Robert C. Pozen, a veteran of the mutual fund industry, assumed the title of non-executive chairman of MFS Investment Management in February. The 57-year-old joined the nation's oldest mutual fund company — a subsidiary of Sun Life Financial, the Canadian life insurance company — within months after MFS got embroiled in the mutual fund trading scandal. (On March 31, the company paid $50 million to settle charges by the Securities and Exchange Commission about directing trades to brokerage firms that marketed and distributed its mutual funds.) Earlier last month, he surprised the industry by announcing MFS would not use "soft dollars" to pay for independent outside investment research, and by demanding Wall Street brokerage houses break out their execution and research costs in the commissions they charge. Mr. Pozen talked to Washington Bureau Chief Vineeta Anand about what MFS is doing, and what the SEC and others should be doing.
Q Early on, you said about MFS' involvement in the mutual fund scandal: "I think we need to emphasize how relatively benign this is." In hindsight, would you still say that?
A I think the atmosphere in terms of mutual fund regulation is somewhat harsher than I had imagined. I'm not sure exactly what I was referring to by ‘benign.' In a more realistic assessment, I think there's clearly a significant regulatory change in store for the mutual fund industry.
Q What do you anticipate by way of regulatory changes?
A If you look at it from the SEC's point of view, the thing that they're spending the most time on is disclosure.
Q What do you see beyond what the SEC is already working on?
A The important thing is MFS' effort to lower the commission rate for brokerage transactions. … Then you have a series of other issues that relate to research. ... The things where the full-service broker serves as a conduit, in my view, should not be eligible for soft-dollar payments. I would rather see a lower commission rather than in-kind discounts in the form of soft dollars for these things in which the brokerage firm is essentially a conduit. …
Now that MFS is leading the way, and I believe that there are other firms like American Century, I hope the big pension funds will follow …
We want to know, first of all, exactly what we are buying when we are paying 5 cents a share. Maybe their bundles are good and attractive, and maybe they're not. We don't really know. And second of all, in some circumstances we are going to say we would rather have a lower price than these in-kind services.
Q Why didn't you halt soft dollars when you were CEO of Fidelity Investments?
A Fidelity is now taking a strong stance to try and require itemization of full-service brokerage commissions. They are probably the strongest advocate of that. I think there are a lot of things that are coming together now. You have the development of the ECNs, decimalization, discussions now about the trade-through rule and about changes in that so there are a whole series of things that are happening in terms of market structure that I believe start to warrant reconsideration of this practice. And I think because the SEC has put out its proposal on itemization, people are becoming much more sensitive.
For MFS in particular, we wanted to tell the world that we wanted to cut off (soft dollars). … We wanted to make a stronger statement that the whole area of soft dollars needs to be re-examined so this is why we took a broader position in terms of third-party research and market data.
In an environment where people are questioning whether the mutual fund industry really deserves its reputation for… having integrity, it was important to make a statement that MFS is going to go further than required in the law, and we're going to show others that we are going to be a sort of ‘Mr. Clean.' …
We did it in connection with the individualized reporting. This is an area that has been debated for years as to what is the appropriate disclosure. You have in the prospectus an expense table that shows you how much in basis points you paid in advisory fees, how much you paid for transfer agents, how much you paid for 12b-1 fees. But people said they don't really understand basis points so well … and there's this hypothetical example …
We basically looked at this and our chief operating officer, her name is Robin Stelmach, came up with two simplified assumptions. One is that (we'll) look at the end of the quarter and we see what funds you hold and assume you held them for the full quarter, and the second assumption we make is that you've reinvested your dividends. Now the fact is, more than 90% of MFS shareholders are in those categories. … We make those two simplifying assumptions and we can get a very good estimate that will be useful and accurate for the vast majority of shareholders. …
Q What do your competitors think of your decisions?
A I've already been getting letters of support from various fund managers. I noticed Morgan Stanley, their management arm, came out in favor of a partial ban on soft dollars. I see that American Century is strongly in that position, and this is something that will be discussed more and more by pension funds. People are going to look at this a lot harder. I think it's the sort of thing we're likely to build consensus on, and if the SEC gives us a little help, we'll move in that direction. The Wall Street firms are all willing to talk about this. They understand that the system is under a lot of pressure from decimalization, electronic crossing networks, changes in the trade-through rule, so they understand this is going to change.
As to the customization, it's been very well received. It's like solving the Gordian knot. I can't say what the (Investment Company Institute's) position is going to be, but in the past, it's been viewed as an all or nothing, and if the two simplifying assumptions are accepted, people are going to say this is a reasonable proposal.
Q In 1994, the SEC had proposed mutual funds include in the expense table the cost of trading securities. Should that be revived?
A I think all the proposals that try to take brokerage costs and make them part of the expense table are misguided. Brokerage commissions are capital costs. They're added to the cost basis of the security. They're very different than advisory fees or 12b-1 fees or transfer agency (fees) which are taken out on a monthly and quarterly basis as ordinary expenses. To put them in to the expense table with these other costs is confusing to people and misleading, because it's apples and oranges. Second of all, when you think of true brokerage costs, (they) include not just commissions, but spreads, and we actually have very sparse information about what spreads really are. So what we are doing at MFS, which is what I urge the SEC to do too, is to put below the expense table in a separate category what the average commission rate is for the fund. That is probably the best we can do at the moment.
The broader implications are that the required costs of doing business are going up. So the core expenses that you can't avoid are going up. I think what that means is it will become more and more difficult for smaller and middle-sized firms to survive in the industry. … I would predict we are going to see a bifurcation of the industry.
On the one hand, you'll have a number of firms over $100 billion, and on the other hand you'll have lots of these smaller firms, under $10 billion or $20 billion, but the middle is going to have a difficult time and they're going to be acquired or merged.