Welcome to the Wild West | Mutual fund regulation update

Exponential growth in investing. The evolution of investment products. Technological advances. The mutual fund industry continues to experience all of these changes. Yet, one aspect of the industry is arguably evolving more quickly than any other: Distribution.

Mutual Fund RegulationAt the West Coast Regional meeting held in Los Angeles earlier this month, Mike Downer, Senior Vice President, Secretary and Chief Legal Officer
, Capital Research and Management Company, addressed the current regulatory environment for mutual funds in light of changes in the way funds are distributed.

Here is a summary of his insights.

The main question to ask about regulation is: Why hasn’t rule-making kept pace with all the changes? There are several reasons. A cost-benefit analysis requirement has to be incorporated when SEC rule-making occurs or the new rule may be vulnerable to challenges. There are many recent examples, including a challenge to the so-called proxy access rule in the DC Circuit a couple of years ago.

The SEC tries to take into account what a rule’s effect may be on market efficiency and capital formation. This is a slow process. For example, the SEC has long been studying derivatives, but keeping up with these instruments is challenging. Dodd-Frank is another example; many of its mandated rules remain unadopted.

The potential impact of a rule on the industry should also be considered. Ongoing legal challenges to the recent CFTC removal of a mutual fund exemption from registering as a commodity pool operator are an example. The uniform fiduciary standard and the money market reform effort are others.

What happens in an environment where the rule-makers can’t make rules and are reluctant to give guidance because the rule is too complicated? A legitimate fear is that the path of least resistance for regulators is to simply regulate by enforcement. This makes life very difficult for industry participants because it heightens unpredictability.

An interesting trend suggests this may become a problem. The SEC has gone after fund directors in two recent cases: Morgan Keegan, which involved security valuation, and another case where the SEC charged directors for disclosure problems. There appears to be an assumption that directors’ jobs should be completely aligned with the SEC’s agenda.

The proposed funding for the SEC is also interesting. President Obama’s proposed 2014 budget includes $1.67 billion for the SEC, a 25% increase over last year. Of that amount, roughly $500 million is allotted to enforcement, $350 million to the Office of Compliance Inspections and Examinations, and $50 million to the Division of Risk, Strategy, and Financial Innovation.

When resources are constrained, scare tactics are often perceived as getting the most bang for the buck. This makes for a very uncertain environment in which to do business.



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