Copyright 1999 Federal Document Clearing House, Inc.
Federal Document Clearing House Congressional Testimony
July 21, 1999
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 4247 words
HEADLINE:
TESTIMONY July 21, 1999 MATTHEW P. FINK HOUSE BANKING AND
FINANCIAL SERVICES FINANCIAL INSTITUTIONS AND CONSUMER CREDIT UNIONS FINANCIAL
PRIVACY
BODY:
STATEMENT OF MATTHEW P. FINK
PRESIDENT, INVESTMENT COMPANY INSTITUTE BEFORE THE SUBCOMMITTEE ON FINANCIAL
INSTITUTIONS AND CONSUMER CREDIT COMMITTEE ON BANKING AND FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES ON EMERGING FINANCIAL PRIVACY ISSUES JULY 21, 1999
I. INTRODUCTION Good morning. My name is Matthew P. Fink. I am President of the
Investment Company Institute, the national association of the American mutual
fund industry. The Institute's membership includes 7,546 open-end investment
companies (mutual funds), 457 closed-end investment companies, and 8 sponsors of
unit investment trusts. Its mutual fund members have assets of about $5.730
trillion, accounting for approximately 95% of total industry assets, and have
over 73 million individual shareholders. I appreciate the opportunity to testify
on emerging financial privacy issues. My testimony will focus on the use and
protection of shareholders' personal information in the mutual fund industry. As
members of the Subcommittee are aware, the mutual fund industry takes this issue
very seriously. Over the past sixty years, the mutual fund industry has enjoyed
steady growth. Mutual fund assets have grown from less than $450 million in 1940
to over $5.7 trillion today. The number of U.S. households owning mutual funds
has nearly doubled in the past ten years, from 24.4 million in 1988 to over 44
million by the end of 1998. Mutual funds have become the investment vehicle of
choice for over 77 million Americans, helping them reach financial goals such as
planning for retirement and saving for their children's education. All of this
success could not have occurred, and will not continue, without one key
ingredient - investor confidence. Investors must remain confident that their
mutual funds are being run for their exclusive benefit. This principle served as
our touchstone during our recent analysis of the role of mutual fund directors
in safeguarding shareholder interests. Investors also must remain confident that
their mutual funds protect the confidentiality and security of their
personal information. In considering privacy
issues in the context of mutual fund organizations, it is important to
understand their unique structure and operations. As discussed below, a mutual
fund is a pool of assets whose operations typically are conducted by a number of
affiliated and unaffiliated third parties. For this reason, shareholder
information must flow between a mutual fund and its service providers to allow
servicing of shareholder accounts and the maintenance of shareholder
relationships. Thus, it is critical that legislative or regulatory proposals
concerning financial privacy take these special characteristics into account. We
are pleased that the privacy protections included in H.R. 10, as recently passed
by the House of Representatives, do so. We believe these provisions strike an
appropriate and necessary balance between two important shareholder interests:
providing shareholders with control over their information and ensuring that
they receive efficient service from their mutual fund organizations and other
financial institutions. Today, I will begin by briefly describing the structure
and operation of mutual fund organizations. I will then discuss the use of
personal information by mutual fund organizations and how information flows
between a mutual fund and its service providers. Finally, I will explain why the
Institute supports privacy protections such as those included in H.R. 10. II.
THE STRUCTURE AND OPERATION OF MUTUAL FUND ORGANIZATIONS A. The Mutual Fund A
mutual fund is an investment company that pools the money of many investors and
invests it in stocks, bonds, or money market instruments according to the fund's
investment objectives. An investor in a mutual fund buys shares of the fund,
representing a proportionate interest in the securities held in the fund's
portfolio. Most mutual funds continuously offer and sell new shares to the
investing public. Mutual fund shares are redeemable, which means that an
investor has the right to sell his or her shares back to the fund at any time at
their current net asset value. Most mutual funds are organized as part of
"complexes" comprised of multiple mutual funds managed by the same investment
adviser. Each mutual fund in a complex must be organized as a separate
corporation or business trust, or as a series of shares issued by a corporation
or business trust. In either case, each fund is treated as a separate investment
company for accounting and regulatory purposes under the Investment Company Act
of 1940. B. The Mutual Fund Organization The typical mutual fund is externally
managed. This means that it does not have employees of its own and that all of
its operations are conducted by third parties. These third party service
providers, including the fund's investment adviser, principal underwriter,
transfer agent, and custodian, may be affiliated companies or independent
contractors. A diagram depicting a typical mutual fund organization, including
the fund's key service providers, is attached as Exhibit A. C. Mutual Funds'
Principal Service Providers The functions performed by the principal service
providers to mutual funds are outlined below. Except as otherwise noted, each of
these entities performs services pursuant to a contract with the fund. All of
the entities listed are subject to federal regulation either by the Securities
and Exchange Commission or by bank regulators. 1. Investment Adviser The
investment adviser to a mutual fund is responsible for selecting portfolio
investments consistent with the fund's investment objectives and policies, as
described in its prospectus. Frequently, the investment adviser is also the
fund's sponsor, meaning that it is responsible for organizing the fund and
setting its initial investment objectives, policies and restrictions. In most
cases, the fund's investment adviser is a part of the same overall organization
as the fund or funds it serves. In some cases, funds employ unrelated investment
advisers or sub- advisers. In very rare instances, funds are internally managed,
with employees of the fund making its investment decisions. 2. Principal
Underwriter Mutual funds offer new shares to the public at a price based on the
current value of fund assets (plus a sales charge, if applicable). Mutual funds
usually distribute their shares through a principal underwriter. The principal
underwriter (sometimes referred to as the fund's "distributor") arranges for the
sale of fund shares to the public. Fund shares are sold to investors primarily
in two ways. In some cases, investors purchase fund shares directly from the
fund or its principal underwriter. In other cases, fund shares are distributed
through a sales force, which may be affiliated (i.e., comprised of employees of
the fund's affiliated principal underwriter) or independent (i.e., comprised of
employees of independent broker-dealer firms, financial planners, bank
representatives, and insurance agents). Like investment advisers, the fund's
principal underwriter commonly is part of the same overall organization as the
fund or funds it serves. A notable exception to this involves bank- related
funds (i.e., funds that are advised by or sold through banks). These funds must
be distributed by an unaffiliated underwriter.(1) Some funds handle distribution
internally (i.e., without a separate distributor), although this is very
uncommon. 3. Transfer Agent Mutual fund transfer agents maintain records of
shareholder accounts, which reflect daily investor purchases, redemptions, and
account balances. Transfer agents typically serve as dividend disbursing agents,
and their duties as such involve calculating dividends, authorizing payment by
the custodian, and maintaining dividend payment records. They also prepare and
mail to shareholders periodic account statements, federal income tax
information, and other shareholder notices. In many cases, transfer agents also
prepare and mail statements confirming transactions and reflecting share
balances. In addition, transfer agents maintain customer service departments
that respond to telephone and mail inquiries concerning the status of
shareholder transactions and accounts. Transfer agency functions may be
performed by either affiliated or unaffiliated transfer agents, or by a
combination of the two. For example, an affiliated transfer agent may perform
limited shareholder servicing functions, such as telephone communication,
written correspondence, or account research, and subcontract the remaining
transfer agency functions to an unaffiliated transfer agent. In addition,
affiliated transfer agents include both the "remote" transfer agent that
contracts with an outside service company for use of its data processing system,
and the "captive," or fully internal, organization that utilizes its own
computer resources and shareholder accounting system. 4. Custodian The
Investment Company Act of 1940 requires mutual funds to keep their portfolio
securities in the custody of a qualified bank or otherwise protect them pursuant
to SEC rules. The custodian's primary responsibilities are safekeeping of the
fund's portfolio securities and cash, clearing and settling transactions,
collecting and distributing income, and reporting and processing corporate
actions. Nearly all mutual funds use unaffiliated banks as their custodians.
Rules under the Investment Company Act of 1940 permit other types of custody
arrangements, such as self-custody, although these arrangements are highly
uncommon. D. Practical Considerations It is important to recognize that as a
practical matter, fund shareholders generally view themselves as customers of
the entire mutual fund organization (or perhaps of the broker-dealer or other
intermediary through which they invested), rather than of a particular entity
within that organization (such as an individual fund or service provider). Fund
shareholders typically assume that they are doing business with the fund
organization as a whole and few, if any, would be aware of or appreciate that
each of the entities within the mutual fund complex is organized separately.
This is illustrated by the popularity of features such as exchange privileges
among affiliated funds and consolidated account statements. III. THE USE OF
PERSONAL INFORMATION IN THE MUTUAL FUND INDUSTRY In order for a mutual fund
organization to operate on a day-to- day basis, shareholder information must be
shared between the mutual fund and its service providers. This sharing occurs
primarily in order to maintain a shareholder's account or service a
shareholder's relationship with the fund organization, but may happen for other
reasons. For example, information may be transferred among affiliates in order
to provide the shareholder with information on other financial products or
services offered by the mutual fund organization or by an affiliate. A. The
Types of Information Collected and Maintained by a Mutual Fund Most of the
personal information collected and maintained by mutual funds is simply that
which is necessary to appropriately handle shareholders' accounts and inquiries.
For example, a mutual fund organization must obtain the name and address of a
person who requests information about a fund, whether by mail, telephone, or
through the mutual fund organization's web site, in order to respond to the
request. Most personal information is collected when an investor initially
establishes an account. For example, most mutual fund account applications
require the investor to provide his or her name, address, and social security
number. Depending on the nature of the account and servicing options the
shareholder elects, the application also may request information about the
shareholder's designated beneficiaries, the shareholder's bank account number,
the identity and address of an accountant or investment adviser the shareholder
designates to receive copies of account statements, and the shareholder's
occupation and employment information.(2) Other information is generated and
maintained as part of the ongoing relationship between the mutual fund and the
shareholder, such as account balances and transaction histories of shareholders
holding accounts in their own names.(3) This information may come to the mutual
fund organization directly from the investor or indirectly through the
investor's intermediaries and typically will be shared by the mutual fund, its
distributors and its transfer agent. The processing of new account applications
provides a good example of the variety of ways that this can occur. For funds
distributed directly to the public, new account applications generally are
received and processed by the fund's transfer agent, acting as an agent for the
underwriter. For funds distributed by an affiliated sales force (e.g.,
representatives of an affiliated broker-dealer firm), new account applications
are processed by the broker- dealer's representatives at the broker-dealer's
home or branch office, but maintained on the fund's transfer agent's system. For
funds distributed through an independent sales force (e.g., representatives of
an unaffiliated broker-dealer firm), the broker-dealer can either process the
new account applications at its home or branch office or it can forward them to
the fund's transfer agent for processing. This process is further complicated
for funds that are sold through a mutual fund "supermarket". In that case, the
"supermarket" receives and processes the new account applications and does all
recordkeeping for each shareholder, and the fund maintains an omnibus account on
its transfer agent system to track share purchases and redemptions. B. Transfers
of Information Necessary to Service the Shareholder Account or Maintain the
Shareholder Relationship All mutual fund organizations use personal information
to service their shareholders' accounts and maintain their shareholder
relationships. In order to do so, the information often must flow from a fund or
one of its service providers to another service provider, or vice versa. For
example, in order to provide the shareholder and the Internal Revenue Service
with necessary tax reporting information, a fund's transfer agent would need to
know that shareholder's name, address, social security or tax identification
number, account number, account balances, and transaction history. Without this
information, it would be impossible for the fund or its transfer agent to
prepare the necessary reports.(4) The sharing of information also allows mutual
fund organizations to offer certain valuable benefits to shareholders, such as
permitting exchanges among different funds within the organization or offering
automatic investment options. Sharing also must occur to provide shareholders
with consolidated account statements, reflecting all of their investments held
within the same overall financial services organization. This is a particularly
important benefit for shareholders of funds that are affiliated with other types
of financial institutions, as contemplated by H.R. 10. As noted above, service
providers to the fund may be affiliated or unaffiliated, meaning that
information often must flow to both affiliated and unaffiliated entities in
order to service shareholder accounts and offer the value-added benefits
described above. C. Transfers of Information for Other Purposes In addition to
using personal information to service shareholder accounts, some mutual funds
use this information to better communicate with their shareholders about other
products or services that may be of use or interest to the shareholders. For the
most part, this communication takes the form of information about products or
services offered by the fund organization itself (e.g., other mutual funds).
Mutual fund organizations that are part of larger financial services firms, such
as those contemplated by H.R. 10, may also use personal information to inform
their customers about the products and services offered by their affiliated
financial service providers (e.g., brokerage, investment advisory or trust
services). These uses of information benefit shareholders in at least two ways.
First, a mutual fund organization might use personal information to reduce the
number of mass mailings a particular shareholder receives, sending that
shareholder only information considered to be appropriate given his or her
transaction history. This results in better service to the shareholder, at lower
cost. Second, these communications often are intended to educate shareholders
about the range of investment choices available to them. Ultimately, this
enables shareholders to make informed decisions regarding their personal
finances. It should be noted that offering documents and sales literature for
mutual funds and other securities products and services (e.g., investment
advisory services) are strictly regulated under the federal securities laws. We
are not aware of any widespread use of personal information in the mutual fund
industry apart from servicing shareholder accounts or cross-marketing other
financial products and services. In particular, we are not aware that any of our
members sell their customers' personal information to unaffiliated companies or
otherwise view that personal information as a source of additional income. IV.
INSTITUTE RESPONSE TO LEGISLATIVE AND REGULATORY PROPOSALS REGARDING SHAREHOLDER
PRIVACY The Institute has been an active participant in the public debate over
how best to address financial privacy issues. Over one year ago, the Institute
urged the National Association of Securities Dealers to adopt a rule governing
the sharing of customer confidential financial information by NASD members with
business affiliates and others.(5) The Institute supported an approach that
would require disclosure to customers of transfers of information to business
affiliates. The Institute's recommendations to the NASD highlighted the
importance to mutual fund organizations of being able to share information with
affiliates and other service providers. Legislative or regulatory proposals that
would restrict this critical type of information sharing would create serious
obstacles that ultimately would diminish the range and quality of services
provided by fund organizations. For example, an opt-out provision(6) that
applied to mutual funds would necessitate the development of systems that could
(1) differentiate between shareholders who opted out of certain information
sharing and other shareholders and (2) track this information on an ongoing
basis. In addition, fund organizations would have to institute procedures and
train personnel to ensure continuing compliance. The costs of these measures
likely would be substantial and would be difficult to justify given the small
number of people likely to opt out. As a result, these costs may discourage some
fund organizations from engaging in the activity that would give rise to the
opt-out. Requiring that shareholders opt in would be even more problematic,
because of the extreme difficulty of obtaining affirmative consent. Proposals
that would require shareholders to opt in before their information could be
shared with anyone, including an affiliate, essentially would make it impossible
for mutual funds to conduct normal business operations. The same proposals with
an exception for servicing or maintaining the account would permit basic fund
operations, but essentially would prohibit a fund organization from offering
shareholders features that they have come to expect and/or other products or
services available through the fund organization.(7) For these reasons, the
Institute favors an approach that, subject to appropriate exceptions to allow
for servicing of customers' accounts and other necessary transfers (such as to
comply with legal requirements), would (1) require disclosure for transfers of
personal information to affiliates and other service providers and (2) permit
customers to opt out of transfers of information to unaffiliated third parties.
As mentioned above, fund shareholders generally do not know that separate legal
entities are involved in providing them with mutual fund products and services.
Similarly, we believe that the vast majority of information sharing among mutual
fund affiliates and service providers would not trouble most shareholders. This
sharing therefore should be permitted subject to appropriate disclosure. The
privacy provisions in H.R. 10 are consistent with the approach supported by the
Institute. Title V of H.R. 10 would require all financial institutions
(including mutual fund organizations) to adopt a privacy policy and disclose the
details of that policy to their customers. It would also require financial
institutions to give customers an opportunity to opt out and thereby prevent the
sharing or sale of their personal information to unaffiliated third parties.
There are exceptions for, among other things, transfers of information in
connection with maintaining or servicing the customer's account with the
financial institution. The Institute supports this balanced approach to
increasing consumer awareness and control over information without unduly
hampering the efficient use of information by financial institutions to provide
services for their customers. H.R. 10 would greatly expand current disclosure
practices and would give shareholders control over information sharing practices
that might reasonably be considered objectionable. At the same time, it would
allow mutual fund organizations and other financial institutions to use
information as necessary to provide the financial products and services that
customers desire and expect. Although the Institute supports the balanced
approach taken by H.R. 10, one important issue that H.R. 10 does not currently
address is the possibility that individual states could adopt inconsistent
financial privacy legislation that might upset this balance. Inconsistent state
requirements would be very burdensome for companies, such as mutual fund
organizations, that do business nationwide. If individual states were permitted,
for example, to adopt their own unique disclosure requirements, this could
necessitate the development of different disclosure documents for different
states or could lead to extensive and confusing disclosure in one document that
incorporates all state requirements. Similarly, it would be difficult, if not
impossible, to develop systems that could accommodate and ensure ongoing
compliance with different privacy requirements for residents of different
states. To avoid these results, we strongly believe that federal legislation to
protect financial privacy should override inconsistent requirements under state
law. We also are pleased to see Congress carefully considering privacy issues
and privacy legislation specifically in the context of the U.S. financial
services industry. As you know, privacy issues have received increased attention
internationally as well as domestically. There has been particular concern over
the effect of the European Union's Data Protection Directive,(8) and we have
closely followed negotiations between the U.S. Department of Commerce and the
European Commission over a "safe harbor" from that Directive for U.S. companies.
In this context, we have argued to the Department of Commerce that the European
model of comprehensive legislation for all sectors of the economy is not
appropriate in the U.S. One size does not fit all with respect to privacy. Rules
that are appropriate for the mutual fund industry, given the unique structure of
mutual fund organizations, may not be appropriate for another industry. As a
bill devoted to financial institutions, H.R. 10 recognizes this fact and crafts
a solution that is tailored to the U.S. financial services industry. We hope
that any safe harbor negotiated by the Department of Commerce will recognize the
privacy provisions in H.R. 10 and the rules promulgated thereunder as being
appropriate and adequate in protecting privacy for our industry. V. CONCLUSION
In conclusion, let me reiterate three points: First and foremost, the mutual
fund industry is committed to serving the interests of fund shareholders,
including protecting the confidentiality and security of their personal
information. We believe that good business practices currently exist in this
regard, and will continue to develop in the future. Second, information must be
permitted to flow between a mutual fund and its affiliates, as well as
unaffiliated service providers, in order to service shareholder accounts and
maintain shareholder relationships. Any legislative or regulatory approach to
privacy must reflect this fact, striking a balance between two important
shareholder interests: giving shareholders control over the uses of their
personal information and ensuring that they are provided financial products and
services efficiently. Finally, we believe that the privacy provisions in H.R. 10
strike an appropriate balance in this regard, and we therefore support inclusion
of these provisions in the final financial services modernization bill. Thank
you for the opportunity to participate at this hearing on financial privacy
issues. We would be pleased to provide any additional information that the
Subcommittee might request.
LOAD-DATE: July 26, 1999
