Wall Street: Mutual Disenchantment

In its ambitious, 22-month investigation of the securities markets, the Securities & Exchange Commission has taken a crack at almost everyone — traders, brokers, specialists, stock exchange officers. Last week it was the turn of the mutual funds, those havens of school teachers, soldiers and other mostly small investors who want to scramble their nest eggs over scores of stocks.

The number of mutual fund investors (3,000,000) is greater than the adult population of Chicago, and the value of their holdings ($21 billion in 6,000,000 accounts) exceeds the gross nation al product of Australia. The typical mutual fund buyer, reports the SEC, is a high school graduate in his mid-40s, who is married, has two children, and earns $5,000 to $10,000.

In the third and last installment of its report, the SEC charged that many such unsophisticated investors are in poor company when they put their trust in certain mutual funds. The SEC’s 65 special investigators documented what the industry’s leaders have known and tolerated for a long time: fund buyers are often overcharged, fund salesmen are usually undertrained, and fund executives sometimes exploit their inside information for personal profit.

Front-End Loaders. The SEC did not by any means condemn all mutual funds, but centered its fire on the “contractual” funds, in which the investor signs up to buy regular monthly shares over a period of years. The commission, or “load,” on mutual fund sales is typically 8.5%, plus a “custodian’s fee” of 1% to 3%. What irked the SEC study group is that commissions commonly run to 50% during the first year of the so-called “front-end load” plans, in which more than 1,000,000 small investors have contracted to make monthly payments. For buyers who pull out of the front-end load plans in the first year or two—as about one in three do—much of their investment is soaked up by commissions.

The SEC turned an equally cold eye on mutual fund salesmen. The lure of plumper commissions prompts salesmen to tout the plans with front-end loads above all others. An Investors Planning Corp. salesman who sells a 121-year front-end plan at $20 a month, for example, collects $57 in commissions on the first year’s payments of $240; if he sells a $1,000 one-payment plan, he gets only $32.50. Most mutual fund salesmen are part-timers who earn less than $1,000 a year, and many of them are ill-trained recruits who give up the game after less than one year.

The SEC found that some funds deliberately seek salesmen with little or no savvy in the securities business, recruit a large number in the armed forces to sell to buddies or subordinates, and have their salesmen play to the “fear, pride and patriotism” of prospective buyers. One brokerage firm that also specializes in selling training materials for fund salesmen—Kalb, Voorhis & Co.—advises them to use the “accidentally-on-purpose” technique: when filling out a fund contract, write in an astronomically high monthly investment—perhaps $250—to start the buyer “thinking big.”

The insiders of five mutual funds, the SEC discovered, bought certain stocks just before the fund did, or sold them just before the fund unloaded. The five funds mentioned: Lehman Brothers’ One William Street Fund, the Chase Fund, Value Line Special Situations, Guardian Mutual Fund and Leon B. Allen Fund. The SEC group wants these practices corrected and, in fact, it wants Congress to consider outlawing all front-end loads.

A Closer Watch. These and other suggested reforms were important but not shattering, and the stock market hardly reacted to the news. Perhaps the most significant request in the final report was for more SEC power to keep closer tab on all the other abuses turned up in its investigations. The SEC’s effective Chairman William L. Gary, 52, preaches self-reform in the securities markets rather than Government crackdown, but the SEC found that Wall Street’s self-reform has been “uneven” and suggested closer SEC regulation. The special study recommended that Gary & Co. brandish tougher controls over brokers’ commissions, over-the-counter trading and the disciplining of errant brokers, which is now handled privately by the exchanges themselves. The SEC has the power to do most of that already, and what little new legislation it needs is likely to be passed next year. The White House and key Congressmen from both parties have already endorsed the SEC’s recommendations.