Compliance November 20, 2003

Mutual Fund Reform Sails Through House

November 20, 2003 (PLANSPONSOR.com) - The House of Representatives overwhelmingly got behind a mutual fund reform bill yesterday - and while it may not make it into law this year, it offers some hope for both those concerned about the need for reform and those concerned about the shape those reforms might take.
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>The bill, H.R. 2420, sponsored by Representative Richard Baker (R-Louisiana), passed by a 418-to-2 vote (the two “no” votes came from Representatives Ron Paul (R-Texas), and Jeff Flake (R-Arizona).   Significantly, it would establish a strict monitoring of 4 p.m. trading deadlines with an audit trail – but that requirement could offer a ray of hope to plan sponsors and participants who would potentially be impacted by a proposal touted by the Investment Company Institute that would impose a “hard” requirement that all mutual fund transactions be delivered to the mutual fund by 4 p.m. (see Mutual  Fund Proposal No “Treat” for Retirement Plans ).

Trading Places

>Referencing that audit requirement, the American Society of Pension Actuaries (ASPA), said that the provision “will protect the retirement security of 401(k) participants by providing the SEC with greater assurance against late-day trading, without negatively impacting the investment rights of 401(k) participants,” according to a news release.   According to Brian H. Graff, Esq., ASPA’s executive director, “If the SEC adopts the rule currently being considered, it would prevent a substantial majority of 401(k) participants from being able to trade on the same day and get the closing price of that day.”  

>ASPA, as well as a number of employers and employer groups, has previously expressed concerns about the ICI proposal (some parts of which have been embraced by some at the SEC)   (see  K Plan Participant, Recordkeeping Groups Fret Over ICI Proposals ).     

Systems Stamp

>However, in response to the audit requirement included in Baker’s bill, ASPA noted that “sophisticated software systems used by plan administrators can easily be modified to ensure that there is no possibility of manipulation by either the third-party recordkeeper or the intermediary. Each of these systems date and time stamp every trade using an atomic clock, and will be subject to an independent audit under the proposal. Further, these systems are transparent, allowing the SEC to verify that trades are not received after hours.”

>Additionally, the Mutual Funds Integrity and Fee Transparency Act of 2003 would allow - but not mandate - funds to charge more than a 2% fee to discourage short-term trading.   The bill would also:

  • Require two thirds of a fund's board of directors to be independent;
  • Ban fund executives from short-term trading in shares of their own funds;
  • Prohibit the same person from managing a mutual fund and hedge fund (though a fund complex could still run both);
  • Require brokers to disclose special financial incentives they received to sell a fund;
  • Require funds to have a chief compliance officer who reports directly to independent directors;
  • Require independent directors to approve fund manager compensation and make that information public;
  • Expenses would have to be reported in dollar amounts for a hypothetical $1,000 investment;
  • Funds would have to show portfolio- turnover rates;
  • Funds would be required to detail revenue sharing and directed brokerage deals with brokers who sell mutual funds.

>It also would require clearer rules from the Securities and Exchange Commission on fair valuation of mutual-fund assets, a measure aimed at eliminating stale pricing that generates profits for market timers.

Fee Focus

>The bill, whose initial focus was largely on mutual fund fees, was approved on a voice vote by the House Financial Services Committee in July (see  House Bill Would Beef Up Fund Disclosure Regs ) - but that was prior to the current eruption of mutual fund trading scandals.   The bill has now been expanded to deal with those concerns.

>But the act is not likely to become law soon, since the Senate is already weighing several bills pertaining to mutual funds.   With Congress soon expected to break for the year, the Senate is not expected to take up fund legislation until 2004.

>The aim of the measure, said Representative Baker, was to "help bring the bright light of truth into fund fees, clean up the way funds are managed, and eliminate the conflicts of interest and utter disregard of (fund directors') duty to mutual fund investors that plague this industry."

The Securities and Exchange Commission is set to propose a package of reforms related to late trading and market timing December 4.

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