(From Money Management Executive)
As funds companies and their intermediaries continue to grapple with a Securities and Exchange Commission redemption-fee rule, industry groups have been working out ways to simplify compliance.
The rule, which is to take effect Oct. 16, has been controversial since its March 2005 adoption. It allows fund companies to impose a redemption fee of as much as 2% on shareholders who sell their stakes within one week of purchase. Meant to discourage market timers whose trades might increase expenses for long-term shareholders, the rule poses logistical challenges for intermediaries and offers little guidance on how to meet them.
“One of the main questions we were getting from our members was, ‘What is everyone else doing? What guidelines should we follow?’ ” said Larry H. Goldbrum, general counsel at RG Wuelfing & Associates and the chairman of the government relations committee at Spark Institute, an organization of retirement plan service providers with headquarters in Simsbury, Conn.
The SEC rule leaves to the discretion of fund companies just what information is required, how often it is requested, and in what format it should be delivered. The companies are then responsible for determining that none of their internal market-timing policies has been breached.
“The onus will be on the fund companies,” said Tamara Salmon, a senior associate counsel at the Investment Company Institute, the trade group for the mutual fund industry. “The SEC will come down on the mutual funds, not the intermediaries, to demonstrate that they are in compliance.”
The rule further requires that fund companies negotiate and have in place agreements with all their intermediaries before Oct. 16, a task that has been projected to cost at least $2 billion industrywide. Progress on this complicated endeavor has been slow as fund companies and their intermediaries looked to the SEC for clarification.
Meanwhile, Spark Institute is one of several groups that has lobbied the SEC for an extension of the rule’s effective date.
It cited a survey of its members in which 70% said they could not meet the Oct. 16 deadline and 39% said that doing so would require a commitment of “significant additional resources.” Spark’s report also said many of its members had yet to receive contracts from the mutual fund companies with which they work.
The Investment Company Institute in Washington, which has supported the rule, requested an extension of at least six months, and the National Association for Variable Annuities in Reston, Va., has lobbied for an 18-month delay so that insurers can determine fees and devise a way to accommodate the automatic rebalancing programs that many plans offer without triggering redemption fees.
Ms. Salmon noted that there is a loophole. “They can choose funds that don’t have redemption fees,” she said. The rule, as revised from its original form, leaves to each fund’s board of directors the decision whether to impose the fee.
As the SEC considers these requests and continues to fine tune the rule and clarify its language, industry groups like Spark are developing template contract language and best practices guidelines to prepare their constituents.
The institute’s guidelines, published June 29, came out of consultations with both retirement record keepers and fund companies in an effort to devise a system amenable to both and still within the rule’s general parameters.
“There were unlimited possible variations of how fund companies want to enforce market-timing restrictions and how the monitoring is done,” said RG Wuelfing’s Mr. Goldbrum. “This kind of limits the field.”
The best practice guidelines call for record keepers to be required to monitor only the transactions that participants request be scrutinized for potential market-timing or other trading abuse. The guidelines would exempt all purchases and redemptions under $1,000. They also call for round-trip monitoring periods to be defined as 60 days and suggest software development guidelines.
“Record keepers should program their systems in order to also accommodate a 30- or 90-day identification period that may be required by certain funds,” the Spark guidelines said. “However, unless the needs of the fund are so unique as to warrant an exception, record keepers should encourage the funds to accept the 60-day period in order to minimize the number of alternatives required for compliance.”
The guidelines also suggest that the monitoring period be defined as the 60 days immediately after a round-trip trade, or the two calendar months after such a trade, whichever a record keeper’s computer system is better fit to handle. Furthermore, the guidelines suggest that the rolling period allow no more than six round trips annually before incurring trade restrictions.
Participants that exceed the appropriate number of round-trip trades should be barred from exchanges or purchases for 60 days after the offending trade and must be notified in writing of the date when they will again be allowed to trade, the guidelines said. Restoration of trading privileges should be automatic, they said.
As for how record keepers report trading activity to funds, Spark called for monthly reports of any restriction imposed during the month and an annual compliance report prepared by an outside auditor.
Finally, the guidelines call for record keepers to clearly communicate their standards and practices to funds; plan sponsors; and, in enrollment documents, to participants. The information should be repeated to participants through trade confirmations, or regular account statements, as well as before monitoring begins.
The guidelines, like the sample contract language, are meant to serve as a framework. They would also be a means to control the cost to intermediaries, which Spark estimated at $30 million to $50 million a year for the time, software, and system changes that would be required.
