The 1940 Act is old, but is a shareholder friendly approach
There is an interesting post by Mark Cuban, asking if Madoff investors are better off than mutual fund investors. (click here for the post) It is thought provoking, but a little misleading. Eligible Madoff investors are not “getting their money back”, they are getting the securities they believe they had in their account, nothing more, and nothing less (at least to the extent of the SIPC coverage). The questions that should be asked are should SIPC conduct greater due diligence over brokerage firms they insure, and did they rely to heavily on other regulators. Unfortunately, if the scenario is as Mark describes and they “were able to invest through a friend”, unfortunately, that investor is probably not covered under SIPC, and they would have been very happy with the mutual fund return.
As much as the 1940 Act rules are criticized for being old and antiquated, the rules provide for a very shareholder focused structure, that provides a significant amount of accountability and transparency. It is certainly not perfect, but there has been relatively little “major” fraud in a mutual fund/ETF structure. As the SEC reviews its regulatory framework, I hope they look for opportunities, to bring hedge fund strategies into the 40 Act structure. Why not allow for true performance fees in a mutual fund or actively managed ETF? If we are trusted enough to shop for the right value and price when selecting an automobile, why can’t we be trusted to find the right value and price when selecting an investment. And while I am asking for things, let’s get rid of the required capital gains distribution for funds. Let the gains carry in the fund, and when the shareholder sells, the shareholder pays their appropriate tax. I know this would have other ramifications to tax revenue, but it would put the fund on the same playing field as a stock (from a tax perspective), it has worked well for Berkshire Hathaway and GE (both mutual funds disguised as stocks), why not for a true mutual fund or ETF?