The Cost of Conflicts of Interest

John P. Freeman* & Stewart L. Brown**
The Journal of Corporation Law, University of Iowa | Spring, 2001

* Campbell Professor of Legal and Business Ethics, University of South Carolina. B.B.A., 1967; J.D., 1970, University of Notre Dame; LL.M. 1976, University of Pennsylvania. Member, Ohio and South Carolina Bars.
** Professor of Finance, Florida State University. B.S.B.A., 1970; M.B.A. 1971; Ph.D. 1974, University of Florida; CFA.

Text: 28,783 words

SUMMARY:
… In the early 1970s, America’s mutual fund industry was suffering net redemptions, meaning it was contracting in size. … Wildly different fee structures apply to equity portfolio investment advisory services purchased by public pension funds on the free market compared to the same form of services purchased by investor-owned mutual funds. … ” Other evidence that advisory fee structures are unusually lucrative in the fund industry in comparison with pension advisory business comes in the form of reports that fund advisor buy-outs are more costly than acquisitions of firms that advise pensions. … Regressions of the following form were run on both the pension and mutual fund data: Advisory Fee = a + b (Ln Size), where the advisory fees are scaled in whole basis points, and size is scaled in millions of dollars under management. … This means that equity portfolio size explains only 6% of the variation of mutual fund advisory fees but 27% of pension advisory fee. … ” A fund shareholder who today seeks “clear disclosure” about the advisor’s bill for portfolio management, its advisor’s profitability, or its demonstrated willingness to perform comparable services for significantly lower prices will not find this information…


Citation:
n200 Improving Price Competition, supra note 40, at 79-93 (statement of Matthew P. Fink, President, Investment Company Institute). In fairness, Mr. Fink is not alone in extolling the fund industry’s alleged competitiveness. See, e.g., Alyssa A. Lappen, Funds Follies, Inst. Inv., Oct. 1993, at 39 (“[A] pressing concern [is] quite simply, whether the nation’s banks, as a group, have the financial – or intellectual – wherewithal to succeed in the ferociously competitive mutual fund business.”)….

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By Jerry W. Markham +
North Carolina Banking Institute | April 2000

+ Professor of Law, University of North Carolina at Chapel Hill

LENGTH: 25926 words

SUMMARY: … The current regulatory structure for banking services in the United States is not the result of any grand design or reasoned blueprint. … Another regulatory issue affecting banking was restrictions on branch banking. … Charles G. Dawes, Comptroller of the Currency, was among those who had come to oppose branch banking. … Between 1900 and 1902, several branch banking bills were introduced in Congress. … Opposition to branch banking was at first scattered but was growing after the twentieth century began. The American Bankers Association was a firm opponent of branch banking. … Even then, the trend was to prohibit or tightly restrict branch banking. … He declared a national bank holiday on March 6, 1933, and new legislation was enacted to strengthen the banking system. … Credit “crunches” were occurring in which loan demand was out stripping the amount of funds banks had available to lend. … Another aspect of this regulation would involve protection of customer funds that are on deposit with a retail financial services firm. … The growth of financial service offerings on the Internet will only accentuate the diffusion of those services. …

Citation:
n233. See Penny Lunt, How Are Mutual Funds Changing Banks?, A.B.A. Banking J., June 1, 1993, available in 1993 WL 3004317. In 1993, Concord Holding Corp, which had been created in 1987, was administering and distributing mutual funds for banks. At that time, it was handling over $ 36 billion in assets. There were some 16 similar firms that were operating mutual funds for banks in order to avoid Glass-Steagall prohibitions on banks underwriting activities. See Alyssa A. Lappen, Fund Follies, Institutional Investor, Oct. 1, 1993, available in 1993 WL 12229261. Mellon Bank acquired Dreyfus and became the largest bank manager of mutual funds. It was also the second largest asset manager in the United States. See Spiegel, Gart & Gart, supra note 177, at 300. For descriptions of other bank mutual fund arrangements, see Marcia Parker, Crains New York Business, 1993 WL 2989529 (Apr. 19, 1993); Stan Hinden, Banks Picking Mutual Funds Face Questions on Disclosure of Risks, Washington Post, Mar. 24, 1993, at F3.

First Union bought Lieber & Co. in 1993. It was the manager of $ 2.2 billion dollars of Evergreen Mutual Funds. See Jane Bennett, Banks Using Mutual Funds to Keep Customers, The Jacksonville Business Journal, Dec. 31, 1993, available in 1993 WL 3026956. First Union announced in 1996 that it was seeking to have $ 100 billion in mutual fund asset sales by the year 2000. See Introduction, 1 N.C. Banking Inst. xiii, xix (1997). First Union had earlier announced that it was training 2,600 employees to sell mutual funds including 12 of its own funds by the end of 1994. In the following year, NationsBank added 11 mutual funds to its 28 mutual funds that were already under its management. See Rick Brooks, Banks Rush to Offer Blitz of Mutual Funds, Charlotte Business Journal, July 12, 1993, available in 1993 WL 2988430. Citibank was selling a family of mutual funds, after regulatory changes allowed the banks to use their names in selling such securities. See Julie Creswell, Citibank Fund Group to Get a Change of Name, But Will It Help Returns?, Wall St. J., Feb. 17, 1998, at 8B.

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Issues for Independent Directors of Bank-Related Funds, Variable Insurance Product Funds and Closed-End Funds

By Diane E. Ambler *
The Business Lawyer, American Bar Association | November, 1999
55 Bus. Law. 205

* Ms. Ambler is a partner with Mayer, Brown & Platt in Washington, D.C. C. Dirk Peterson, an associate in the D.C. office of Mayer, Brown & Platt, co-authored the section on bank-related funds. Thomas E. Bisset, counsel in the D.C. office of Mayer, Brown & Plaff, co-authored the section on variable insurance funds. Beth R. Kramer, counsel in the New York office of Mayer, Brown & Platt, co-authored the section on closed-end funds. The authors wish to express their appreciation to Kristin H. Smith, Monica S. Amparo, and Michael G. Palek for their contributions to this Article.

LENGTH: 24502 words

INTRODUCTION
The independent directors who are members of a board of directors (Board) of a registered investment company (or mutual fund) n1 serve a central role, by virtue of their independence from management, in the operation of the mutual fund under the Investment Company Act of 1940 (1940 Act). n2 The Commission has expressed the view that “the disinterested representation of shareholders in the management of investment companies constitutes an important investor protection.” n3 Judicial decisions also have emphasized the investor protection aspect of independent directors’ duties, characterizing independent directors as “independent watchdogs” whose role is “looking after the interests of the fund’s shareholders.” n4 The scope of the role of independent directors has been the focus of recent public attention. n5 The discussion below relates to the role of independent directors of three specific fund types: bank-related funds, variable insurance product funds, and closed-end funds.

A bank-related fund has been defined very generally as “[a] fund that is managed by a bank or sold through bank distribution channels . . . subject to certain restrictions . . . under the banking laws.” ABA SECTION OF BUSINESS LAW, FUND DIRECTOR’S GUIDEBOOK 73 (1996) [hereinafter FUND DIRECTOR’S GUIDEBOOK].

Issue: Do the bank exclusions from the federal securities laws create any unique issues requiring special review or monitoring by the independent directors of the Board of a bank-related fund?

Conclusion: Generally speaking, a bank, or an affiliate of a bank, acting as distributor of or adviser to a mutual fund presents no materially unique issues to the independent directors of the Board. Obviously, the Board must be made aware of the limitations of the federal securities laws in connection with bank-related funds and should be apprised of specific aspects of those limitations as they may affect the mutual fund and its shareholders. Nevertheless, in the absence of contradictory evidence, the Board, and its independent directors, would be justified in relying on the representations of the mutual fund’s distributor and investment adviser as to their compliance with the existing regulatory structure that Congress, in its wisdom, has determined sufficiently protects mutual funds and their shareholders.

BANKS UNDER THE FEDERAL SECURITIES LAWS

The Securities Exchange Act of 1934

National banks, member state-chartered banks and trust companies, and nonmember state chartered banks (but not thrifts or credit unions) rely on the bank exclusion from the definition of “broker” n7 and “dealer” n8 in the Securities Exchange Act of 1934 (Exchange Act), n9 in performing their securities brokerage functions. As excluded banks, they are not subject to registration with or regulation by the Commission or the National Association of Securities Dealers, Inc. (NASD) as a broker or a dealer. n10 An affiliate of an excluded bank that acts as a broker-dealer does not itself fall within the bank exclusion and is subject to Exchange Act and NASD regulation.
….
Citation:

n111 Some 80% of domestic closed-end equity funds and 86% of foreign equity funds trade at discounts to their net asset values, far more than the half of all closed-end funds that historically traded below net asset value. These discounts can be wide, currently averaging about 15% and running as high as 35%. See Periodic Repurchases by Closed-End Management Investment Companies Redemptions by Open-End Management Investment Companies and Registered Separate Accounts at Periodic Intervals or with Extend Payment, Investment Company Act Release No. 18,869, [1992 Transfer Binder] Fed. Sec. L. Rep. (CCH) P85,022, at 83,160 n.10 (July 28, 1992) [hereinafter Release No. 18,869]; Alyssa A. Lappen, Why Closed-End Funds Will Survive, INSTITUTIONAL INVESTOR, Oct. 1998, at 220; see also PROTECTING INVESTORS, supra note 3, at 432-36; Eric Balchunas, CDA/Weisenberger to Provide Daily NAVs for Closed-End Funds, FUND ACTION, Aug. 4, 1997, at 1 (stating that the average closed-end fund has been trading at a 13% discount over the past two years); Paul J. Lim, Thinking Foreign? Closed-End May Be the Ticket, L.A. TIMES, Nov. 3, 1998, at C6 (stating that the typical closed-end emerging markets stock fund is trading at a 16.1% discount to net asset value).

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By Paul D. Cohen*
Stanford Journal of Law, Business and Finance | Winter, 1999

LENGTH: 19386 words

* Duke University, B.A., 1992; Washington University School of Law, J.D., 1996; Washington University John M. Olin School of Business, M.B.A., 1997. I would like to express my appreciation to Professor John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia University School of Law, for his insights and suggestions; to Ms. Ann D. Wallace, Special Associate Director, Division of Corporation Finance, U.S. Securities and Exchange Commission, for her advice and inspiration; to Kevin Coenen, Kirkland & Ellis; and to Scott J. Golde, Greensfelder, Hempker & Gale, for their comments.

SUMMARY:
… Moreover, new economic approaches to investing have led to modernized trading strategies. … All types of investors have access to an Internet-based bulletin board to trade securities. … One crossing system promises to provide investors access to a database of offers to buy and sell as well as the ability to communicate with other investors. … These markets will enhance an investor’s ability to trade securities in short periods of extreme trading. … Implementing the tiered approach to regulation of Internet-based trading systems would require the SEC to use an expanded application of the “limited volume” exception for exchange registration. … The proposed rules would permit Internet-based trading systems to choose between regulation as a national securities exchange and regulation as a broker-dealer with additional requirements depending on their activities and level of trading volume. … For those exchange-listed and NASDAQ securities in which a system has five percent or more of the trading volume, Regulation ATS requires Internet-based trading systems registered as broker-dealers to publicly disseminate through a registered exchange or the NASD their best priced orders, including institutional orders. … The regulations also prohibit unfair discrimination by an Internet-based trading system that has twenty percent or more of trading volume. …

Citations:
n10 David P. Brown, Why Do We Need Stockbrokers? 52 FIN. ANALYSTS J. 21 (1996). The Designated Order Turnaround (DOT), technologically updated with the SuperDOT system, permits exchange members to forward orders of up to 100,000 shares to the trading floor electronically. Nyquist, supra note 2, at 298, 318. Other markets also offer automatic routing systems. Id. at n. 86. Money managers often use electronic networks such as SuperDOT, which charge 2.5 cents per share, because of the price advantages they offer. By using these systems, money managers also reduce or avoid market impact. Use of SuperDOT accounts for 80% of the orders placed on the NYSE and more than half of the NYSE’s annual share volume that measures 74.4 billion shares. Alyssa A. Lappen, The Cost of Inefficiency, MONEY MANAGEMENT, [Institutional Investor] Mar. 1995, at 65. For further discussion of these systems, see LOUIS LOSS & JOEL SELIGMAN, 5 SECURITIES REGULATION 2556, 2557-58 (1990).

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Printing is allowed for personal use only | Commercial usage (For Profit) is a copyright violation and written permission must be granted first.