Taking the Risk Out of Mutual Fund Compliance
March 24, 2008
Today, the majority of financial services firms are involved in selling mutual funds, yet very few give any thought to the validity of their data or the technology that is responsible for aiding in the sale or disclosure of these funds. Selling a mutual fund relies on complex mutual fund information getting summarized down into small parts that sellers can understand. If a firm unknowingly relies on bad data, it can get in the way of good, profitable and reputable investor interactions.
Missing or bad mutual fund data is nothing new but it has recently garnered the attention of regulators. As a result, sellers of mutual funds now find themselves asking what they can do to better understand the fundamentals of mutual fund data, why it's important, and how to identify possible risks.
In 2002 a blemish appeared on the generally spotless record of mutual funds. Discovered by examiners at NASD--now the Financial Industry Regulatory Authority--the "breakpoint issue" related to investors being overcharged commissions due to some brokerages and other firms not disclosing or using detailed fund policies, like "rights of accumulation" or "letter of intent," when selling a fund.
While committees were formed, the net result is that very little has changed. The breakpoint issue is alive today, a fact that would seriously erode investor and regulatory confidence were it to become better known.
The problem is, on one level, simple. Mutual fund sales are driven by technology that relies on mutual fund policies being summarized as data points. Firms may sell billions of dollars of funds every week and maintain considerably more on their books, but frequently they pay scant attention to the accuracy of their mutual fund reference data. Reference data is the critical link as it electronically represents a number of key data attributes including investors, intermediaries, issuers, products and prices. With reference data comprising the majority of the data content in trades, firms now realize that ensuring that data is accurate is an issue that can no longer be avoided.
Even when firms believe they have the reference data issue under control, random data audits have found that when comparing the mutual fund data held by distributors to the mutual funds' own rules, a disturbing accuracy problem still exists. Comparisons have shown that for many firms, discrepancies in data results because funds have one policy as disclosed to the SEC while their distributors use entirely different ones.
Streamlined Disclosures, Reduced Risks
The best source of mutual fund information--its pricing and other policies--is contained in each fund's prospectus and more detailed statement of additional information (SAI). From a legal view the prospectus is key; it is defined by the Securities Act of 1933, and again in the Investment Company Act of 1940, as the definitive source of information about a fund. Policies within the SAI are equally binding to a distributor, but rarely are these documents provided to investors.
A fund is required only to provide its prospectus and SAI to one place--the SEC. Initially required in a paper-based format, beginning in the late 1990s the SEC mandated that mutual fund companies file these documents electronically with the Edgar system.
Without an easy way to get the information out of these electronic prospectuses, brokerage firms, industry associations and vendors have been devising ways to establish a data repository with prospectus-like information for their trading and information technologies. Each solution--running the gamut from teams of people in back offices, to industry-led repositories--has touted their data quality as the most reliable. Yet because each ignores the inherent power of the Edgar system as the base resource, many initiatives begin with a flawed model.
