Squawking at 'Iron Rooster' Fund Managers

飞雪寒冰

Investment dividends from closed-end funds are a pretty sure bet in China, thanks to well-defined securities rules that require at least yearly dividends on earnings equal to at least 90 percent of a fund’s realized annual income.



But open-end fund investors lack an equivalent degree of regulatory protection from closed-fund watchers at the China Securities Regulatory Commission (CSRC). In fact, contract terms for earnings distributions at open-end funds are generally rather vague. They’re also testy for investors.



Because terms for open-end funds specify neither time periods for dividend distributions nor payout percentages, some money managers refuse payouts altogether, said a lawyer familiar with the system, speaking under condition of anonymity. Several tight-fisted money managers have been identified.



“Sixteen open-end funds are refusing to pay out,” the lawyer said. “This is apparently a violation.”

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An open-end fund managed by Southern Funds named 202002.OF is a typical example. Under terms described in its investor prospectus, at least some dividends should have been distributed since mid-2006.



Between July 2006 and June 2008 – when China’s stock market was strong -- the net value of each share of the 202002.OF fund exceeded the 1 yuan threshold for dividends. By the end of 2006, the fund earned 541 million yuan eligible for dividends of 0.1225 yuan per share. By the end of 2007, the fund could have paid dividends on 973 million yuan in available earnings. But not a single dividend was ever distributed.



As of February 25, nine of the 16 funds had met their own minimum requirements for dividend distribution.



Why don’t money managers want to distribute dividends? It appears they’re not batting for investors

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Money managers have an incentive to withhold dividend payouts: management fees. Payouts reduce the amount of money in a managed portfolio, since the net value of an open-end fund includes dividends on earnings. The fatter the fund, the higher the management fee. Any dividends saved can be used for future investments.



On the other hand, investors like dividends in part because they are tax-exempt. When an investor cashes out, however, the government collects a 25 percent income tax.



Some fund managers use dividends as a mere ploy to attract investors. A salesperson at a fund management company who asked not to be identified told Caijing that dividend distribution is merely a slick marketing tactic.



But in this environment, are investors being protected from unfair contracts? Perhaps not.

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Some fund managers use contract loopholes to minimize or avoid dividend payouts, said Hu Lifeng, a senior researcher at Galaxy Securities.



And in reality, despite its tight rein on closed-end funds, China’s regulatory policies and legal framework for open-end funds lean toward fund managers.



A typical contract defines each fund manager, trustee and investor as an independent party. In the real world, however, each trustee is a non-independent fund manager appointee, said Ma Yun, director of financial securities at the Suotong law firm.

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Neither securities regulators nor current laws specify a system for supervising and checking the hand of trustees. And CSRC has no influence in this regulatory vacuum, since all trustees for open-end funds are commercial banks operating outside the realm of the securities regulator.



Investor input into fund decisions is also weak. Most contracts say investors can call a general shareholders’ meeting if they want to amend terms or change a fund’s money managers and/or trustees. But a shareholders’ meeting does not have to be called for a change that does not “substantially affect” the interests of fund investors, according to a regulation for fund managers called the Securities Investment Fund Operations Measure. “Substantial affect” is not clearly defined.



Fed up with the system, some investors have considered lawsuits against fund managers. But they’ve been discouraged by high costs.

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Other investors have tried negotiating with fund managers, trustees and provincial and other local securities regulators. CSRC has criticized some fund management companies for failing to distribute dividends. But a stingy “iron rooster” style among managers still prevails in the industry.



Pursuing legal action against money managers is complicated when contract terms are vague, said a lawyer who has advised investors. “Fund managers can argue that dividend distribution will have disadvantageous effects on investors,” said the lawyer. “My suggestion for investors is that they directly report to regulators, which can bear fruit.”



Galaxy’s Hu suggests regulators encourage fund management companies to increase the percentage and frequency of dividend distributions. Dividends should be distributed monthly or quarterly, he said, and at least 50 percent of each realized monthly dividend and 75 percent of each quarterly realized dividend should be paid out to investors.



A source close to government regulators said CSRC should take a leadership role by closing loopholes and satisfying investors.



“CSRC should lead all parties toward fair, detailed and mutually beneficial contract terms,” the source said. “Terms regarding dividends should be designed in detail and with clarity. Fund managers should be more closely supervised. Loopholes in terms should be eliminated, and penalties” for violators “should be severe.”



1 yuan = 14 U.S. cents