Would Paying Separate Fund Fees Improve Awareness?

REKENTHALER REPORT: Making fund fees more transparent and standing up for fund investor rights

John Rekenthaler 3 June, 2013 | 8:20AM

By the Book

For $5,876, you can take a 10-week course at the University of Chicago Booth School of Business that will teach how consumers make rational economic decisions. If you charge the same price for an item, but vary the terms--for example, change from an up-front payment to 24 monthly instalments with the interest costs built in--you won't fool the public, which will understand that the economic cost remains unchanged even if the details are different. Or you can live in this world and see just how wrong that precept can be.

At a recent round table of law professors and lawyers who specialise in mutual fund issues, one attendee proposed that mutual funds no longer be permitted to collect their expenses by taking money out of a fund, but instead should send shareholders an annual bill that they would need to pay directly (via cheque, credit card, and so on). This would increase investor awareness of fees, he said. The proposal was nixed by other attendees because then "nobody would buy mutual funds."

This makes no sense whatsoever, per the Booth School. And it's correct.

Sue Me

Another discussion topic at the round table was the 2011 Supreme Court decision Janus Capital Group Inc. vs. First Derivative Traders, which ruled that Janus was not liable for misleading statements made in a prospectus of one of its funds. The court stated that the fund itself rather than the fund company issued the prospectus, so therefore only the fund could be sued. The fund company was immune. The court's analogy was that a speaker (the fund itself) is responsible for what is said, not a speechwriter (the fund company).

This never made sense to me. First, from a practical perspective, restricting shareholders to suing the fund means that shareholders have no real legal recourse for a fraudulent prospectus. In suing the fund they sue themselves; there's no money to be recouped from that action. Second, the analogy is clearly wrong. Speechwriters work for speakers, but fund companies don't work for funds. That holds particularly true with prospectuses, which are technical documents written by employees who work at the fund company. The board does not create prospectuses, any more than it runs the investment operations.

Somewhat to my surprise (I don't expect my gut reaction to a Supreme Court ruling to be correct), the group unanimously shared my viewpoint, and the subject was dispensed with quickly, accompanied by wry smiles.

Read previous editions of the Rekenthaler Report here.

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About Author John Rekenthaler

John Rekenthaler  John Rekenthaler is vice president of research for Morningstar.