The Investment Company Act of 1940, the centerpiece of the government's regulation of mutual funds, turns 50 this year, and both the regulators and the industry have concluded that it's time for a rewrite.
Such an undertaking, though it would plainly take years, is of immense significance to individual investors. If things go as regulators and many in the industry hope, all sorts of innovative new products will appear in the marketplace, allowing investors a variety of options not now available.
At the same time, however, some products now on the market might be brought under the jurisdiction of the 1940 act, a possibility that their sponsors find less than thrilling.
One thing almost everyone agrees on is that the Investment Company Act has been very successful. In the 50 years of its existence, mutual fund assets have grown from roughly $448 million to $1.2 trillion. When the law was enacted, there were 68 mutual funds; now there are more than 3,500.
Today, according to the Investment Company Institute (ICI), a mutual fund trade association, one household in every four across the country owns shares in a mutual fund.
The Securities and Exchange Commission, in its request for comments on the law and possible revisions, said, "Investment companies are fast becoming the primary investment and savings vehicle for a significant portion of the investing public."
The act limits mutual fund fees, prohibits self-dealing -- such as a sponsor selling its own securities to its mutual fund -- and gives the SEC broad authority to regulate other aspects of the business, such as advertising.
Apparently, the results have benefited everybody. The industry has been remarkably free of charges of fraud and misrepresentation, and industry representatives freely acknowledge that consumer confidence has been an important factor in the growth of mutual funds.
"The act has worked," said David Silver, president of the ICI.
But Silver, whose group has been pressing for revision for several years, added that as financial markets have changed, the law has become unnecessarily restrictive in some ways while at the same time it has not dealt at all with some new financial products that were not in existence in 1940.
Because research leading up to the law's enactment was done years before, Silver said, the act imposes "a template of what the industry looked like, actually in the '20s." The result is some requirements the industry regards as archaic.
For example, a conventional "open-end" mutual fund must offer its investors the right to redeem their shares every day. If it does not, it becomes a "closed-end" fund and is not permitted to redeem shares; they trade instead on a stock exchange at a price determined by the market rather than the underlying value of the assets held by the fund.
The ICI suggests that funds be permitted to offer periodic redemptions, such as monthly or quarterly.
On the other hand, products such as real estate investment trusts and other asset-backed arrangements were rare, if not unknown, when the law was written. For example, the ICI argues that interests in pools of credit card receivables ought to be brought under the act. Banks, the ICI charges, have sought to use an exemption meant for certain specific commercial transactions to escape regulation.
The life insurance industry also is concerned about the 1940 law. The American Council of Life Insurance (ACLI), in its comments to the SEC, noted that variable life insurance and annuity contracts have never fit comfortably into the regulatory framework with "the net result ... that these products have never been allowed to live up to their full potential." Application of the law to them "has harmed consumers by limiting the variety of insurance products available and diminishing beneficial competition," the ACLI said.
The banking industry, by contrast, is worried that some of the investment services and vehicles now offered by banks might come under new regulation as a result of a securities law rewrite.
Such regulation would add costs to things such as asset-backed arrangements "and would probably make them impossible to operate," said James D. McLaughlin of the American Bankers Association. "These things work on very, very narrow margins."
The ABA also is eager to take advantage of proposed new banking regulations that would allow bank-operated common trust funds to be marketed more broadly, and it favors allowing banks to begin operating mutual funds. Banks are anxious that any legislative rewrite not be shaped by competitors in a way that would exclude them.
The battle is only beginning, but investors should follow it with interest. The promise of new and varied financial products is enticing but in the jockeying that inevitably goes on in Washington, something less beneficial may emerge. And considering the amount of money involved, the lobbying is likely to be fierce.
"We've thrown a big rock into the middle of a pond," ICI's Silver said, "and as the ripples go out they will shake a lot of things that are floating on the water."