Written by Max Rottersman     Posted on February 20, 2007

Max Rottersman has been a consultant in the mutual funds industry since 1989. He publishes a blog about fund data analysis at www.fundr2.com

No one should underestimate the amount of sacrifice and hardship that XBRL would require from the mutual fund community.

As a mutual fund chief compliance officer between 2003 and 2004, I never found a regulatory problem that XBRL would have fixed. This isn’t to say XBRL is not worth doing, or can’t deliver improvements for regulators and investors alike. But XBRL has a better chance of succeeding if its proponents understand the challenges facing real-life compliance professionals.

Fund compliance starts with seven Congressional acts: The Securities Act of 1933; the Securities Exchange Act of 1934; the Public Utility Holding Company Act of 1935; the Trust Indenture Act of 1939; the Investment Company Act of 1940; the Investment Advisers Act of 1940; and the Sarbanes-Oxley Act of 2002. These laws run over a thousand pages; the SEC maintains thousands more in complex rules. In addition, there are requirements from the NASD, states, case law, and more.

These regulations, which are continually changing, cover distribution, custody, board responsibilities, voting procedures, fees, contracts, and so forth. How intricate is all this? Imagine trying to learn C++, Java, Basic, COBOL, Assembly Language, Perl, etc. so that you never made a serious mistake in any of those domains. It’s not possible. Similarly, each area of compliance is handled by a specialist with years of experience.

XBRL promises efficiency and accuracy, but getting the numbers right is not a major problem in compliance. The priorities are:

1. Making sure the fund is operating legally (with SEC enforcement and class action lawyers hovering about, even innocent technicalities are no laughing matter).
2. Making sure the shareholders understand what the fund is doing on their behalf (and that the fund is actually doing it).
3. Making sure the fund has properly disclosed third-party service provider arrangements and that there is no conflict of interest.

I’ve witnessed millions of dollars and careers that have been ruined from incorrect or cavalier interpretations of the rules. I’ve never heard of someone losing their job over bad data. Therefore, XBRL will have a hard time selling itself to the fund community based on arguments for efficiency and data integrity. These promises are out-of-touch, if not irrelevant.

For XBRL to succeed in the fund industry it needs to think small and find an area that benefits both the shareholder and fund.  It needs to prove that the trade-off in learning XBRL for the fund professional is worth the benefits.

One possibility is that XBRL can deliver create-your-own prospectuses. If so, the SEC might change the rules so that fund companies can legally provide short-form prospectuses and annual reports (an idea the SEC developed before the Internet was mature).

The Investment Company Institute (ICI) and SEC have given XBRL some nice PR. But only with realism and focus will the fund industry ever adopt it.

Add to Del.icio.us | Digg this

This entry was posted on Tuesday, February 20th, 2007 at 5:17 pm and is filed under General, . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.