Mutual Fund Proposal No "Treat" for Retirement Plans

October 31, 2003 ( - Plan sponsors and plan participants got tricks, not treats, from the mutual fund industry's chief lobbying group yesterday.

The Investment Company Institute, while acknowledging that its recommendations would “affect millions of fund shareholders, thousands of intermediaries, and hundreds of fund companies,” nonetheless called for industry reforms that, if enacted as described on their face, are certain to put retirement plan investors at a significant disadvantage.

Backed Up?

The most onerous of the proposals was that all trading orders should be received at funds firms themselves – not through intermediaries – by4:00 p.m.Eastern Time.   Today, the vast majority of 401(k) programs allow participants to place trades up till 4:00 p.m.with their recordkeepers, though the actual details of the trades are not physically delivered to the fund companies until later in the evening.   For over a decade, those communications have been predicated on the representations of recordkeepers to fund companies that the trades were received prior to the market close/cutoff.

The ICI recommendation, which echoed earlier sentiments by Securities Exchange Commission Chairman William Donaldson (see  SEC to Consider Post-Canary Scandal Trading Reforms ), would likely require that recordkeepers impose deadlines earlier in the trading day in order to comply with a 4 p.m. delivery of those instructions to the fund companies.   Depending on the sophistication of the intermediary, the recordkeeper, the fund company, or some combination thereof, participants might conceivably have to wait as long as 24 hours for their trades to be processed – a point ICI president Matthew Fink acknowledged in a conference call Thursday.

In putting forth the proposal, the ICI said, “We considered but rejected exceptions to the deadline for entities subject to full SEC regulation. We considered but rejected several procedural options that would have closed the late trading window substantially, but not all the way. Finally, we considered but rejected reliance on accelerated technological developments,” noting ultimately that “the technology simply could not be ready fast enough to meet our needs.”

Redemption Fee

The ICI also recommended to the SEC that all funds (other than money market funds) be required to impose a 2% redemption fee on the sale of shares made within five days of purchase (that fee would be reallocated to the fund shareholders, not pocketed by the fund company).   The ICI said this was “the only option that ensures that the fees’ desired deterrent effect would be felt in the thousands of omnibus accounts that mutual funds do not and can not control.”

In view of how infrequently most participants trade in their retirement accounts, that change might have little immediate impact.   On the other hand, it could impose a significant burden on recordkeepers who would, therefore, have to track the transactions.   It could become even more complicated if some form of tax lot accounting requirement emerged to track the holdings at a participant level.   The costs of this kind of change will almost certainly be born by fund shareholders, including retirement plan participants.

Finally, in what is undoubtedly the least controversial measure in the package, the ICI called for mutual fund firms to tighten their internal ethical codes on any personal trading by fund employees.

The ICI's proposals represent an attempt to reclaim the high ground in the mutual fund scandal that has widened on a weekly basis ever since New York State Attorney General Eliot Spitzer unveiled a series of allegations that hedge fund Canary Capital Partners obtained special trading opportunities with Strong, Bank of America's Nations Funds, Banc One, and Janus by promising to take substantial positions in various funds managed by these institutions in early September (see  Ripples of Canary Fund Trading Probes Continue to Spread ).   Since September, the probe has expanded to include a number of other fund companies, brokers, and independent trust company Security Trust (see  Market Timing Leads to "Late" Departure of Putnam Fund Managers ).  

ICI Chairman Paul Haaga said mutual funds would continue to work with the SEC and other government officials to seek additional possible responses to the issues uncovered by ongoing investigations. "Our commitment to righting the wrongs that arise from these investigations comes with no caveats, limitations, or qualifications. We said `everything is on the table to protect fund shareholders,' and we mean it. We said we would embrace whatever it takes to rebuild investor confidence and we mean that too. Our decisions today are important steps in an ongoing process."