TCS Daily

William Donaldson: Eliot Spitzer Redux?

By John E. Tamny - July 1, 2004 12:00 AM

The June 29th edition of the Wall Street Journal reported that in addition to the already large penalties levied against scandal-scarred mutual fund firms by Eliot Spitzer, those same firms will be required by William Donaldson's suddenly activist SEC to pay additional restitution to fund shareholders "even if they weren't in the fund on a day that the suspect (late and timed) trading took place."

Small expected "settlements" ($100) aside, retail investors should be more concerned about the long-term impact of what Donaldson's SEC is doing. Impossible as it sounds, Donaldson's "me-too" antics are every bit as harmful to the small investor as those of the man he presumes to be channeling: Eliot Spitzer.

SEC Chairman Donaldson is suddenly in the spotlight, and perhaps envious of all the fawning press received by Eliot Spitzer, seemingly wants to emulate him. Spitzer sees large fines and fee controls as a way to discipline the industry, while Donaldson apparently thinks all investors should be paid for merely having been exposed to the alleged miscreants.

Sadly, neither politician can foresee the second stage results of their actions; actions that will lead to higher fees and less choice for the small investor. For now it appears both view these fines and forced fee restitutions the way an insured patient views the doctor bill: something someone else pays for.

Back in the real world, most of us are starting to catch on to the reality that it's all of us who pay for those "free" doctor visits through lower pay, soaring insurance premiums, and increasingly narrow healthcare options assuming we're lucky enough to have insurance at all.

Aided by a bloodthirsty and alternatively naïve media, Donaldson and Spitzer will succeed in squeezing money out of the mutual fund firms, but investors should not be mistaken about who will pay those fines. It will be them.

It is a fact that large accounts are more profitable for mutual funds than small ones. To remain profitable amidst Spitzer's jihad against fees and Donaldson's disgorgement of same, some firms will simply shut out the small investor all together.

Of course there are ways around lower fees, and small investors can expect to see more of what Cato Institute senior fellow Alan Reynolds calls "maintenance fees" for small accounts. That is, once again, if small investors are allowed into certain funds at all.

Some mutual fund outfits like Strong are already up for sale as a result of the scandals, with more sales certainly on the horizon. Investors can expect funds sharing similar styles to be dissolved into others amidst these state-induced consolidations, with retail investors once again the losers given the shrinking number of asset managers competing for their assets.

The SEC has already succeeded in pushing through regulations governing who (independent vs. interested) can oversee fund management, with more regulations of fees sure to come. What aspiring money manager will wade into this increasingly regulated industry? Will the new regulations governing fees and management effectively shut out new competition altogether? Taking it further, how many existing managers will leave the industry for the greener pastures of the hedge fund world?

Basic economics tells us that customers are the beneficiaries when market-driven participants vie for their business. Time will tell, but nothing done by Spitzer or Donaldson will increase the aforementioned competition, though it's easy to point out how, much like the government-driven evolution of the healthcare industry, their actions will lead to less choice at a higher price, with a growing number of money managers off limits.

Also in the June 29th Wall Street Journal, James C. Miller III, former FTC Chairman and former OMB Director asked "What Would Adam Smith Say?" in light of the regulatory response to the mutual fund scandals. What a shame neither Spitzer nor Donaldson bothered to ask the same question.

John Tamny lives in Washington, DC and can be reached at


TCS Daily Archives