Mutual Troubles

By buying mutual funds, 3,500,000 Americans have spread their investments over scores of stocks--and the average customer has seen his initial stake grow more than 100% in the past decade. Last week, after eight years of probing and parrying, the Securities and Exchange Commission declared that the funds charge too much for too little. While concluding that the funds are "a sound and useful investment medium," the SEC advocated tough new laws to control them. In doing so, Chairman Manuel F. Cohen's activist commission bid to expand its own power, and set off what will surely be a bruising battle in Congress over an industry whose assets top $33 billion.

"Unwarranted." The most important and explosive recommendation in the 346-page report was that the funds' sales charges to customers be knocked down by act of Congress from an "excessive" average of 9.3% to 5%. Commissions on a $4,000 order of mutual funds, for example, now run about nine times as high as on a $4,000 round-lot order of common stock; the SEC found this gap "unwarranted." As one way to narrow it, the SEC suggested that the funds bring down the fees paid to the management companies that advise and usually control them. Such fees generally run to .5% of the funds' assets, far more than the .04% to .18% paid to advisers of bank investment funds and the .06% to .07% that goes to managers of pension plans. These charges take up to 40% of the fund shareholders' dividend income, multiply into enormous profit margins for the fund-management companies (see box) and huge salaries and bonuses for their bosses. Last year, for example, the Massachusetts Investors Trust group paid $621,922 to its chief executive, Kenneth L. Isaacs, and well over $450,000 to each of three other executives.

Recommending a move that would come close to Government control of salaries, the SEC urged that Congress amend the Investment Company Act of 1940 so as to limit payments to fund managers to "reasonable" levels. Then, if the SEC or individual fund shareholders deemed the pay unreasonable, they could bring suit in the courts. There the controversy would be decided by such factors as the nature of the services that the managers provided and the fees paid to bank trust-fund managers and other comparable executives.

"Give-Ups" Plus "Churning." Beyond that, the SEC wants to reduce commissions by forcing stock exchanges to reduce the brokerage fees on large transactions--that is, to give the funds "volume discounts." One complication is that the funds often use brokerage fees as rewards for brokers who supply investment research or push sales of the fund shares. Fund managers frequently tell brokers handling big block trades to distribute up to 60% of their fees to other brokers. The SEC argued that such "give-ups" create pressures for "churning"--meaning that fee-splitting can lead to trading simply to generate brokerage commissions for the friends of funds. Thus the SEC wants to do away with almost all "give-ups."

The SEC would also end all future sales of the costliest kind of funds, the so-called "front-end loads," in which more than 1,000,000 investors have signed up to buy in small installments over a period of years but pay most of their commissions in the first year. Usually 50% of the first year's payment goes to commissions, and buyers are almost certain to suffer losses if they pull out of the plan before the end of the fifth year, as one-sixth of them do. The SEC ban, if adopted, would deal a hard blow to many management companies--including Waddell & Reed, Dreyfus Corp. and Hamilton Management--that offer front-end loads as well as other fund plans.

The SEC charged that funds that invest primarily in other funds are "particularly expensive" and "of doubtful utility." It wants to curtail them, notably Bernard Cornfeld's Swiss-based Fund of Funds.

Confrontation Coming. The investment community has united for a hard lobbying fight. Cornelius Roach, chairman of an association of 19 front-end-load underwriters, damned the SEC for "unwarranted assumptions and improperly drawn conclusions." Many Wall Streeters forecast "the biggest confrontation between the industry and the SEC since the 1934 Investment Act." Fund managers most feared that slashing commissions to 5% would kill many sales because brokers would have much less incentive to push the funds; at the current 9.3% rate, a persuasive fund salesman often earns $25,000 a year. Said one fund officer: "If the 5% ceiling goes through, it will put some guys out of business--but the SEC certainly won't get that through Congress."

Perhaps not, but the SEC will get plenty. Before the debate moves to Capitol Hill early next year, the SEC will let the funds and shareholder groups get in their licks at hearings. The SEC may well have gone a bit too far toward extending the Government's grip, but Congress is likely to conclude that many of the recommendations make sense in a business whose managers, brokers and salesmen have profited even more than the people they serve.

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