Fed Asks Employees to Stop Market Timing Thrift Plan Shares

December 9, 2003 (PLANSPONSOR.com) - Officials at the Federal Reserve are putting out a plea to members of their employee thrift plan: please stop using market-timing strategies in the plan's mutual funds.

Plan administrators for the Federal Reserve’s employee thrift plan have sent two letters to plan participants since September, outlining problems from market timing originally identified by T Rowe Price Associates, which runs the international stock fund.   Additionally, officials at the plan are imposing new rules intended to discourage the market timing of the international fund option, according to a Wall Street Journal report.

T. Rowe Price identified “frequent trading activity” in approximately a dozen Fed employee thrift plan accounts, some of which belonged to former employees.   However, a spokesman for the Fed assured the Journal that none of those employees engaged in the alleged market timing activities had access to sensitive information of the bank’s Federal Open Market Committee (FOMC).


At the time the trading occurred though, a Fed spokesman told the Journal that the trading was permissible, a catch that personifies the rub of the whole market timing fiasco.   While market timing – the rapid trading in and out of mutual fund shares to gain advantage of price differentials – is not illegal per se, it is frowned upon and often discouraged in fund prospectuses.   However, even when the trading is done within the guidelines of the fund’s prospectuses or, in this case, an employee retirement plan, it can raise operating expenses for a mutual fund and siphon off profits from a portfolio, harming long-term investors in the funds.

Last year, Stanford University business-school professor Eric Zitzewitz estimated that such trading costs long-term investors $5 billion annually in his “Who Cares About Shareholders? Arbitrage-Proofing Mutual Funds” paper.   Zitzewitz’s study also concluded that investors could earn 35% to 70% annually pursuing such trading strategies in overseas mutual funds.  

That siren song apparently was too much for Zitzewitz to ignore, as he engaged in extensive timing trades during a three-month period this summer, a separate Journal report found.   Further, highlighting the market-timing conundrum, in a statement, Zitzewitz said, “The trading I did was based on a known pricing anomaly and was legal: No trades were placed after 4 p.m. and there were of course no quid-pro-quo arrangements with mutual funds.”   However, even though the trades did not necessarily violate any rules, they resulted in disciplinary action against his broker at UBS AG for alleged violation of the firm’s policies against such rapid-fire fund trading. UBS fired two brokers and suspended nine others last month for alleged violations of the guidelines, which were put in place in December 2001 (See  UBS Cans Two Brokers for Market Timing ).

In the most recent letter sent to the Fed's thrift plan participants, dated December 1, officials for the plan said starting this month, participants will face a new "14-day" rule that will restrict the transfer of their retirement-plan assets among many funds.   The new rule for Fed current and former employees will require a 14-day waiting period between transfers of money among the following choices in the thrift plan:

  • International Equity Fund
  • Balanced Fund
  • Equity Fund
  • Equity Index Fund
  • Small Company Fund
  • Government Securities Fund.

The letter went on to say the extra trading prohibitions were put in place amid "increased regulatory and public scrutiny of mutual- fund trading practices" and with an eye toward "the responsibility to protect participants' assets." The letter added that current and past Fed employees "hold ourselves to the highest standards of professionalism and public trust."

Overall, the Fed's employee benefits system, administered by Hewitt Associates, has $7.5 billion in assets. About $2.7 billion of that is in the defined contribution thrift plan.   The plan is open to all 26,000 employees of the Federal Reserve Board and the Reserve Banks.

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The revelation of continued market timing activities in the Fed's retirement plans recalls memories of two other related events.   In October, it was revealed that 10 members of New York Local 5 of the Boilermakers Union made more than $4 million in profit through 2,672 trades of Putnam Investments mutual funds from 2000 to 2003, according to Massachusetts state regulators (See Union K Plan Trading Activity Leads to Putnam Fund Probe ).   Then to add a Shakespearian twist to the story, Massachusetts divulged in November that two state employees had been market timing the international stock fund option of the state's deferred compensation plan (See Two Mass. Employees Caught Market-Timing Mutual Funds ).  

Overall, more than 100 trades were made this year by the husband and wife duo betweeninternational stock funds and money market accounts.  Of those, at least two dozen of these transactions were conducted in the weeks following the mass media coverage of market-timing and late-trading scandals erupting throughout the mutual fund business (See Market Timing Leads to "Late" Departure of Putnam Fund Managers ).