Currently, mutual funds disclose  information about their fees as percentages of their assets whereas most  other financial services disclose their costs in dollar terms. Another alternative for disclosing mutual funds fees would involve funds  specifically disclosing the actual dollar amount of fees paid by each  investor. Trading and Other Costs Impact Mutual Fund Investor Returns, but Are Not Prominently Disclosed

In addition to the expenses reflected in a mutual fund’s expense ratio—the  fund’s total annual operating expenses as a percentage of fund assets— mutual funds incur trading costs that also affect investors’ returns. Changes in Mutual Fund Distribution Practices Have Increased Choices for Investors, but Have Raised Potential Concerns

Concerns have been raised over changes in how mutual funds pay for the  distribution of their shares to investors. Concerns also have been raised as to whether the disclosure  of 12b-1 fees is sufficient and whether, another distribution practice— referred to as revenue sharing, in which investment advisers make  payments to broker-dealers for selling and marketing their funds—could  limit the number of mutual fund choices offered to investors. As a result, complete data are not available on the extent to  which mutual fund advisers are making revenue sharing payments. Soft Dollar Arrangements Provide Benefits, but Could Also Have an Adverse Impact on Investors

Soft dollar arrangements allow investment advisers of mutual funds and  other clients to use part of the brokerage commissions paid to broker- dealers that execute trades on the fund's behalf to obtain research and  brokerage services that can potentially benefit fund investors but could  increase the costs borne by their funds. Conclusions

Although mutual funds disclose considerable information about their costs  to investors, some industry participants urge that additional disclosures are  needed to further increase the awareness of investors of the fees they pay  as part of investing in mutual funds and to encourage greater competition  among mutual funds on the basis of these fees. However,  additional disclosures could also improve investor awareness and the  transparency of these fees. Providing existing investors with the specific  dollar amounts of the fees paid on their shares and placing fee related  disclosures in the quarterly account statements that investors receive  would put mutual fund disclosures on comparable footing to many other  financial services that already disclose specifically in dollars the cost of  their services. Although the ways that funds use 12b-1 fees has changed over time, these  fees appear to have provided investors with increased flexibility in  choosing how to pay for the services of the individual financial  professionals providing them with advice on fund purchases. Regulators acknowledged that the currently required disclosures  might not provide needed transparency to investors at the time that mutual  fund shares are being recommended for purchase. The  SEC staff has recommended various changes that would increase the  transparency of soft dollar practices by clarifying the acceptable uses of  soft dollars and providing fund investors and directors with more  information about how their fund’s adviser is using soft dollars. Recommendations

To promote greater investor awareness and competition among mutual  funds on the basis of their fees, we recommend that the Chairman, SEC  increase the transparency of the fees and practices that relate to mutual  funds by  considering the benefits of additional disclosure relating to mutual fund  fees, including requiring more information in mutual fund account  statements about the fees investors pay;   evaluating ways to provide more information that investors could use to  evaluate possible conflicts of interest resulting from any revenue  sharing payments their broker-dealers receive; and   evaluating ways to provide more information that fund investors and  directors could use to better evaluate the benefits and potential  disadvantages of their fund adviser’s use of soft dollars, including  considering and implementing the recommendations from its 1998 soft  dollar examinations report.
Why GAO Did This Study

The fees and other costs that investors pay as part of owning mutual fund shares can significantly affect their investment returns. As a result, questions have been raised as to whether the disclosures of mutual fund fees and other practices are sufficiently transparent. GAO reviewed (1) how mutual funds disclose their fees and related trading costs and options for improving these disclosures, (2) changes in how mutual funds pay for the sale of fund shares and how the changes in these practices are affecting investors, and (3) the benefits of and the concerns over mutual funds' use of soft dollars.

What GAO Found

Although mutual funds disclose considerable information about their costs to investors, the amount of fees and expenses that each investor specifically pays on their mutual fund shares are currently disclosed as percentages of fund assets, whereas most other financial services disclose the actual costs to the purchaser in dollar terms. SEC staff has proposed requiring funds to disclose additional information that could be used to compare fees across funds. However, other disclosures could also increase the transparency of these fees, such as by providing existing investors with the specific dollar amounts of the expenses paid or by placing fee-related disclosures in the quarterly account statements that investors receive. Although some of these additional disclosures could be costly and data on their benefits to investors was not generally available, less costly alternatives exist that could increase the transparency and investor awareness of mutual funds fees that make consideration of additional fee disclosures worthwhile. Changes in how mutual funds pay intermediaries to sell fund shares have benefited investors but have also raised concerns. Since 1980, mutual funds, under SEC Rule 12b-1 have been allowed to use fund assets to pay for certain marketing expenses. Since then, funds have developed ways to apply Rule 12b-1 fees to provide investors greater flexibility in choosing how to pay for the services of individual financial professionals that advise them on fund purchases. Another increasingly common marketing practice called revenue sharing involves fund investment advisers making additional payments to the broker-dealers that distribute their funds' shares. However, receiving these payments can limit fund choices offered to investors and conflict with the broker-dealer's obligation to recommend the most suitable funds. Regulators acknowledged that the current disclosure regulations might not always result in complete information about these payments being disclosed to investors. Under soft dollar arrangements, mutual fund investment advisers use part of the brokerage commissions they pay to broker-dealers for executing trades to obtain research and other services. Although industry participants said that soft dollars allow fund advisers access to a wider range of research than may otherwise be available and provide other benefits, these arrangements also can create incentives for investment advisers to trade excessively to obtain more soft dollar services, thereby increasing fund shareholders' costs. SEC staff has recommended various changes that would increase transparency by expanding advisers' disclosure of their use of soft dollars. By acting on the staff's recommendations SEC would provide fund investors and directors with needed information about how their funds' advisers are using soft dollars.