SEC Denies ICI Petition to Regulate Folios By John Spence August 24, 2001

Chalk one up for do-it-yourself investors. The Securities and Exchange Commission (SEC) released a letter yesterday denying an Investment Company Institute (ICI) petition filed in March to regulate online stock baskets, or folios, as mutual funds.

Essentially, the SEC said folios should not be regulated under the Investment Company Act of 1940 because folio investors have the power to make their own investment decisions. Investment company (mutual fund) investors, on the other hand, own an undivided interest in a pool of securities, and have no control over specific investment decisions in the portfolio. Also, unlike mutual fund investors, folio investors are the beneficial owners of the securities in the folio.

"From day one when the ICI first released its opinions on whether or not folios should be regulated as mutual funds, we believed their arguments had no legal merit," said Nancy Smith, who is in charge of investor education and content at Foliofn.

Commenting on investor protection issues raised by ICI, the SEC said folios will be regulated as broker-dealers, and would be held responsible for unscrupulous sales practices.

"We were confident that our nation's longstanding and comprehensive set of broker-dealer regulations was appropriate for folios and for investors," said Steven Wallman, founder and CEO of Foliofn, in a statement. "The SEC has now dispelled any possible doubts on this issue and affirmed that the path is clear for this innovation."

Wallman is a former SEC commissioner, while Smith previously served as the director of the Office of Investor Education and Assistance for the SEC.

Folios are personalized stock baskets with a maximum of 50 holdings. Foliofn charges $29.95 a month or $295 a year to maintain up to three folios, with additional folios costing $9.95 a month or $95 annually. For those fees, investors can trade twice daily and can utilize Foliofn's tracking and research tools.

Foliofn also currently has 124 "ready-to-go" folios that provide exposure to various slices of the market, such as large-cap growth or energy sector stocks. In June, the firm expanded its services to allow advisors to create proprietary stock baskets and subscribe them to clients.

Other competitors in the online stock basket space include Netfolio, Universal Network Exchange (UNX), ShareBuilder, and SmartLeaf.

Folios have been viewed as a potential threat to the mutual funds, so it should come as no surprise that the mutual fund industry's trade group, the ICI, requested stricter regulation for these relatively new investment products. However, many observers feel the threat has been exaggerated, and that folios are more of a niche product.

"I think folios will be important for the online trading crowd and for people who have the time and energy to manage folios," said CBSMarketWatch mutual funds columnist Paul Farrell. "However, I don't know if your typical buy-and-hold investor wants to be bothered with the extra effort."

When Chicago-based fund-tracker Morningstar recently polled readers for the biggest threat to the mutual fund industry, 59% said a prolonged market downturn, 24% said quality managers leaving to run hedge funds, 14% replied exchange-traded funds, and just 4% said folios.