With all the talk of "systemic risk" and "too big to fail," small investors might assume that the landmark Dodd-Frank financial overhaul bill has little bearing on their portfolios.
They would be wrong.
Buried in the bill's 800-odd pages are the most sweeping regulatory changes for ordinary investors in decades, affecting everything from mutual funds and retirement plans to single-stock investments and other holdings.
The legislation has the potential to make brokers more accountable to their clients, shine light on hedge funds and improve the transparency of the complex derivatives on which many mutual funds and pension plans rely to hedge their risks.
Several provisions promise to give investors a louder voice in policymaking circles and corporate boardrooms. Within the Securities and Exchange Commission, for example, the bill sets up an Office of the Investor Advocate designed specifically to assist retail investors, and an Investor Advisory Committee, which focuses on initiatives to protect investors' interests.
The bill also gives the SEC authority to make it easier for shareholders to nominate directors for corporate boards.
Yet despite its hefty dose of investor-protection provisions, the legislation isn't a home run for small investors, analysts and investor advocates say. So-called stable-value funds, popular investments among the most conservative 401k participants because they are designed to deliver smooth, steady returns, are left in limbo, awaiting regulatory decisions that could affect their costs and availability in retirement plans.
Likewise, while investor advocates had pushed aggressively for the SEC to oversee equity-indexed annuities, these complex products escaped the agency's purview.
What's more, the bill's full effects on small investors likely won't be known for some time. Many provisions call for regulators merely to study certain issues or give them the power, but not the obligation, to make certain rule changes.
But in the meantime, investors can prepare for some significant changes in their mutual funds, hedge funds, retirement plans, brokerage accounts and single-stock holdings. Here are the important factors to watch:
Mutual funds
Although mutual funds are barely mentioned in the Dodd-Frank bill, the legislation could affect everything from funds' bond and derivative holdings to how these products are advertised to investors.For bond funds, the bill creates some uncertainty and could even boost volatility in certain types of holdings, managers and analysts say. That is because it gives the Federal Deposit Insurance Corp., which can seize troubled financial institutions, leeway to pay investors holding identical bonds issued by that institution differing amounts. If investors aren't sure how they will be treated in such a scenario, they may demand higher yields, which means lower bond prices, or they may dump the bonds at the first sign of trouble, money managers say.
The provision "can have all sorts of unintended effects," says Bob Auwaerter, the head of fixed income at mutual fund company Vanguard Group. If mutual funds are trying to sell bonds as the issuer tumbles toward default, the potential for unequal treatment of bondholders "will reduce liquidity and lower the price," Auwaerter says.
One little-noticed provision in the bill could be critical for mutual fund investors prone to poor market-timing decisions. It calls for the comptroller general to study mutual fund advertising, including the use of past performance data, and recommend ways to improve investor safeguards.
Academic research suggests that "short-term performance ads really do drive investor dollars, and unfortunately not in a good way," says Ryan Leggio, a fund analyst at investment research company Morningstar. "Those usually lead investors to the hot fund of the month or the year."
