By ROGER LOWENSTEIN
Staff Reporter of THE WALL STREET JOURNAL
What's the purpose of disclosure? To lay bare the truth, right?
Yes, but only in part. Mandated disclosure, which is as distinctly American as the celebrity lawsuit, also achieves the greater good of influencing the behavior of disclosers. If politicians had to reveal their whereabouts on Sunday mornings, most of them would be in church. "Sunlight," Justice Louis Brandeis said, "is the best of disinfectants." This is close cousin to the modern notion that fiduciaries will "manage what they measure," i.e., pay attention to what they know will be disclosed and counted.
This is the proper context for the big job being tackled by the Securities and Exchange Commission, which is overhauling the mutual-fund prospectus, the only disclosure message most Americans ever see. Because the prospectus is self-contained and defined in advance by the SEC, it also bears the burden of selectivity. We expect it to tell us what matters, governed by uniform rules; arbitrarily selected facts are out. That's why a fund can't tell you in its prospectus that it did great on Tuesdays, even if it did.
With the deadline for comments about to expire (letters to the SEC by June 9), herewith two proposals. One is an item that warrants sunlight but languishes in shade. The other concerns a recent loosening of prospectus rules that is letting new numbers creep in; that window ought to be shut.
Taking the loosened window first, the SEC is letting certain funds include performance records which the public, or the public that owns the fund in question, never earned. Some mutual funds evolve from nonpublic vehicles such as bank-managed or insurer-managed pools. Thanks to rulings by the SEC, the prebirth records of certain of these funds are now fair game for prospectus inclusion. Ditto, the prior records of some fund managers who later transfer their act to new funds.
The same goes for private money managers who expand into mutuals. The results of their unrelated private accounts, if managed in a style purportedly "similar" to that envisioned for their public fund, now has the SEC imprimatur as prospectus-fair.
All should fail on the basis of arbitrariness. Managers with good prebirth, pretransfer or private records will include them; those with poor such records will not. Moreover, in some cases, it will be impossible to know whether managers are including all prior records of "similar" funds. As the SEC's Barry Barbash admitted to me, the question of what is a "similar" style is subject to wide interpretation.
To take a specific case, the SEC let Nicholas-Applegate, a big money manager that branched into mutual funds, continue to publish in its prospectus results of its privately managed accounts. But Applegate will be free to yank its private numbers any time it chooses. That should make inclusion a no-no.
Loosening the windows also fails the behavioral test. Despite SEC protests to the contrary, giving funds discretion, even on a selective basis, to publish alternative records will invite creative runarounds and induce fund companies to launch multiple start-ups knowing they can take the winners (and, they hope, their records in-gestation) public. Especially at the crest of a bull market, the SEC should guard against letting bullish window-dressing contaminate mandated disclosures. Bottom line: Funds should include their own records as public funds and those records only.
Now, where to lift the shade and let in the light? A year ago, I suggested that sponsors voluntarily disclose how much portfolio managers had invested in the funds they managed. I was wrong. It should be mandatory.
Self-confident stock-pickers like Paul Stephens at Contrarian fund and Bob Rodriguez at FPA Capital have nothing against disclosing how many shares they have purchased of their own product, but big fund sponsors inevitably bristle at the idea. (T. Rowe Price: "Can't see any value to it." Janus: "Wouldn't really help." Franklin Templeton: "No official comment.") The portfolio managers at these companies pore through filings of corporate executives, who are required to disclose their holdings in their own stock. As fund managers know, an executive with a large and/or a growing stake in shares bought with hard cash has an incentive to reach for the proper carrot and a demonstrated belief in his ability.
But funds come up with all sorts of "reasons" against such disclosure for their own. Not fair, they say, to managers of exotic funds who can't be expected to heavily bet on way-out assets. Well, perhaps their investors should exercise similar restraint. Remember, nobody is telling managers to invest -- just to disclose.
But watch the sunlight spread its unseen disinfectant. With disclosure required -- just one line showing shares owned at quarter's end -- money, at the margin, would flow to managers willing to bet on themselves. Managers who lacked the confidence would properly be punished in the marketplace. But many would put more money on their own horses. At the margin, they would be better stockpickers: There is nothing like having your own money at risk. That's why this is the single-best prospectus change the SEC could make.