Following an investigation of actively managed equity mutual funds by the Office of the Attorney General of the State of New York ("OAG"), 14 mutual fund managers ("managers") agreed to disclose "active share" information about the funds they manage to retail investors.

The OAG launched an investigation into over 2,000 actively managed equity mutual funds. The funds are considered popular with retail investors. The OAG surveyed 14 major mutual fund managers concerning their fees and disclosure practices during the investigation. In its report, the OAG made several key findings:

  • average fees on an investment in an actively managed fund were approximately 4.5 times more per year than fees on an investment in a passive fund;
  • higher fees or expense ratios do not necessarily reflect a higher level of active management; and
  • "Active Share" information, a widely used metric that measures the "degree of overlap between the holdings in a fund and the holdings in the fund's benchmark index," is provided to institutional investors but generally is not available to retail investors.

Following the OAG's investigation, 13 of the 14 mutual fund firms surveyed agreed to publish the Active Share metric for all investors in their actively managed equity funds (the 14th firm was already publishing Active Share information).

Commentary / Steven Lofchie

This is quite a significant settlement for a variety of reasons. First, it is possible that the "Active Share" information will provide useful investment information, though it is not certain that this is the case. The Report very strongly suggests that investors would generally be better served by investing in passively managed funds with lower expenses than in actively managed funds. It is implicit that the authors of the Report believe that the disclosure of the Active Share information is likely to drive investors to passively managed funds on the theory that the additional fees are not buying them much active management.

Even if the requirement imposed by New York State is sensible (and it might be), the imposition of the requirement has some negative significance in that it is an example of a state regulator effectively imposing requirements on the federal securities markets. That result inherently raises the specter of each of fifty state regulators creating divergent regulatory systems. One benefit of federal rulemaking is that there is a review process in which the regulators attempt to determine whether a rule is worth the expense, a process that is absent when state enforcement authorities impose a "settlement." Overall, the national regulatory system would probably be better served by NASAA (the collective state regulators) petitioning the SEC to adopt a rule, rather than having each of the state regulators go its own way.

Another possible outcome of the settlement is that the disclosure of Active Share information will cause mutual fund managers to increase the degree to which they diverge from a benchmark index simply to increase the Active Share number (rather than doing so to improve performance). Hopefully, it will not, as some managers are already making the disclosure to retail investors today.

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