SEC Allows Fund Boards to Set Timing Curbs

The Securities and Exchange Commission Thursday approved a new rule to combat market timing that would leave the decision to impose redemption fees on mutual funds up to the board of directors and allow funds to hold intermediaries more accountable for abusive trading.

In a unanimous decision, all five SEC commissioners voted to approve a more flexible version of a proposal floated last year that sought to stamp out rapid short-term trading. The original proposal called for funds to impose a mandatory 2% redemption fee on shares sold within five days of purchase. According to the Commission, 85% of the 400 comment letters it received opposed mandatory redemption fees.

Under the revised rule, funds may impose a redemption fee of up to 2% on shares redeemed within seven days of purchase but are not required to do so. The rule excludes money market funds and exchange-traded funds from the equation as well as funds that encourage active trading and disclose to investors in the prospectus its financial impact on the fund. At present, roughly 10% of all mutual funds carry redemption fees.

As stipulated by the rule, fund boards will be asked to determine on a fund-by-fund basis whether there is a market-timing issue by looking at flow data and relevant trading information. If market timing exists, the fund can delay or restrict trading activity, redeem shares in kind or send in their internal market-timing police squad to investigate. However, these efforts can be costly so it is up to the board and the chief compliance officer to decide whether or not a fund warrants a redemption fee based on the level of activity.

Another tenet laid it out in the anti-market timing provision is a requirement that funds negotiate written contracts with their intermediaries obligating them to hand over shareholder trading information. The data provided by brokers and retirement plan administrators will help funds identify customers who trade through omnibus accounts and oversee intermediaries' assessment of redemption fees when shareholders violate market-timing policies.

The SEC estimated the cost of setting up systems for intermediaries to do their due diligence at $630 million over three years, after which only an ongoing maintenance fee would apply. The original rule proposal would have cost funds and intermediaries $1 billion, but the revision shifted lowered costs due to the shift to fee system based on fund demand.