GAO Tells SEC to Be Mindful of 401(k) Market Timing Concerns

August 9, 2004 ( - A government watchdog group is concerned the Securities and Exchange Commission's (SEC) "hard close" proposal to combat late-trading and market-timing abuses could do more harm than good for retirement plan participants and thus, the agency is asking the SEC to consider a couple alternatives.

Examining the proposals submitted by the SEC at the end of 2003(See  SEC Lays Down Mutual Fund Proposals ), theGovernment Accountability Office (GAO) said plan participants could be distinctly affected by the late-trading proposal because it creates potential complications in processing certain transactions unique to pension plans, such as plan loans, according to the GAO’sreport to theSubcommittee on Oversight, Committee on Ways and Means, US House of Representatives.

Further, the GAO sees potential problems with the proposed regulations and expected cost increases, such as for technology updates thatwould be passed on to long-term mutual fund investors.   Also, the new “hard close” rules could result in retirement plan participants paying fees intended to deter market timing, “even when there is clearly no intent to engage in abusive trading,” the GAO said.

GAO Alternatives

Under the SEC’s proposal, for all fund transactionsa fund or a certified clearing agency – rather than an intermediary such as a broker-dealer or other unregulated party – would have to receive a purchase or redemption order prior to the 4 p.m. close for an investor to receive that day’s price.   Also, to curb short-term trading, including market timing, SEC has proposed regulations that would impose a 2% fee on the proceeds of fund shares redeemed within five business days of purchase.

As an alternative, the GAO makes two recommendations:   t he “Smart 4” proposal, which “seeks to maintain the flexibility intermediaries currently enjoy of accepting fund orders until the market close and then processing and transmitting them sometime after the market close,” and the “Clearinghouse” proposal, which “would require all mutual fund orders to receive an electronic time stamp at a central location that would verify their time of receipt.”

Under the Smart 4 proposal, all companies that want to accept orders until the market close, and process them thereafter, would be required to adopt a three-part series of controls:

  • electronic time stamping of all transactions so all trades could be tracked from the initial customer to the mutual fund company;
  • annual certifications by senior executives that their companies have procedures to prevent or detect unlawful late trading and that those procedures are working as designed;
  • annual independent audits.

The Clearinghouse proposal would require all mutual fund orders to be time-stamped electronically by an SEC-registered central clearing entity before the market close to receive that day’s fund price. The clearing entity’s time stamp would be considered the official time of receipt of an order for a mutual fund transaction.

“SEC officials told us that they are considering changes and alternatives to the proposed regulations that would address these concerns,” the GAO said.   ” Without such changes, pensionplan participants could face complications with certain transactions that are unique to pension plans and be assessed fees when they would clearly not be engaging in abusive trading.”

The GAO is not alone in its concerns about the impact of such a proposal on retirement plan participants.   Last week, the SPARK Institute, a 401(k) industry group, submitted its plan to the SEC for allowing intermediaries to submit mutual fund orders after 4 p.m.   The group’s proposal, unveiled in April (See Trade Group Pushes Hard Close Alternative ) would restrict the post 4 p.m. orders to those based on “instructions” received from plans and plan participants before 4 p.m., and to the intermediaries that had adopted the stipulated controls, policies and procedures designed to prevent late trading.

A copy of the full GAO report is available at