be difficult to quantify some of the transaction costs individually, such as spread, market impact and opportunity costs. Attempting to combine these costs into these categories would be costly and burdensome. Additionally, the results from fund to fund would be inconsistent and confusing to investors.
4. Fund directors should be given complete and accurate information about transaction costs so they can fulfill their fiduciary duty to the fund
The concept release requests information about whether existing requirements for board review of transaction costs can be improved; whether directors and investors should be provided periodic summaries of soft dollar and directed brokerage payments; and whether advisers should provide directors with an internal allocation of brokerage commissions used to obtain soft dollar benefits, detailing the types and amounts of various kinds of benefits.
The Roundtable agrees that directors should be given soft dollar and directed brokerage payment information. We believe that a majority of this information is already provided to mutual fund boards and do not feel additional requirements are necessary. Under the current system, the investment manager provides transaction cost information to the board periodically and as requested. Fund directors are charged with reviewing this information keeping in mind they have a fiduciary obligation to the fund.
The Roundtable supports providing accurate information about transaction costs to fund directors so that they can fulfill their fiduciary duty. Disclosure to fund directors should include soft dollar expenses and directed brokerage payments. Fund directors should also be encouraged to review fund turnover rates and inquire whether these rates provide beneficial results for shareholders.
We believe that all information presented to the fund directors should be quantifiable and structured in a way that it measures the fund's performance against funds of similar size and objective. The Roundtable supports providing more periodic disclosure of information such as brokerage commissions and portfolio turnover ratios that may be included in semi-annual and annual shareholder reports.
The member companies of the Roundtable appreciate the SEC's efforts to improve disclosure of mutual fund transaction costs. The Roundtable supports transparency of mutual funds and providing investors the information necessary to make an educated investment decision. However, we believe that it would be costly and burdensome, in addition to providing little benefit to the investor, to disclose costs that are not easily quantifiable, such as spread, market impact and opportunity costs. Unless the industry can unanimously agree on a standard form of measurement of these costs, there will be inconsistency and confusion. And, if these costs cannot be adequately measured individually, they should not be measured as part of an analysis of the total level of costs associated with a fund.
If you have any further questions or comments on this matter, please do not hesitate to contact me or John Beccia at (202) 289-4322.
Richard M. Whiting