I just saw the following article show up on SmartMoney. Although mostly a pulp magazine, this article piqued my curiousity.
http://www.smartmoney.com/invest/mutual-funds/why-mutual-fund-guardians-are-failing-1339088682278/Excerpts:
"YieldPlus, according to the fund's prospectus, was designed to offer "high current income with minimal changes in share price." That didn't turn out to be the case in 2008, when the fund's net asset value plummeted more than 35 percent, some four and a half times what short-term bond funds lost as a whole. Nor was it true in 2009, when shares of the once-stable fund tumbled another 11 percent."
"In the end, Schwab, without admitting or denying wrongdoing, would agree to pay $119 million to settle SEC civil charges that it misled investors; the company also paid $235 million to settle a private case brought by investors."
And the kicker - who could have saved the day?
"an important if little-known layer of investor protection failed. This safeguard did not involve a government agency or an outside auditor, but an internal group of highly paid overseers: the fund's own board of trustees. The lapses in oversight that occurred with YieldPlus, experts say, are part of a system of fund governance that is almost designed to fail."
Comments
It draws a distinction between corporate boards and investment company (mutual fund) boards in claiming that the former is much more active and concerned with stockholder interests. If true, that would address OJ's comment regarding foxes and chickens. This self-regulatory mechanism would not appear to be intrinsically flawed.
However, in what appears to be the vast majority of corporations, it is the officers (managers) of the company who control; not the board. So this is one example where the article, in attempting to show how uniquely bad mutual fund protections are, misstates its case. A problem is not that fund boards are somehow different, but that boards in general are not sufficiently concerned with stockholder interests, or that they even oversee the company operations to the extent they are supposed to.
A misleading statement in the article is that boards rarely if ever change fund management. From a legal perspective, this is technically true. Funds change the management company extremely rarely, and it is the management company that is the legal manager of the fund. Pragmatically, it is not rare (though perhaps not common enough) for management changes to be initiated by the board. That is, the day to day (lead) manager of the fund may be changed without this being consider a change in management from a legal perspective. Arguably one does not want this to happen too frequently - even with mediocre results, there is a certain expectation of shareholders that they are buying into a particular (daily) manager when they invest.
Then consider fund companies like Vanguard, Harbor, American Beacon. These companies technically manage all(?) their funds (e.g. Vanguard Group is the legal manager of the individual Vanguard funds). But they outsource the management to submanagement companies. Not infrequently they swap one submanagement company for another. Yet the legal manager (Vanguard Group, etc.) remains the same. The board has hired Vanguard Group to manage a fund, and that manager remains, regardless of what company actually manages the fund.
Regarding Schwab Yield Plus - like Enron, the story is not nearly as black and white as this article (and most) make it appear. Most of what Enron did was technically legal, or at least in a gray area. What Schwab did regarding what it could invest in was change the definition of maturity (for the purpose of determining what the fund could invest in), so that monthly resets had a maturity of a month. That's different from "break[ing] the fund's 25 percent limit on holdings of certain risky mortgage bonds" as the article wrote.
I believe that treating resets as short term bonds also used to be allowed in some regulations (perhaps MMFs?), and I also believe that those regulations were changed in the past couple of years. Not sure here - would have to go digging - but the concept sounds very familiar to me. It's not unreasonable, because in any sane market, where liquidity did not vanish, pricing of floating rate debt should be pretty stable - that's why people are looking, e.g. at bank loan funds. (There's a different issue there, but that's for another thread.)
Likewise, one of the assertions against Schwab was that it kept less cash on hand than other ultra-short bond funds. Not illegal as near as I can tell, nor did the article even mention this. But the two factors combined to cause the plummet in Yield Plus's price. A NYTimes column provides this information. From that article, one might infer that while Schwab failed to properly disclose, it is not all that clear that the actual operation of the fund violated any rules.
I write this not to say that Schwab was a good actor (it wasn't), or that the suits were without merit. Rather, that things are rarely as clear cut as this article would have one believe, and the article may not even be identifying the actual cause of the problem. In the case of Schwab Yield Plus, the fund may have done nothing wrong in its operations, but it may likely have been mis-sold, and inadequately disclosed. There are already regulations covering disclosures and advertising. So one could argue that an underfunded SEC was problem - all it could do was come in after the fact and clean up the mess. (It did impose fines on execs who did not go along with the settlement, albeit slaps on the wrist.)