SEC Rethinking Hard Close Proposal

March 10, 2004 ( - The US Securities and Exchange Commission (SEC) is considering alternatives to the agency's proposed 4 p.m. "hard close" rule aimed at ending illegal late trading in mutual funds.

>The director of the SEC’s investment management division, Paul Roye, told a Senate hearing that the agency had received over 800 comments on its proposed hard 4 p.m. rule aimed at ending illegal late trading in mutual funds, the majority of which asked the SEC to reconsider.  While we believe the proposed rule amendment would virtually eliminate the potential for late trading through intermediaries that sell fund shares, it is clear from the comments that some believe that the ‘hard four’ rule is not the preferred approach,” Roye told the Senate Banking Committee, according to a Reuters report.

Roye added that the SEC is “studying other approaches” to address the illegal trading of mutual funds.   Details of possible alternatives were not provided during the Senate hearing.

>Originally, t he 4 p.m. deadline was designed to close any window of opportunity for late trading abuses in the $7 trillion mutual fund industry (See  SEC Lays Down Mutual Fund Proposals ).   The proposal put out for comment by the SEC in December would require that a fund or a certified clearing agency – rather than an intermediary such as a broker-dealer or other unregulated party – receive a purchase or redemption order prior to the 4 p.m. close for an investor to receive that day’s price.

>As the law currently stands, the late trading of mutual funds is illegal, as trades ordered after the close are supposed to be executed at the next day’s prices.   However, the agency in a November report found this is not always the case, projecting as many as a quarter of all mutual fund brokers allowed late trading in and out of mutual fund shares (See SEC: One Quarter of All Mutual Funds Allowed Late Trading ).

Retirement Industry Response

A number of retirement plan industry groups have chimed in about the possible hard close option.   In its comment to the SEC, the Society of Professional Administrators and Recordkeepers (SPARK) Institute also said the SEC proposal could subject funds to “front running” – a situation where an investor takes a position in order to capitalize on advance knowledge of a large upcoming transaction expected to affect the fund’s share price.   In this case, the SPARK Institute warned, fund insiders and investing wrongdoers could take advantage of the knowledge (or assumption) regarding the queue of plan trades waiting to be processed and use that knowledge in deciding on their own investment moves. That could lead to losses to participants, the group said (See  ‘Hard Close’ Proposal Could Mean Millions for System Changes ).

Putting pen to paper, the National Defined Contribution Council (NDCC), which represents retirement plan service providers, argued that plan participants will lose more than $152 million in current defined contribution assets because of lost investment opportunity of assets in transit. Not only that, but the group asserted that the estimated impact could be just under $1 billion in lost retirement savings over the next 3 1/2 decades. That’s because the retirement inflows (contributions and loan repayments) will take an additional day to be invested in the plans’ investment options so they will lose the opportunity of earning interest during the period the assets are in transit, NDCC said (See  Industry Groups Unanimous in “Hard Close” Opposition ).