VIII. Wanted from the SEC: Investor-Oriented Leadership

Congress expressly invited searching scrutiny of fund industry sponsors and managers when it made this policy finding, which was included in this language in the 1940 Act: [T]he national public interest and the interest of investors are adversely affected ... when investment companies are organized, operated, managed ... in the interest of ... investment advisors ... rather than in the interest of ... securityholders ... [or] when investment companies are not subjected to adequate independent scrutiny. (363) The SEC was vested with regulatory power over the fund industry and has used that power extensively. In the words of a former SEC chairman, [n]o issuer of securities is subject to more detailed regulation than a mutual fund. (364) The last five years show there is a difference between detailed regulation and careful, intelligent oversight. In a nutshell, the mutual fund industry has been over-regulated and under-policed. (365) Help in understanding 12b-1 from the SEC's perspective is provided in the form of a Memorandum from Thomas P. Lemke, Chief Counsel for the SEC's Division of Investment Management, to Mary Joan Hoene, (366) Associate Division Director in 1986, reporting on the chief reasons advanced in support of 12b-1, the opponents' position, and the scope of SEC rulemaking power according to commentators: Eighteen persons appeared at the public hearings and over thirty written statements were submitted. The overwhelming majority of presentations were made by persons associated in some way with the mutual fund industry, and they were virtually unanimous in the view that, as a matter of policy, using fund assets to promote distribution could benefit shareholders and should be permitted, at least under some circumstances. Industry commentators made a number of arguments in favor of permitting such expenditures, and these arguments were generally repeated in connection with the subsequent proposal and adoption of Rule 12b-1. They argued that such expenditures would lead to additional sales of shares, thereby increasing the size of a fund's asset base and benefiting shareholders in a variety of ways. Specifically, they argued that increased size (1) could lead to economies of scale because the overall expense ratio of a fund declines as its size increases, (2) may permit a fund to employ a greater variety of portfolio management techniques and strategies and may aid a fund in maintaining a significant degree of portfolio diversification, (3) generally permits a fund to obtain better, and lower cost, portfolio execution services, and (4) attracts useful reports and recommendations about securities transactions from Wall Street professionals. They also argued that if mutual funds were permitted to use fund assets for distribution, instead of traditional front-end sales loads, investors would benefit directly because funds could offer better and more attractive investment products. Without a traditional front-end sales load, a greater proportion of investors' dollars could be invested immediately. In addition, commentators pointed out that the rigidity of the then-existing distribution regulatory scheme imposed an unfair burden on new shareholders because all shareholders benefit from a viable distribution network and that the scheme, in fact, was no longer viable because investors were increasingly unwilling to pay a high entrance fee. The scheme was also said to put funds at a disadvantage with competing investment products because it precluded alternative distribution methods to attract investors' funds they could not reach with the traditional method. Finally, commentators pointed out that the mutual fund industry generally was suffering from net redemptions, and that if this malady were not reversed, the interests of all shareholders would be harmed by, among other things, increasing the overall expense ratios of funds and jeopardizing shareholders' right of net asset redeemability. …