E*Trade Funds of Palo Alto, Calif. has asked the SEC to permit the fund group to automatically redeem shareholders who, after investing in an E*Trade fund, seek paper rather than electronic copies of fund documents.

The proposal, which industry lawyers and accountants described as the first of its kind, is now pending with the SEC's division of investment management as a request for a no-action letter - essentially an opinion from the SEC staff that the proposed plan will not prompt an SEC lawsuit. E*Trade made the no-action request as part of an effort to keep fund expenses low, said Brian Murray, president of E*Trade Funds, in an interview last week.

Although they are difficult to quantify precisely, the costs associated with printing and mailing are considerable, Murray said. For example, significant changes to a fund's prospectus can force a fund company to print and mail new prospectuses for all shareholders, Murray said.

"It can add up," Murray said of the printing and mailing expenses.

SEC guidelines now require that investors have access to paper filings such as account statements, annual reports and prospectuses. The E*Trade Funds, which were offered for sale to the public beginning in February, now include six funds with assets under management of approximately $60 million.

E*Trade has established a consent form for shareholders who invest in E*Trade funds. Shareholders who sign the form agree to receive all communications by means of electronic delivery. The funds' prospectus says that E*Trade requires the shareholders themselves to redeem if shareholders revoke their consent to receive documents by electronic mail. Now, E*Trade wants to have the right to make redemptions itself if a shareholder seeks paper documents.

No investor has sought paper copies of documents since E*Trade began offering the funds, Murray said. Because E*Trade investors are Internet-oriented, it seems unlikely shareholders will make such requests, Murray said.

Nevertheless, E*Trade is considering creating a new class of shares for investors who seek the paper version of documents, Murray said. E*Trade has not decided whether to pursue that option, he said.

E*Trade has an alternative planned if the SEC does not agree to issue a no-action letter, Murray said. He declined to identify the plan.

The no-action request has generated discussion at the SEC, said John S. Capone, acting chief accountant for the division of investment management. The SEC's decision on the matter is likely to come in the next few months, he said.

"I think it's a compelling case," Capone said of the no-action request.

Capone made his remarks at The National Investment Company Service Association's annual Mutual Fund Compliance Conference in Boston last month. Capone declined to identify the mutual fund involved during his remarks and declined to comment further during a subsequent interview. Murray confirmed that E*Trade had made the request.

Redemptions of a fund can cause adverse tax implications for investors. Shareholders must pay taxes on the capital gains from their investments. Investors holding funds in taxable accounts sometimes try to time fund sales so that they can match sales that result in capital gains with sales of investments that have lost money. The capital losses then can be used to offset gains, reducing shareholders' taxes on their profitable investments. The E*Trade automatic redemption provision seemingly could make it harder for investors to manage the tax effect caused by a forced sale. Automatic redemptions also could come at a time when markets were down.

SEC lawyers examining the no-action request are concerned about an interruption in service to the electronic network that provides investors access to their fund documents and other potential technological glitches, Capone said. The lawyers are also concerned about shareholders' rights to receive paper under SEC guidelines, he said.

One industry consultant expressed skepticism about the potential popularity of a fund with an automatic redemption provision. The Internet-only emphasis on its own is unlikely to attract a significant amount of investments, said Jon Zeschin of Denver, Colo., a consultant on mutual fund distribution and former fund executive. The automatic redemption requirement seems extreme, Zeschin said.

"It's not going to get anywhere in the marketplace because people are not going to put up with that," Zeschin said.

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