A report from the U.S. Government Accountability Office (GAO) finds 401(k) plan participants often face trading policies that restrict frequent or collective trading in mutual funds.
GAO reports often criticize current business or regulatory practices—for example when the watchdog group published a 2013 report alleging widespread impropriety among individual retirement account (IRA) service providers targeting qualified plan rollovers. But a new report on in-plan trading restrictions suggests current regulation “strikes an appropriate balance between a participant’s ability to manage his or her retirement investments and the duty of plan fiduciaries to operate and manage their plans prudently, at low cost, and solely in the interest of participants, and the obligations of mutual funds with respect to all their investors.”
GAO found the most common restrictions placed on participant-driven trading in 401(k) plans come in two forms. First are “discretionary provisions found in mutual fund prospectuses that allow mutual funds to reject purchases or exchanges of mutual fund shares they find inappropriate or disruptive to the fund’s investment and management strategy.” The other common form of restriction places a time limit on how quickly a participant can purchase additional shares of a given mutual fund after he or she traded out of the fund.
With these restrictions in place, GAO found frequent and collective trading by plan participants is uncommon. “Since the market timing abuses in mutual funds of the early 2000s, neither frequent nor collective trading by participants has been a concern for plan sponsors, mutual funds, or participant advocates that [we] interviewed,” GAO says.
GAO conducted the study to examine whether problems that arose in the early 2000s have been adequately addressed by retirement plan administrators and the investment companies that sell mutual funds to participants. At that time, GAO explains, “federal regulators identified patterns of short-term trading abuses in mutual funds, including certain undisclosed market timing practices.”
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Such practices compromise the savings of long-term investors because they have the potential to dilute the value of mutual fund shares, disrupt the efficient management of a fund’s investment portfolio and increase net fund costs. GAO notes that, in response to these practices, federal regulators adopted rule changes requiring mutual funds to disclose any frequent trading policies in their prospectuses and to permit the imposition of redemption fees of up to 2% of the sales price for fund shares redeemed within a short time period.
The report goes on to acknowledge that some participants in 401(k) plans are skilled enough to actively manage their retirement accounts to seek higher returns, but most are not. Participants who take charge of their own trading often incur additional fees or face trading restrictions due to, for example, trades they make based on third-party investment advice.
“At times, the objectives of plan fiduciaries and of mutual funds may seem in conflict with those of plan participants,” GAO says, but in general the restrictions put in place by plan officials and investment providers work in favor of participant returns. Again, it’s highly unlikely that a participant could predict short-term market movements with the consistency required to make this a reasonable long-term investment strategy.
The findings are gleaned from extensive interviews with government officials, academics, industry representatives, officials at mutual funds, retirement plan recordkeepers, participant advocates, and retirement plan sponsors representing a range of industries and plan sizes. GAO also reviewed trading policies found in a non-generalizable sample of 15 mutual fund prospectuses and five summary retirement plan documents.
The full report is available for download here.
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