On the Money the War on Gobbledygook

By JOHN ROTHCHILD

The new chairman of the securities and exchange Commission, Arthur Levitt, wants to take the confusion out of investing, and his crusade is raising eyebrows on Wall Street -- which until now has managed to make investing as confusing as possible.

Beginning this week, you can call the new SEC hotline (1-800-SEC-0330) and get prerecorded answers to a variety of questions about stocks, bonds and mutual funds. But Levitt has more ambitious plans, starting with how to get the straight story out of your stockbroker.

As it stands now, broker-client is the most one-sided of all human relationships. Before you can open an account, brokers make you fill out a questionnaire in which you must reveal your net worth (something you wouldn't tell your best friend) and whether you are a gambler or a tightwad -- all in the interest of designing a custom-made portfolio. At the end of this inquisition the broker knows a great deal about you, whereas you know almost nothing about the broker. Then you hand over your life's savings to this total stranger.

Levitt thinks the broker should answer a few questions on his own, such as, "Have you ever been censured or reprimanded or been a party to an arbitration settlement?" and "What's in it for you?" The broker may be getting commissions the client doesn't even know about: extra bonuses for selling the in-house mutual funds or free trips to Hawaii for selling the "product of the week." Did you realize, for instance, that a broker who switches firms is often rewarded with a double commission on whatever he buys and sells during his first few months on the new job? This explains why the stock he told you to buy when he worked at Dean Witter, he wants you to sell when he gets to Smith Barney.

If Levitt had his way, the commission system would be abolished altogether and all brokers put on salary so they could give the disinterested advice they're supposed to be giving. Short of that, he would settle for taking the gobbledygook out of mutual-fund literature.

Several states, in their homegrown securities offices, have been teaching consumers how to decipher what mutual funds are saying. These education projects are funded with fines and settlements paid by Wall Street firms that on occasion landed on the wrong side of the law: Prudential, Salomon Brothers and the old Drexel Burnham Lambert. Getting hoodwinkers to bankroll a program to train investors to avoid being hoodwinked has a nice symmetry to it. Levitt, meanwhile, is taking consumer education to the national level. The sec has recently published a useful pamphlet, Invest Wisely, that demystifies the mutual fund, but Levitt's real goal is to get the mutual funds to demystify themselves.

This year the Public Advocate for the City of New York studied 30 typical prospectuses and found a rich harvest of obfuscation, especially when it came to the fees, to the risks being taken by the funds and to the descriptions of how well the funds performed. "A dense set of numbers with technical subheadings and little or no explanation" is how the Advocate's office described these documents.

To show how a prospectus can be improved, Levitt took a typically dense paragraph, shown here, and asked Warren Buffett -- America's most successful stock picker -- to translate it into simple English. Suddenly, the fog lifted.

Maybe that's what the industry should do -- hire Buffett to write all the mutual-fund prospectuses so investors would know what it was they were buying. And here's another idea: if we've got food labels and energy labels, why not an investment label? That's a proposal being floated by the Advocate's office. Fees and commissions, the performance of the fund, the risk rating and a short explanation of the strategy -- including any extra risks the fund is taking with, say, derivatives -- could all be included on the label. Maybe there could also be a generic fund warning INVESTING CAN BE HAZARDOUS TO YOUR WEALTH, AND SHOULD NOT BE COMBINED WITH ALCOHOL.

So far, the industry has expressed a willingness to cooperate with Levitt, and half a dozen or so funds have decided to try communicating in English. Many of the "conservative" bond funds have got heat from investors who lost money in 1994 and are saying they didn't understand what they had invested in. The managers of these funds have learned that an uninformed consumer can easily turn into a hostile consumer.

If Levitt succeeds, we'll soon see the day when investors know as much about how to invest their life's savings as they do about how to buy toaster ovens and tires. But good writing alone won't solve the biggest confusion with mutual funds: there are too many of them. At current count we've got twice as many funds as there are stocks on the New York Stock Exchange. Getting rid of a few thousand would be a big help.